Entrepreneur Insight

5 Key Things to Consider Before Expanding Your Business to a New Location

Branching out? Be sure to consider labor costs, tax implications and logistics.

Before opening another location in a new city, business owners need to research and determine various factors that could impact future sales and profit margins such as labor costs, tax implications and logistics.

As the Federal Reserve continues to lower interest rates, expansion costs remain low, especially for owners seeking a small business loan or to refinance an existing new loan. But expansion comes with many risks.

Conducting due diligence will ensure a smoother transition and increase the odds that opening a second location will be profitable. Expanding in different regions allows many companies to remain competitive and offer additional goods and services.

1. Research new markets

Conduct a deep dive into your current operations, especially if your business is dependent upon specific suppliers. Find out where your existing vendors operate and consider expanding into those markets, said Stephen Schober, CEO of FlannelJax’s—an axe-throwing entertainment center based in Minneapolis-St. Paul, Minnesota—and Metal Supermarkets, a Canadian company that sells metals such as steel, copper and bronze.

Businesses also need to understand their current customer demographics and identify other markets that have similar demographics. When you are marketing to a different region, examine any differences in regional demographics and the target customers.

“If you can find a common denominator across target customers, then you need to focus on what works,” Schober said. “Otherwise, a good advertising or marketing agency can assist with this.”

Before business owners go into a new market, make sure that you can replicate your prior success and not reinvent the wheel, said John Blake, a CPA and partner at accounting and advisory firm Klatzkin & Company LLP.

“Figure out what cash flow will be needed to penetrate the market, know the market, train employees to follow the established company culture and build your brand,” Blake added.

2. Update financial analysis

A company’s existing financial model needs to be updated to ensure that the current cash flow can meet the demands of a new location, and pay for more inventory and employees until the most recent storefront is profitable. If you need a new business loan, make sure you can meet the debt payments.

Identify the differences between your existing market and your target market, and adjust your sales projections accordingly. “For example, if you are running an ice cream business in Minneapolis and looking to expand into Phoenix, adjust your seasonal sales appropriately,” Schober said. “January ice cream sales in Phoenix will be much higher than Minneapolis at a similarly sized location.”

Look at other key drivers of your financial model, such as recruiting and hiring employees, paying for a new lease and delivery costs.

3. Tax implications

Expanding a business into another location is a significant undertaking, and considering the tax implications beforehand is critical.

Retailers face more of a challenge, since the laws vary from state to state and across international borders, said Aleksandra Bal, a senior product manager of indirect tax compliance at Vertex Inc., a software company based in King of Prussia, Pennsylvania.

“Making a sale or using a third-party delivery service in a new location can affect transaction tax responsibilities,” she said. “It is critical for growing businesses to determine if they have a requirement to collect sales tax in each new market, which can be challenging, given that there are more than 11,000 tax jurisdictions in the U.S. alone.”

Businesses also need to pay attention to tax rates that change frequently. There were 335 standard sales tax rate changes in the first half of 2019, which is a 5 percent increase from the same period in 2018, said Bal. Over the past decade, there have been 6,230 new and changed standard sales and use tax rates.

Taxes also vary depending on the type of products—clothing is taxable by most states, but some jurisdictions exempt it up to a certain amount or all together. A few states also impose a luxury tax on clothing above $1,000.

A company’s existing financial model needs to be updated to ensure that the current cash flow can meet the demands of a new location, and pay for more inventory and employees until the most recent storefront is profitable.

(Photo credit): Gettyimages.com/Hero Images

“Retailers need to ensure they track all of the rules and exemptions, which can be hard to do manually when operating in several locations,” she said. “From a transaction tax perspective, expansion into multiple markets can quickly overwhelm a business and lead to costly non-compliance. Retailers need an automated solution to simplify tax calculations and ensure accurate taxes are applied to sales in each location.”

Businesses that ship items to other states face another tax challenge. There is some federal protection for certain types of companies against having to file income tax in multiple states, if all they do is ship items to other states, said Blake.

“The tax implications of expanding into another state are complex, and an advisor should be consulted before your expansion to help avoid any surprises,” he said. “For financial analysis purposes, always try to keep as much of the new location separate as possible in your reports, so you can monitor how the new location is performing.”

4. Labor costs

Cost should not be the only factor to be considered when adding a new location. While adding another brick-and-mortar location in your current city or another state is costly, don’t forget to factor in the expenses on hiring and training more employees, too. The cost of doing business and the cost of living need to be balanced by the ability to hire great people, said Chris Murdock, co-founder and chief sourcing officer at IQTalent Partners, a Nashville-based recruiting company.

Before you decide on a city or location, evaluate the location’s labor market. One advantage to local businesses is if there is a robust pipeline from which to find people who are qualified to work in your business, such as the presence of universities and colleges.

“If you expand, but you can’t find the necessary talent to support the expansion in that location, you’ve set yourself up for failure,” said Murdock, whose company has two locations.

Employees can be trained remotely, but determine your technology bandwidth, he adds. Evaluate if you can support remote workers in another city, or even another state, and if your company is equipped to provide them with the technological support and tools they need to succeed.

“Plan the systems you will need to install to support these remote employees, both from an engagement and functionality point of view,” Murdock said. “Expansion and growth are exciting for entrepreneurs, but increased demand for your product doesn’t always mean you are ready for expansion. A careful evaluation of expansion cost and labor supply will create the foundation for long-term success.”

5. Expanding logistics

Adding more locations means that companies will have economies of scale, allowing them to better utilize their purchasing power and have a shorter supply chain, said Schober.

When companies are able to increase their purchasing power, the additional volume in raw materials or products usually means being able to negotiate a lower purchase price, “as long as you can continue to consolidate your purchasing with your existing suppliers,” Schober said.

Another advantage is having a shorter supply chain through better communication and transportation systems, “resulting in more consistent inventory and more frequent inventory replenishments,” he said. This can also ensure more loyalty from your customers because of a lack of disruption in the delivery of their goods.

Where to get help

If you don’t have a mentor or a board of directors to advise you before you begin an expansion plan, consider getting some free financial advice and real-life expertise from the more than 13,000 counselors, advisors and mentors who volunteer their time with SCORE, a nonprofit organization that offers business education to entrepreneurs.

You can find a mentor online, meet with your mentor in person or attend a business workshop. In addition, there are free online workshops and webinars to help owners conduct more research.

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