Once upon a time in the body shop industry, all you needed to start a shop was a garage, a couple pieces of used equipment and a good work ethic.
These days, however, that formula no longer adds up to success. The advent of direct-repair programs (DRPs), the increased influence of insurance companies in determining where work is done and at what cost, and all the high-tech, high-cost equipment have changed – and complicated – everything.
To start a shop today, a potential owner will need significant financial resources, meaningful contacts in the insurance industry and a well-developed business plan. Issues such as shop location and curb appeal, industry consolidation and market demographics also must be considered during the process of opening a new shop.
“It’s a lot different situation today to start a new shop because everything has changed so much in the industry,” says Russ Verona, owner of East Rockford Automotive and Collision in Rockford, Ill. “It’s becoming more and more difficult for the Ma-and-Pa family-owned body shop to make it in today’s environment.”
Verona is right. It’s much tougher to start a new shop – or any small business for that matter – in 2003 than it was in years past. (And the same holds true for a shop owner looking to expand an existing location or open a new one.) Still, it is possible to open or expand a shop – but only if you do a lot of careful planning and access the right financial and industry resources.
Why Start a Body Shop?
Many small businesses are started without the entrepreneur really considering why he’s starting the venture.
This is a mistake.
Before you look for a location or check out the latest spraybooths at NACE, you really need to consider why you want to start your own body shop. Starting and owning your own business is a dramatic, life-changing event and requires a great deal of hard work. Yes, it can be very rewarding, but you need to test the waters before diving in.
Alice Magos – writer of the popular “Ask Alice” column for the online CCH Business Owner’s Toolkit at www.toolkit.cch.com – agrees. Magos says that every prospective small-business owner should ask himself “Why?” very early in the start-up process. Asks Magos: “If someone were to ask you why you’re going into business for yourself, what would you say?”
Magos says that the most effective method for answering this question is to set goals. She further suggests developing these goals around three key categories:
- Economic goals – For many entrepreneurs, this is a strong inducement. The opportunity to increase personal earnings and achieve financial potential is often a powerful motivation in starting a business.
- Personal goals – Unlike money, many of these factors can’t be quantified but are important nevertheless. For many people, the chance to build something of their own, according to their own vision, drives them to start a business. Personal goals might include freedom, career change, satisfaction, recognition, flexibility, responsibility and professional growth.
- Retirement goals – It’s vital for everyone, employee and entrepreneur alike, to recognize that a time will come when you want to kick back and enjoy the fruits of your labor. In this time of growing concern over the continued viability of the Social Security system, any goal setting you do should involve consideration of your needs after you’ve built and run your business.
Magos further points out that setting goals will not only help you to determine if starting your own shop is the right thing to do, but that these goals will also prove very useful once you get started.
“Goals are important because they will affect just about everything you do as you plan and operate your business,” she says. “Goals are not just the destination you’re driving toward. They’re also the painted white lines that keep you on the road.”
Study the Market
Once you’ve determined that you’re interested in starting or expanding a body shop for the right reasons, the next step is to study your potential market.
“A critical step in the process is sizing the market,” says Verona. “You should obtain information from insurance companies about their expectations for auto repairs in the area.”
After determining the total potential market in the area, you need to determine what segment of that market you can reasonably expect to attract to your shop. This will be dictated by competition, location of your shop and, most importantly, your insurance company contacts.
“If you want to be independent, you can try to appeal directly to consumers, or you can adapt your body shop to the insurance company business model,” says Verona. “Our industry is unique in that we have a separate industry – insurance companies – supplying service to our industry. And the insurance companies are motivated largely by trying to reduce costs. So, a body shop must have the right computer systems, e-commerce capability and shop capacity to work with insurance companies.”
Verona also advises the prospective body shop owner to be aware of the competition. In a more rural area, you’ll likely be competing against other small shops with service and price at an equal level in terms of attracting collision repair business. In an urban area, however, you’ll likely have at least one consolidator with which to compete. While many are critical of consolidators because of their big-business approach, the fact remains that they make it very difficult for a small shop to compete on price. So, while you may be able to beat a large, multi-location body shop on service and responsiveness, cost-conscious insurance companies (all of them) will likely favor the consolidator or other low-cost provider as the shop of choice for most referrals.
“There are eight markets that do over $1 billion a year in claims, and this is where many of the consolidators are focusing,” Verona says. “The insurers work with the consolidators because they want to deal with one body shop in an area. It’s similar to the Wal-Mart process, which is, ‘Here is our computer system, this is what we’ll pay, keep our shelves full.’ This is very difficult for a small shop to compete with.”
Write a Business Plan
As you’re undergoing an extensive market study, you also should be writing a business plan. Many prospective new business owners think that a business plan is necessary only if outside financing will be sought. But this is a flawed philosophy. Successful entrepreneurs will tell you that they not only maintain a business plan, but that they regularly revise the plan to adjust for changes in the market, personnel, competition, etc.
In short, a business plan enables a shop owner to construct a blueprint of the direction in which a company is heading, how it will get there and the projected result of what it will look like when it arrives.
A business plan doesn’t have to be “New York Times Bestseller” length to be effective. The important thing is to cover all of the key areas involved in starting your shop. These areas should include:
- Executive Summary
- General Background of the Business Idea.
- Owner’s Background and Skills.
- Products and Services.
- Funds Required to Operate the Business.
- Financial Information and Projections.
One last suggestion concerning the preparation of business plans. Many good resources are available on how to prepare a business plan. You should find a number of good books on the subject at your local book store or library. Organizations such as the Service Corps of Retired Executives (SCORE) and local Small Business Technology and Development Centers also offer low-cost or even free Business Plan advisory services. (Also, in an upcoming issue of BodyShop Business, we’ll devote an entire article to how to write a business plan for a start-up body shop.)
Run the Numbers
According to Magos, one of the most common reasons small businesses fail is the owner underestimated the start-up capital needed to fund the business.
“It always seems to cost more than they thought,” says Magos. “The lesson to be learned from the many small-business failures is that you need to be extremely careful when determining how much money you need to start your new business. Don’t fall into the ‘rosy forecast’ trap in which the new owner over-optimistically predicts robust sales in the first year and, as a result, doesn’t have enough money on hand when the cash flow dries up.”
To prevent this, you need to budget. Why? The key reason is financial control. Financial control enables you as an owner to better accomplish important, big-picture and day-to-day financial objectives. Budgeting helps you to become a better macro-manager by enabling you to:
- Manage pro-actively rather than reactively.
- Borrow money easier. Not only can you plan ahead better for financing needs, but sharing your budget with your banker will help in the loan-approval process.
- Make your prospective body shop operation more profitable and more efficient.
- Provide yourself with a great decision-making tool for key financial considerations.
Budgeting helps you to become a better micro-manager by enabling you to:
- Avoid investing too much money in unproductive equipment or seldom-needed inventory materials.
- Maintain working capital needs more efficiently.
- Set sales goals. You need to be growth oriented, not just an “order taker.”
- Improve gross profit margin by pricing your services more effectively or by reducing supplier prices, direct labor, etc. that affect Cost of Goods Sold.
- Operate more efficiently by keeping Selling General and Administrative (SG&A) expenses down more effectively.
- Perform tax planning.
- Plan ahead for employee benefits.
Two areas of budgeting are crucial in the process of starting or expanding a shop:
- The cost to build the new shop.
- The operating budget for the shop once it’s opened.
Verona says the cost to build a new shop varies depending on the size of the market, the sales potential and niche of the shop. A pre-cast building typically will run about $50 per square foot with land costs varying greatly (anywhere from $10,000 per acre in a rural setting to $250,000 an acre or higher in large metro markets), depending on the area of the country.
As for the equipment, Verona says the cost has increased dramatically over the past 10 years or so. A fully equipped collision repair shop now has frame platform and unibody equipment, computerized measuring, a paint department and a number of other equipment requirements to serve the repair needs of its customer base. If purchased new, the aggregate cost of the equipment and inventory necessary to stock a facility can easily run $500,000 or higher.
Below is an example of the cost to build and equip a new body shop:
Three acres of land:
Equipment & inventory:
Here’s an example using a 5,000-square-foot shop:
One acre of land:
Equipment & inventory:
While a prospective body shop owner should be able to prepare an accurate estimate of the cost to build a new facility by obtaining estimates from contractors and equipment and inventory vendors, the preparation of an operating budget is a less-exact science. Armed with your market-study information, you need to estimate categories such as sales, gross profit margin, number of employees and corresponding compensation, administrative expenses, utilities, taxes, debt service and a number of other cash inflows and outflows that will potentially impact your shop.
Because every shop is different, it isn’t feasible to go into a lot of detail on the actual preparation of the budget for your prospective or expanding business. However, I have three key recommendations. First, involve your CPA in the financial planning process. His role will depend on the internal resources available to you and your background in finance. You may want to hire your CPA to prepare the financial plan for you, or you may simply involve him in an advisory role. Regardless of the level of involvement, your CPA’s input will prove invaluable in providing an independent review of your short-term and long-term financial plan.
Second, use the resources provided by BodyShop Business and other industry sources. For instance, the BSB Web site at www.bodyshopbusiness.com provides excellent industry averages for statistics such as sales per shop ($551,000 in 2001), average ticket per sale ($1,638), gross profit margin (25 percent on parts, 46 percent on labor), and salaries for specific types of skilled employees such as metal technician, painter and mechanic. Comparative information also is given for DRP versus non-DRP shops. Of course, your budgeting will vary depending on the location and size of your shop, DRP status, labor force and many other factors, but good industry information will help you to more effectively project the potential operating performance of your new or expanding shop.
My third recommendation is to invest in an inexpensive automated accounting software package such as M.Y.O.B. Premier 1.0 (M.Y.O.B. Software), Peachtree for Windows 6.0 (Sage Software), QuickBooks Pro 6.0 (Intuit) or One Write Plus 7.0 (Sage Software). All can be purchased for well under $1,000, and any of these will be an invaluable tool in starting or expanding a shop.
Licensing and Legal Organization
Certain licenses and registration fees are necessary to start your shop, no matter your location. The cost should be minimal, but fines can be heavy if you fail to obtain proper licenses and registrations to operate a new business. Here are the licenses typically required:
- Business License – This is required for a sole proprietorship and can be obtained from the city or county clerk.
- Tax Identification Number – You must apply with the IRS for a tax identification number if you have any employees or if you organize as a corporation. If you organize as a one-person sole proprietorship, your Social Security number is your tax identification number. If you organize as a partnership, you must apply with the IRS for a partnership identification number.
- Labor Commission Registration – If you employ workers in a manufacturing operation, you must register with the Labor Commission through the Department of Labor.
- Use Permit – This may be required for home-based businesses in areas zoned for residential if you plan to operate your shop on the same property on which you live. Contact the city zoning board for a use permit.
Another critical step in starting a new shop is the process of legal organization and the acquisition of the licenses necessary to start a new venture. There are five different options for legal organization.
1. Sole Proprietorship – To start a business organized as a sole proprietorship, you need only pick a name for your business and start using it. According to Magos, the only form needed is a fictitious owner affidavit, which informs the local government and the public that the business is operating under an assumed name and indicates who the owner is. The cost to file this document varies, but generally runs only a few dollars.
In addition to it being the least expensive option, the advantages of organizing as a sole proprietorship are control, simplicity and taxation. The two disadvantages are that it limits ownership to one person and that the owner is personally liable for any obligations of the business. This allows creditors of the business to go after personal assets and vice versa in the event that the owner has problems repaying loans.
Even with the disadvantages, many small-business owners choose this form of organization. Says Magos: “If you’re not concerned with limiting liability because your business is virtually risk free, a sole proprietorship may be the perfect vehicle in which to operate your business.”
2. Partnership – A partnership is formed when two or more owners in a business set up a Partnership Agreement document. It should be in writing and drawn up by an attorney. The cost for this document can range from $250 to well over $1,000, depending on the complexity of the partnership.
The primary advantage of a partnership is the ease of setting one up. The disadvantages are that the partners may be liable for the debts of the partnership (same risk as with sole proprietorship), there can be double taxation and partnerships can be difficult to dissolve. For these reasons, very few small businesses choose to organize as partnerships.
3. C-Corporation – There are two types of corporations (C and S). The C-Corporation is identified by four characteristics: continuity of life, centralization of management, limited liability and free transferability of interests. Forming a corporation, however, is more complicated and more expensive than forming a sole proprietorship or a simple partnership.
To form a corporation, articles of incorporation with a unique business name must be filed with the secretary of state’s office in the state in which the corporation is being organized. If the articles are accepted, the secretary of state’s office will send a certificate of incorporation that often must be recorded in the local recorder’s office. Also, a corporation has shareholders and a board of directors.
The cost to set up a corporation will likely run $2,500 or more even for a small shop. There also are annual filing fees to be paid in most states that can range from $25 to $500 or more. The administrative costs of accounting and tax preparation can also be more expensive than for other forms of organization.
The advantages of a corporation are that earnings can be retained in the company, corporate shareholders aren’t personally responsible for debts of the corporation and the ease of formation (the process is dictated by state law). The disadvantages are the formalities required, the administration and the relatively high cost.
4. S-Corporation – An S-Corporation operates in the same manner as a C-Corporation in most situations in that it must have directors, officers and shareholders with the same formalities. The key difference is that S-Corporation earnings are taxed for federal purposes only at the shareholder level. And while C-Corporation dividends are taxed, S-Corporation dividends are not.
The advantages of an S-Corporation election are that the cash method of accounting can be used (accrual accounting must be used for a C-Corporation), lower tax rates on capital gains and sometimes lower tax rates on regular earnings (this depends on the level of earnings).
Most of the disadvantages of an S-Corporation are “big” company related: You’re limited to 75 shareholders, the pass through of losses is limited to pro-rata ownership, the company must operate on a calendar year and only one class of stock is allowed.
5. Limited Liability Company (LLC) – A relatively new form of business organization, the LLC has become very popular among many business owners because of its versatility.
“A limited liability company is a hybrid entity that combines the tax flow-through aspects of a partnership with the liability protection of a corporation or a limited partnership,” says Magos.
The formation of an LLC requires that articles of incorporation be filed with the secretary of state’s office. Costs are similar to those associated with setting up a corporation.
According to Magos, the advantages of an LLC are: limited liability, flexible memberships (members can be individuals, partnerships, trusts, corporations), no limit on the number of members and flow-through of income, loss deductions and tax credits to the members. The primary disadvantage, particularly compared to a proprietorship or partnership, is the cost.
So which type of legal organization is best for your shop? Because there usually are multiple employees in a body shop, very few are organized as sole proprietorships. For a small shop with one to five employees, an S-Corporation or LLC election will likely work best. For larger body shop’s, C-Corporation status may be the best fit.
Before you decide, consult an attorney and a CPA. According to Magos, the accountant can help decide on the form of organization from a tax planning standpoint, while the lawyer will not only help you choose the form of business you need, but will help you to prepare the necessary paperwork and make sure you’ve complied with all local laws. Additionally, the attorney can help you draft contracts and leases and can provide legal advice for many of your business decisions.
Starting a new body shop or expanding an existing one will prove to be one of the most exciting (and stressful) initiatives you’ll ever experience. But if you roll up your sleeves, plan ahead and follow the recommendations included here, you’ll substantially improve your chances of building a successful body shop.
BodyShop Business Contributing Editor J. Tol Broome Jr. is a financial expert who’s been in the lending business for more than 15 years.