Just came across this:
If all stories were written like science fiction stories
It’s not just limited to Sci-Fi. When we talk to people, do we check to see their level of technical comfort before we start explaining either “this thing we call ‘electronic mail'” or “just check Sourceforge for an open-source alternative”?
Know your audience!
I hope you’ve enjoyed reading MBA-A-Day, and more importantly, I hope you’ve learned something.
I would leave you with 3 final thoughts:
Finally, the knowledge presented in the previous essays is the result of weeks of preparation on the behalf of the various professors who taught me throughout my evenings at BU. While the interpretation is my own, the source material is theirs, and I remain indebted to them all. They are:
Thanks for reading!
Remember that cash is king.
Know the difference between cash and revenue. Revenue means that you expect to get paid a certain amount of money at some point for services rendered and goods provided. Revenue is not useful for paying your lease, buying office supplies, or compensating your employees. Only cash can do those things.
Remember that you usually estimate a certain percentage in your Accounts Receivable for money that you’re never going to get paid. That’s why revenue is not equal to cash.
Until the cash comes in the door, forget about revenue.
Assumptions are ok. You aren’t going to know whether or not you’re going to close as many deals as you hope, or be able to charge as much as you’d like. The numbers you show are based on assumptions that certain things will go a certain way. Write the assumptions down. Make note of them. You need some kind of starting point, even if you turn out to be completely wrong.
The best source of information about whether or not your idea is going to work–who will buy it, how often, and how much they’ll spend–is your customer. Tell them about your idea. Ask them if they’d buy it. Talk to your competitors. Ask them how they’re doing. People love to talk about themselves.
Nobody is going to steal your idea.
There is no secret cabal of executives sitting in a boiler room with a million bucks in capital, just praying to overhear your ridiculous, risky, untested idea so they can pull it out from under you.
Ideas are a dime a dozen. A thousand people have had the same idea. You have to be the one guy who takes the idea that everybody else has thought of, runs with it, executes it better than anybody else, does better sales and marketing, puts a unique spin on it.
A plumbing service is not a unique idea. Computer solitaire is not a unique idea. A car with four wheels and an internal combustion engine is not a unique idea. Yet there are dozens, hundreds, thousands of companies who compete in each of these spaces, thousands more who support them. You can be one of them, if you think you can do it better.
You have a limited number of hours in a day, and you cannot pursue every idea you have. You need a way to figure out if a sudden flash of genius in the shower is going to turn into a million-dollar business. Learn to do back-of-the-envelope feasibility.
Let’s do one based on our hot dog stand. If a year lease costs you $6000 a year, and cooking equipment costs $2000, and your supplies are $1000 a month, will you be able to generate at least $20K in revenue to break even? How many hours will you have to stay open? How much will you charge, and how many customers will you have to have? What about hiring employees?
The bottom line is this: if you can’t even fathom how you could sell $20K in hot dogs every year, you know that this isn’t a business that’s even feasible. And supposing that you manage to sell $40K in hot dogs a year, is the pain and risk and difficulty of running the business worth a salary that is, at most, $20K?
You have to kill your ideas, and kill them quickly. You need to evaluate an idea, decide that it doesn’t meet your objectives, and move on. You can’t hem and haw about how if you could just get some venture funding, or the market was more receptive, or you could somehow convince people to pay $20 for a hot dog, that you could make the business work.
Kill it. Move on. Find a winner of an idea. And when you find one that looks good both in your head and on paper, you’re ready to commit.
You have to have an exit. One of the best exit strategies is to get bought by a larger company–or even a competitor.
You can even start your business by getting funding from your eventual purchaser. You propose to a corporation that you will develop a product or concept for them–using money they give you to develop it–and if it works out, you can sell the company to them for an even higher multiple. This actually works because of the lower risk profile of large companies: they will gladly give you $500K to develop a really great idea, then buy you out for $5 million down the line, rather than take on the task themselves. They may not have the time or resources to spend trying out a bunch of risky ideas, but giving you $500K to give it a shot may be short money from their perspective, as you’re the one assuming all the risk.
If you do pitch to investors, this is a great thing to mention. It shows that you have considered how the investors are going to get their money back out, which is really all that’s important to them.
By the way: if you take equity financing, you have to sell the business. You have to. If the value of the business is all wrapped up in the business itself, then how does the investor get paid? You might own the portion of your house that you’ve paid off–that’s equity, by the way–but you can’t turn it into cash unless you sell it. Same thing.
You are very unlikely to get venture financing.
Of the approximately 500,000 companies formed in the US annually, only about 1 in 5 is not a sole proprietorship–your barber, your general contractor, your freelance writer. There are about 3500 venture capital deals per year, including additional rounds of financing (additional money paid into a business to help it continue to grow). Figure that only about a third of those are first-round financing.
That means you have about a 1% chance to get first-round venture funding for your business. You are unlikely to be in that 1% for several reasons.
First, you probably aren’t fundable enough. You really, really, really have to have your ducks in a row to get VC money. VCs like to see people with experience in startups; ideally, you will have founded and run a previous startup that achieved great success using VC funding.
Yes, that means that in order to get VC funding, it helps to have gotten it in the past.
Second, your idea probably isn’t right for a VC. That doesn’t mean it’s a bad idea. It just means that it isn’t capable of generating the 10 to 20X return on investment that VCs require.
A quick explanation: a given venture fund may have 10 investments outstanding at a given time. Of those, 5-6 are likely to be a complete bust in which the VCs lose all the money they put into the business. 2-3 might break even, or allow them to get close to doubling their investment. Ideally, 1-2 are what they call home runs, which generate ten times the initial investment and then some. Those home runs cover the losses from the rest of the portfolio, and generate the profit that is the reason why VCs exist.
Suppose that you want to run a hot dog stand. You may have worked at another hot dog stand for years. You may have a perfect marketing plan, a really unique hot dog, and tons of testimonials from people who have tried and loved your hot dogs. All you need to grow is a quick investment of $100K to buy a stand and do some advertising.
It’s a great business. It’s likely to be profitable for you and sustainable in the long term. No VC is going to touch it.
Why? Well, how is a single hot dog stand going to have a chance of someday generating $100 million in revenue? How is it even worth their time and effort to evaluate your business plan if it doesn’t have a chance of being an absolute home run?
Bootstrap it. Start selling your hot dogs out of your car, or out of your house. Cater birthday parties for kids; they love hot dogs. Save up some money and buy a used stand, the cheapest you can find, don’t take a salary, and reinvest the profits until you get bigger.
You can do the business. Just accept that it’s not going to be the next Amazon.com, and it’s going to take a different sort of entrepreneurial financing.
Matching your type of funding to your objective–to your exit–is the key to success.
There are three main types of funding: grants, debt, and equity.
A grant is money that is just given to you–usually by some sort of governmental or socially-responsible agency–to perform a task that is judged to be desirable to society even if it’s difficult or impossible to monetize. If you fill a particular niche that is deemed important by the powers that be, you might find some initial funding through grants.
Debt is money that you borrow, usually from a bank. You have to pay it back. The bank does not care how successful your business is or how many customers you have lined up or how you’re going to be worth millions someday. On the 1st of the month, your payment is due with interest. If you miss it, the bank can shut you down. At the very least, they may increase your interest rate and charge you a penalty.
It is hard to get debt financing without having collateral to invest, since banks like to keep risk minimal. In other words, if you want to borrow $50K, it helps if you already have $50K saved so you can pay it back if need be.
Small business owners will often use the one thing of value that they own as collateral: their house. This is a spectacularly bad idea, for several reasons, unless you have a lion-tamer level of risk tolerance and incredible certainty in your success.
First, most businesses fail. Second, you should try to keep your personal finances and business finances separate, both for liability reasons, and for ease of exiting the business should you choose to do so. Third, all entrepreneurs will tell you that it is best to start a business with other peoples’ money: investors know that not all of their investments will succeed, and are able to spread out that risk. The risk of losing your house is very, very real, and will hurt you much more than losing some cash will hurt them.
The last kind is equity financing. This is the part everybody thinks about when they think of entrepreneurs. They dream of owning a percentage of the Next Big Thing, then cashing in their stock to retire early, or they have nightmares of the business going under and them having nothing to show for it but worthless stock certificates.
They’re not far off. Equity financing means that you give up a portion of your business in order to get funding. This is not a decision to make lightly: you are giving up some control over running the business, and you may find it difficult or impossible to extract your investor from the relationship later on.
It’s not always a good idea to pay employees in stock–are you absolutely certain you want the bargain-basement web designer you hired in your first week of business to be a part of your company for the next 5+ years? Furthermore, there are plenty of contractors who were either burned in the dot-com bust–or who have a realistic idea of how unlikely it is that ownership in your company is ever going to amount to anything–and will therefore not work for anything other than cold, hard cash.
So if you don’t qualify for a grant, you don’t have collateral to take out debt, and you don’t want to give up ownership of the company, how do you fund it?
Again, wrong question: what funds do you have access to? Can you borrow from the traditional trio of Friends, Family and Fools? Do you have savings from your current “real” job? Can you bootstrap?
Bootstrapping, or starting a non-capital-intensive company with minimal funding, is a popular way to start a business; something like 90% of technology companies are bootstrapped. Do you need to buy a color printer right away, or can you use Kinko’s? Can you work out of a home office? Can you do most of the work yourself? Can you sell enough goods or services to give you enough cash to make some small profit which you can then reinvest to grow the business?
That last strategy is called “customer financing.” Yes, you might be able to grow faster if you had a sudden injection of cash. And if you had wings, you could fly. At any rate, there’s no more traditional way to run your business than by growing organically and reinvesting your profits.
This was my final class, and it was amazingly practical and educational. There were so many lessons I decided to divide it into several entries. Enjoy!
People are messy. Nowhere in business is this more true than in entrepreneurship. Most people starting their own businesses have absolutely no idea what they are doing–particularly when it comes to managing their money–which is why so many of them fail.
That said, some business owners manage to stay in business long enough to learn from their mistakes. Some get lucky. Some do it all perfectly, but the market doesn’t materialize or something else goes wrong. One of the best things you can do, though, is start from a position of knowledge.
An entrepreneurial business is just a business, and entrepreneurial finance is just finance; the lessons from every previous MBA-A-Day still apply. The difference is that entrepreneurs deal with the types of questions that have already been answered by an established company.
There aren’t right or wrong answers, but there are better and worse ones.
Why do you want to start a business? Why you? Why now?
It’s ok if the answer is not “to get rich.” You might have a desire to start something that is socially beneficial. You might feel that you have a really unique product or service idea that others would like. Maybe you just want to be your own boss.
People think about entrepreneurial finance backwards. They say, “Where can I get money to do a business?” They should say, “What business can I do with the money I will be able to get?”
If you are looking for money to start your business, ask yourself: would YOU give you money?
Are you fundable?
Do you have a good idea, and the expertise to manage it, and the industry contacts to make it happen? Is the market ready for it, and will you be able to sell it, and will you be able to make enough money from it to cover your costs? Will you make enough money from it to be able to satisfy your investors, who are risking their money with you?
Can you do your idea with the money you’ll be able to raise?
If you don’t know anything about running a factory, you are going to have an impossible task of getting somebody to invest the millions of dollars that building and running a factory will require.
In this case, you are not fundable. Don’t do the business. Do something else.
If you know a lot about fixing cars, and you have worked for various garages for years, and you own many of your own tools, and you have saved some of your own money for a lease on a building, you might be able to convince someone to invest in you for the rest of the equipment. In that case, you are much more fundable.
What is your outcome? What is your exit?
Do you plan to run the venture as a family operation? Do you want to sell it to a larger company? Do you want to do an IPO?
You need to know this. How you plan to get out is one of the most important parts of starting a business. You aren’t going to be around forever. Who takes care of the customers? Who takes care of the employees? How do the investors get a return on their investment?
How do you get a return on your investment? Keep in mind that many entrepreneurs don’t take a salary in the early years of a business.
Finally, if things don’t go as swimmingly as you plan, you need to figure out a way to recoup some of your losses and move on to the next startup. It might take a few tries to get it right.
Finally, something that has no ambiguity: the law is the law. Right?
Right?
The fact is, if you end up in court, you’ve already lost. It’s going to be expensive and time-consuming to win your case, even if you’re 100% in the right.
The law is the law, but it is ambiguous, and requires interpretation. The application of law depends heavily on case law, which is just legal tradition: the outcome of your case may be determined by how a similar, previous case was decided.
The vast majority of cases are settled out of court.
There’s criminal law and then there’s civil law. If an employee steals from the till, a criminal case might send them to jail, but you’ve got to sue them in civil court to see a red cent.
There’s causing deliberate harm, and then there’s negligence. You can be found negligent only if you have a specific duty to keep a specific person from harm, that you didn’t do your job, that your lack of action caused an actual injury, and that a reasonable person could foresee that your lack of action would cause that injury. A mechanic not attaching a wheel properly which causes your car to crash is negligent. The wheel falling off, rolling into an open manhole, shutting off a water main and causing the fire company to not be able to put out a fire is not negligence.
In the US, employees are considered “at-will”: you can fire them for any reason, or no reason at all–as long as it isn’t a “protected” reason, such as gender or race.
That said, even if you don’t have a formal, signed contract with somebody that states that you’ll give them severance if you fire them, or that they have to have a formal hearing before they’re fired, it is possible that an implied contract might exist if they have a realistic expectation of certain things. Companies have gotten in trouble because their employee handbooks accidentally imply just such contractual obligations. Nowadays, you’re likely to sign an explicit “at-will” document when you get hired.
A contract can be oral. It’s harder to enforce than a written one, though.
Minors cannot legally consent to a contract. If you sell a car to a minor, the minor can completely destroy the car, come back to you and declare that the contract is void, and you are out of a car with no option for restitution. That’s why minors often need a cosigner.
Non-compete agreements are often not enforceable, and they always have to be realistic: if there are only two automotive dealerships in a 500-mile radius, and you quit working for one of them, they can’t keep you from working for the other. Non-competes can’t eliminate your ability to make a living.
If you start a corporation, you have certain legal protections: if somebody sues the company, they can’t take your house, for example. But you have to be very careful to run your corporation like a corporation. If you use corporate funds to pay your home mortgage, to go on personal vacations, and to buy things not related to the business, and you get sued, a judge may well “pierce the corporate veil” and decide that you are liable after all.
Patenting an idea is difficult and expensive, and it doesn’t guarantee that you get to make the product. It only guarantees that somebody else can’t. Also, a patent needs to be done for every country where you want your product to be protected.
A popular story about negotiation goes as follows: two sisters both wanted the same crate of oranges. But as they talked about it, they realized that one of them just wanted the peels for use in a recipe, while the other wanted the fruit to make juice. In the end, they each got what they wanted.
That’s a good negotiation.
Most people hate negotiating because they think it’s a competition: you have to get the biggest slice of the pie for yourself at the expense of others. That’s called “distributive negotiation,” and it certainly exists…particularly when you’re making a purchase from someone you don’t intend to build a long-term relationship with.
But the type of negotiation performed by the sisters in the example above is probably so common that we don’t even think of it: it’s called “integrative negotiation.” In that case, winning at any cost is likely to hurt your relationship, hurt future negotiations, and might not be the best outcome…after all, what can you do with a crate full of orange peels once you’ve used the fruit?
Regardless, you have to be careful not to fall victim to “agreement bias,” which is agreeing to something that puts you in an even worse position than the one you started from, simply to get consensus. You also have to make sure you don’t end up asking for too little, or leaving value on the table–getting into a situation where neither party gets as much out of the deal as they could.
There are three main components of a negotiation: your BATNA, your reserve value, and your target value. The target value is the number you’d like to get. The reserve value is the number at which you’d rather just walk away…it’s the absolute lowest or highest you will go.
Incidentally, the range between your reserve and target value needs to overlap at least somewhat with your partner’s range. That forms a zone of negotiation. But if you aren’t willing to accept a penny less than a million dollars and your partner isn’t willing to pay more than a thousand, you’ve got nothing to discuss. Reconsider, or walk away.
Your BATNA is, by far, the most important component: it’s your Best Alternative To a Negotiated Agreement. It’s what you can do instead of negotiating. For example, if you are starting a job in a new city on the 15th and it’s the 1st, you don’t have a lot of wiggle room; you need a place to live. Your BATNA is to live in a hotel or not take the job, neither of which puts you in a position of strength. On the other hand, if you’re buying a motorcycle for the weekends, your alternative is only that you’ll miss out on some fun rides. Your BATNA is pretty strong; you can always walk away and look for a better deal elsewhere.
The most important part of negotiation is preparation–and really thinking things through. Is the negotiation distributive or integrative? Are you going to have an ongoing relationship with the person such that it might be sensible to give up some value in the short-term for a better long-term outcome? What factors influence your perception of what is a fair price or outcome? Is it really fair? What about the other person’s price? What is the perspective of the other person? What’s your BATNA? What’s theirs? How well are you communicating? If you’re getting hung up on relinquishing 5%, is it 5% of $20, or 5% of $20 million?
Research shows that the person who makes the opening offer does what’s called “anchoring.” This means that all subsequent offers tend to go up or down from that point. If you don’t set an anchor point that benefits you, you won’t get the maximum value from the negotiation.
Finally, it’s a myth that a good negotiation leaves everybody unhappy. Keeping everybody at least somewhat satisfied increases your chances of the negotiating actually finishing. Don’t forget: if you’ve got a strong BATNA, you can always walk away.
When you make dinner, you need a menu. When you start a business, you need a plan. A Business Plan.
A Business Plan is a formal document that you use to describe your business: what you intend to do, how you think you’ll make money doing it, who your customers are, how you’re going to get their money, how you’re going to convince them to buy your product, how much money you’re going to charge, how much more money you need to accomplish your goal, and how much money you’re going to return to your investors to compensate them for the enormous risk of funding your crazy business concept.
If you’re going to open a hamburger stand, it’s somewhat important to point out what your vision for the perfect hamburger will be. It is (from the potential investor’s standpoint) far more important that you convince them that their million-dollar investment will net them a multi-million-dollar profit.
You don’t necessarily need investors to start a business. But if you do need more money than you have on hand, you need investors, which means you absolutely need a Business Plan. The more money you need, the better your Plan needs to be.
It’s worth pointing out that VC, or Venture Capital, is nearly impossible to get–unless you’ve already gotten a VC investment for a prior company that ended successfully.
Given that your Business Plan is unlikely to net you a 10-million-dollar investment from a VC, it still makes sense to have one, and to update it frequently. It is a living document. It’s the blueprint for your company.
You don’t absolutely need a business plan. But it helps.
As it turns out, having more than 4 employees increases your chances of the business lasting more than a few years. That’s likely because of the increased responsibility of such a venture: it’s easy to call it quits and get a regular job if it’s just you. It’s much harder if several people are depending on you for a paycheck.
If you have no education or experience in the industry you are starting your business in, you are–surprisingly–just as likely as someone who has both education and experience to have a surviving business. It’s about 70% for inexperienced versus 77% for experienced.
However, that just means survival: the business is still running.
If you have no education or experience, you have about an 8% chance of being profitable, versus a 61% chance for someone with both education and experience.
If you don’t know what you’re doing, you probably don’t know enough to know when to quit. Strength of will can keep you going, but education and experience are essential if you want to make a living.
Dilution means that you reduce the percentage of your company you own in order to get outside investors. You might tell an investor that he can have 50% of your company–a company worth $100K–in exchange for a million dollars that you use to grow the business. Ideally, you get a smaller piece of a bigger pie: that million dollars might help you grow the company to be worth over $10 million. You get 50% of $10 million rather than 100% of $100K.
But, accepting that million dollars might have another cost: loss of some control of your company.
Do you want to be rich, or do you want to be king? You can’t have both.
Entrepreneurship is business. It’s the whole enchilada. It’s finance and HR and marketing and R&D and sales and making coffee and answering phones and probably some amateur carpentry.
It’s about making something out of nothing. It is, by far, the messiest, most uncertain aspect of business. It is also, potentially, the most rewarding.
But, an entrepreneur is not necessarily a crazy risk taker. Or, to be more precise, entrepreneurs have very specific risk profiles–levels of risk that they are willing to tolerate–which, admittedly, might be higher than risk levels for people who don’t start their own companies.
It takes a particular type of personality to start a company.
9 out of 10 startups are based on refinements to products or services that already exist, rather than crazy new gadgets or revolutionary inventions. Amazon didn’t invent the concept of selling goods for money. Neither did Google invent looking for things.
Once you have an idea, you’ve got to “pitch” it. This takes practice. You’ve got to have an “elevator pitch,” which is just what it sounds like: a description of your idea short enough to express during an elevator ride. The eventual intention of this pitch can be different depending on whom you’re pitching to, but it’s generally to get somebody to buy your product, or join your company, or give you funding. Ideally, the elevator pitch leads to a longer meeting at a later date.
The easiest way to come up with a new idea is to look for white space. This is the intersection of different industries or products or markets where a need exists that hasn’t been addressed well, or at all.
