Category Archives: Differentiation

Why Invest in Creative Entrepreneurs?

BogotaWhat are creative entrepreneurs, and why should investors spend time and money on them?

Let’s start by explaining what creative entrepreneurs are and how they differ from entrepreneurs in general.  Of course, all entrepreneurs create companies, so they are all creative, but I’m using the term in the sense of Creative Startups:

“Creative entrepreneurs drive global change, create economic value and promote cultural tradition and innovation. They . . . are found across the creative industries: fashion design, music, film, cuisine and local agriculture, architecture, tourism, museums and cultural centers . . . . Wherever culture is thriving, creative entrepreneurs are busy building ventures that generate economic opportunity and a diversity of creative and cultural expression.”

Generally speaking all entrepreneurs do some of the items in the first sentence but not all. Creative entrepreneurs are unique in that they are driven to create economic value with a greater emphasis on creative and cultural expression.

In an earlier blog posting, What Expectations of Time and Money Do Investors Have?, I explored the differences between time investors and financial investors. Let’s now explore why each of these types of investors should care about creative entrepreneurs.

Should Time Investors Invest in Creative Entrepreneurs?

As ecologist E. P. Odum pointed out in 1971, variety and diversity increases on the “edges” caused by changes in population characteristics or community structures. Thus when people with diverse backgrounds work together, the results are far more impressive than the sum of what they could produce individually.

This is just one of the many reasons why teams that include diversity such as creative (in the artistic sense) genius, financial talent, sales talent, and marketing talent (to name just a few) can be so productive.

Running a company is highly interdisciplinary. It requires skills in product leadership, marketing, finance, human leadership, accounting, sales, negotiation, and so on. That is why most successful startup companies are managed by teams, not just one individual.

Wasserman’s Founder’s Dilemmas is a great book about this and other issues relating to startup founders. A mentor can supplement a startup’s team during its formative stages with complementary skills, prior to its ability to fully staff.

I recently had the opportunity to look over the companies in Creative Startup’s 2015 accelerator program (http://www.creativestartups.org/participants), every one left me in awe of its founders. All have a product or service and a creative raison d’etre.

Creative entrepreneurs couldn’t thrive without time investors.  The answer to the question of whether investors should invest time in creative entrepreneurs is unequivocally “Yes”!

Should Financial Investors Invest in Creative Entrepreneurs?

To start to answer this question, it’s valuable to understand how companies in creative industries stack up against other companies in terms of revenue growth rates, M&A activities, and multiples.

Revenue Growth

Revenue growth rates vary tremendously from company to company and have little relationship to industry.  This suggests that revenue growth rates should not be a major factor in influencing financial investors to focus on or steer clear of creative entrepreneurs.

M&A Activity

M&A activity is very much tied to industry. According to Price Waterhouse and Cooper, the four industries with the most active M&A activity in the first half of 2015 were technology, pharmaceuticals, entertainment & media, and oil and gas.

Of the four, entertainment & media clearly includes many companies whose humble beginnings were envisioned by creative entrepreneurs.

In a 2015 survey by KPMG, respondents were asked which industries would be the most active in M&A. Here are the results:

  • 84% – Healthcare/Pharmaceuticals/Life Sciences
  • 62% – Technology/Media/Telecom
  • 36% – Energy/Oil & Gas
  • 34% – Consumer Markets
  • 30% – Financial Services
  • 24% – Industrial Manufacturing

Of these, both media and consumer markets clearly include companies whose beginnings could have been envisioned by creative entrepreneurs. However, creative entrepreneurs and their companies can play a role in all industries; just look at the artistic creativity behind any of Apple’s products as one example. And technology companies are just as likely to acquire a design company to enhance their products as another technology company.

Multiples

According to Hoover’s, the average valuation for all small companies in 242 industries the US in 2014 was:

  • 1.2 times revenues, or
  • 5.1 times EBITDA

I extracted 11 industries from this list that seem dominated by creativity (once again, I need to acknowledge that creativity can exist in any industry). The industries I selected were catering, apparel manufacturing, bakeries, candy manufacturing, cookie manufacturing, jewelry manufacturing, art dealers & galleries, jewelry retail, music stores, architecture services, and graphic design services. Using just these 11 industries, the average valuations for small companies in 2014 was:

  • 1.08 times revenues, or
  • 8.75 times EBITDA

This leads one to believe that valuations should not be a major factor in influencing financial investors to focus on or steer clear of creative entrepreneurs. .

The Team

The final, but incredibly important, factor that influences investors to become involved with a company is its team. Investors like teams with experience and or knowledge. There are four ways to gain credibility as an investible entrepreneur (this list excerpted/edited from “’A-Team and B-Product’ Better Than ‘B-Team and A-Product’”):

  • Team with others who have “been there before.” Perhaps the most difficult thing for a first time entrepreneur to understand is that you are much better off with 10% of a $100M company than 100% of a $100K company.
  • Compete for a spot in an accelerator. Competition for entry is fierce, but you will learn a lot and some investors will consider your experience to be as good as having “been there.” Creative Startups in Albuquerque and Santa Fe is one of the few that welcomes creative entrepreneurs. Three others are briefly described in Where is All the Love for Creatives?
  • Plan to grow slowly with little or no investment money. Learn the tricks of Ries’ The Lean Startup, especially the creation of a series of minimally viable products.
  • Put your idea on hold and join an experienced team pursuing their dream.

The answer to the question of whether investors should invest money in creative entrepreneurs is another resounding “Yes”!  Financial investors should be attracted to creative entrepreneurs as much as to any other entrepreneurs.

Summary

Ultimately investors have goals that they need to meet and all entrepreneurs, creative ones included, must demonstrate that they are the best horse to back.  Those that can clearly articulate why investors should invest their time and their money are demonstrating that they understand every element of their startup and their environment and have the knowledge needed to succeed.

About the Author

Dr. Al Davis is a mentor for Creative Startups in Albuquerque and Santa Fe, NM and was formerly a mentor for startups in the Colorado Springs Technology Incubator. He has published 100+ articles in journals, conferences and trade press. He is a passionate world traveler and has visited 8o countries.

He is the author of 8 books, including, Will Your New Start Up Make Money? He was a founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003. He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting and optimizing their business strategies. Click on the following to see a short video on Offtoa:

 

4 Things You Must Do When Starting a Company

BXP135658The lean startup movement (of which I am a big proponent) has thankfully eliminated the “build it and they will come” attitude among aspiring entrepreneurs.

In its place, most new entrepreneurs build minimally viable products (MVP), test them with real customers, receive feedback, adapt and refine, and continually repeat until they find a product that customers like (at a minimum) or ideally, crave.

This new process reduces risk, minimizes cash burn, allows companies to fail early, and allows investors to put their larger investments into only those companies that look like potentially big winners.

However, it also puts a very heavy emphasis on the product – an emphasis that can result in distracting startups away from other essential activities that when initiated at the start of a business can help to identify and reduce other risks just as enormous.

The Biggest Risks

Those risks will vary from company to company and industry to industry, but some risks are common to all startups:

  1. Will customers crave your product?
  2. What will customers pay for your product?
  3. Are their sufficient numbers of customers?
  4. How will you make customers aware of your product?
  5. What will it cost to produce your product?
  6. What will it cost to run your company?
  7. How much cash do you need?

So how does a startup manage these risks from their inception and consistently?

Reducing Those Risks

The popular iterative process described in the second paragraph of this article addresses risk #1 very well. If pricing experiments are included, it can also address risk #2.

Addressing risk #3 requires some level of market and industry research. I’m not suggesting a major effort here, but I am suggesting that you spend at least some time understanding market segmentation, the competition and which segments each competitor aims for. Make sure you include substitute (indirect) competitors.

Failure to address risk #4 early is perhaps the most common mistake of newbie tech entrepreneurs. Often, they’ll think “once we figure out what the product is, then we’ll figure out how to sell it.” This is just a few steps away from “make it and they will come.”

Another common attitude among newbie tech entrepreneurs is “oh, the internet will take care of sales.” The fact is making sales takes work for 99% of companies. Internet sales are not easy! And margins when selling through Amazon are close to nil.

Iterate on your sales model just like you iterate on product features. Start with an initial proposal (based on serious thought!). Then iterate as you learn more. Some of your basic options include inside sales force, outside direct sales force, sales channels/distributors (e.g., Amazon), and internet sales from your own website along with a major SEO effort. Each choice has major impact on your costs and thus your viability as a company.

The easiest way to address risks #5-#7 is to create a quick financial model.

  1. First, make a list of all your business assumptions; this is a good idea to keep you organized in your experiments anyway; after all, it is these very assumptions that serve as the hypotheses that you are testing in your lean startup experiments.
  2. Use a tool to automatically transform the assumptions into pro forma financial statements. These financial statements will then tell you (a) when you will be profitable, (b) when you will break even, (c) how much cash you will need, and (d) what your company’s valuation will be based on industry averages, and (e) what kind of return your investors are likely to receive.

The actual process of entering data for business assumptions should take you no more than 30 minutes. But the real value of using a tool that requires you to write down your business assumptions is the thinking that it inspires you to do. For example, for manufactured products, it asks you questions about what you assume the cost of raw materials will be; for software products, it asks you questions about how many customer support people you plan to hire, and so on.

Remember, these are just assumptions, so you can launch your company with your eyes wide open. You don’t want to start a company that you know will be unprofitable from the start.

I am not advocating for a full business plan. On the other hand, I do not believe that just having the right product is a sufficient first step. Instead you need (from the start!) to be engaged in at least four simultaneous risk-reduction activities:

  1. Building an MVP and then iterating it until customers crave it
  2. Studying the market, segmentation, and competition
  3. Assuming a sales model and iterating as more is learned
  4. Building a financial model based on assumptions and iterating as more is learned

Here are some examples of why just getting the right product is not good enough:

Why the “Right Product” is Not Sufficient: Example 1

Let’s start with a hypothetical case. You have created a product that provides a special nutritional source for pregnant women in Niger, to help reduce the country’s 14% rate of maternal death during childbirth.

You can run a series of experiments to determine if the product is palatable and refine it if necessary. You can also run a series of experiments to determine its efficacy on reducing deaths.

However, the biggest hurdles are not the product’s features. The biggest hurdles are logistics, costs, prices, and everything else that makes up the business.

Why the “Right Product” is Not Sufficient: Example 2

Turning to a simpler example, suppose you are building an app. You can tweak it based on myriad experiments until you have the product that customers love. But if customers expect to download the app for free, you have no business.

 

Why the “Right Product” is Not Sufficient: Example 3

Let’s look at another example, this time from a real company: This company planned to manufacture industrial lubricants with very unique properties and capture a large percentage of the market by (a) marketing unique differentiators that were the result of unique raw materials that were “green,” and (b) price the products well below competition.

That sounded like a great value proposition for all stakeholders. However, a careful early financial analysis revealed that the green raw materials drove the cost of goods sold up to around 85% of the planned price. This left just a 15% gross margin, far too low to support infrastructure costs. A financial analysis at the beginning revealed that this company was a non-starter.

Why the “Right Product” is Not Sufficient: Example 4

Let’s look at one final example, another real company: Adapta Medical. Founded by Dr. Glen House, and based on his numerous patents, Adapta iterated on and perfected an intermittent urinary catheter that an individual with limited dexterity (e.g., a C6-C7 quadriplegic) could use to self-catheterize.

From the beginning, Dr. House experimented with product designs, customer satisfaction experiments, multiple manufacturing sources, and financial models, simultaneously. The tasks that took the longest time and consumed the most energy were working out the manufacturing and cost models. Fortunately for him, he started on these from the beginning, so after about a year product iteration (to arrive at the first commercially viable product), he only had another two or so years to work out the manufacturing and cost model glitches.

Now that he is in production, he continues to perfect the product, iterate on the financials, hone the costs, and adapt the manufacturing processes. Learn more about Adapta at www.adaptamedical.com.

Summary

These days, everybody thinks they can launch a new company. The popular process of “iterate the product until customers like it” provides necessary but not sufficient assistance to the naïve first-time entrepreneur. At a minimum, an entrepreneur must start with these four activities to mitigate the risks of starting a business:

  1. Building an MVP and then iterating it until customers crave it
  2. Studying the market, segmentation, and competition
  3. Assuming a sales model and iterating as more is learned
  4. Building a financial model based on assumptions and iterating as more is learned

Start doing all of them at the beginning; don’t do them sequentially.

About the Author

Alan DavisDr. Al Davis has published 100+ articles in journals, conferences and trade press, and lectured 2,000+ times in 28 countries. He is the author of 6 books. He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting their business strategies to optimize financial return for themselves and their investors. Formerly, he was founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003.

If you’d like to learn if your great business idea will make money, take a look at Will Your New Start Up Make Money? If you’d like a tool that transforms business assumptions directly into pro forma financial statements, check out www.offtoa.com.

 

 

Starting Line Photo Credit: “Female Track Athletes at Starting Line” by Tableatny (Creative Commons)

Risk Photo Credit: “Los Angeles Graffiti Art” by A Syn (Creative Commons)

Niger Flag Photo Credit: “Niger Flag” by Philippe Verdy (Wikimedia Commons)

Not for Sale Photo Credit: “Onis Not for Sale Sign” by Noblestrawberry (Creative Commons)

Seven Signs your Startup will Succeed

Banded Snake Eagle, Ubuntu, TanzaniaMatthew Toren wrote a terrific article 7 Myths About Starting a Business That I Used to Believe. In it he debunks 7 myths about startups that could otherwise easily deter those with a great idea that don’t know any better. With these myths debunked, let’s talk about the seven signs that indicate your startup will be among the 50% that survive 5 years.

1. You Know Your Competition

Key to a product being successful in the market is that customers see it as a better solution to their pain than alternatives offered by the competition.

Better can be mean lower priced, or more convenient, faster, cleaner, greener, more exclusive, more reliable, and so on. These qualities are called differentiators.

I use the word competition here in the broadest possible sense, including companies that are directly competing with you (e.g., Avis if you are Hertz), companies that are indirectly competing with your company (e.g., bus companies if you are a rental car company), and the status quo (e.g., people who are not traveling because of the lack of transportation options).

2. You Know Your Financials

Lean is the only way to start most companies today, but prudent does not mean blind. Responsible lean companies document all their business assumption so they can run experiments to validate those assumptions and incrementally lower risk. Those same documented assumptions are also sufficient to create pro forma financial statements.

Those financial statements enable you to determine whether the company could succeed if the assumptions prove to be true.

3. You Have Room for Error

Pilots always have enough fuel to return to an airport, and always use a runway longer than is required for their aircraft type. Having room to navigate the unexpected is also crucial for startups because inevitably one, some or even all of these things will happen:

  • Fewer visitors will come to your website
  • Customer acquisition cost will be higher than planned
  • Revenues will be lower than expected
  • Customers won’t pay on time
  • Materials, raw goods, and services will cost more than budgeted

4. Your Sales Are Planned Bottom Up

If you guess at your projected revenues, you are not setting up your startup for success. Instead, determine how you are going to sell. For example:

  • Are you going to drive traffic to your website and then convert x% of the visitors to paying customers?
  • Are you going to make x outgoing sales calls per day, and convert y% of them to paying customers?

See the article, 5 Steps to Get & Keep Your Startup on Track, to learn how to calibrate your revenue projections.

5. Your Experiments Are Planned

After you state your assumptions, run experiments to validate (or refute) them. Either way, you are making progress. Knowledge is always better than guesswork.

For example, run advertisements and perform SEO and see how many actual visitors you can drive to your website. Run A/B tests on various pricing models to see what price attracts customers.

6. You Have an External Board

If you put your co-founders and/or your officers on your board of directors, you will receive zero benefit from them; after all, you’ll hear the same things from them in the board room that you hear every other day.

Instead, fill your board seats with experienced individuals who (a) can offer you different opinions, (b) can bring skills that your current team does not have, (c) are not afraid to question the decisions you are making, and (d) can serve as a totally independent sounding board for you.

This is what a board of directors can do for you. And then compensate them with stock options.

7. You Are Sharing Ownership

Jerry Kaplan said it best: “Equity is like sh*t. If you pile it up, it just smells bad. But if you spread it around, lots of wonderful things grow.” Incent those who contribute to the success of your startup with stock options (or reverse vesting stock), and the company is more likely to grow and prosper. There is little downside, and lots of upside. See You are Not Your Company for more details on this subject.

Summary

Starting a company has inherent risks. But some risks are easy to reduce by planning, validating, refining, pivoting and then doing it all again!

I recently visited JoJo, a young woman in Kigali, Rwanda who started a Jibu water franchise. During my hour-long visit with her, I asked her a dozen or so questions. I was impressed by the fact that although she had little formal business education, she had tons of business common sense, understood what her biggest risks were, knew how to reduce those risks, and understood which levers influenced the success of her franchise.

I have no doubt that she will be one of the long-term survivors. JoJo knows how to make a startup succeed! In her case, she knows her competition, knows her financials, has room for error, knows exactly how she is going to sell water, and is constantly running marketing experiments. Although she does not have an external board of directors, she has surrounded herself with individuals with lots of experience.

If you want to learn how to generate pro forma financial statements automatically from your lean business assumptions, check out www.offtoa.com.

About the Author:

Dr. Al Davis has published 100+ articles in journals, conferences and trade press, and lectured 2,000+ times in 28 countries. He is the author of 6 books, including the latest, Will Your New Start Up Make Money? He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting their business strategies to optimize financial return for themselves and their investors. Formerly, he was founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003.

If you’d like to learn if your great business idea will make money, take a look atWill Your New Start Up Make Money? If you’d like to verify that your great business idea makes financial sense, sign up for www.offtoa.com.

Four Ways to Validate Your Great Startup Idea

You have a great idea for a start-up company.

Thumb

Validate your idea by answering four simple questions:

  • Is the market right?
  • Is the industry right?
  • Will it make money?
  • Will it need money?

Let’s explore these one at a time.

1. Is the market right?

Determining if the market is right means demonstrating that enough people exist who will purchase the product or solution you have developed, you can find them, and you can turn them into customers. For this you need to understand the size of your market and the characteristics of the buyers that personify your market.

Size of market

How large is your target market? You want your potential market (called the total available market, or TAM) to be quite large. But you want your initial target vertical market to be relatively small. By being focused, you can align your product features and marketing messaging with the unique pains/needs of this unique market.

And then you can claim you “penetrated 25% of your target market” instead of having to claim that you “penetrated .02% of your target market.” Sure sounds better to future investors!

You can measure the size of both your TAM and your initial target vertical market in terms of:

  • Number of customers
  • Dollars spent on products like yours
  • Units sold

Targeting Customers

NeedleHow easily can you find potential customers? Will they find you? Or will you find them? In either case, how? It is very easy to say “oh, we’ll just use Google AdWords and we’ll get tens of thousands of visitors every day.”

It is much harder to actually attract qualified leads. If you plan on finding the leads, how will you reach them and engage with them until they become customers?

Converting Customers

Catheter Solution 2Converting customers is not only influenced by the severity of pain your product is addressing. It is also influenced by how you position your solution and your messaging. Your target market must be able to identify with what pain your product resolves. The three bullets shown above demonstrate how one company, Adapta Medical, has honed their message to align perfectly with their target markets, C6-C7 quadriplegics and hospitals.

I like to use the words “clear and compelling” to describe the right message, i.e., when a lead hears or reads the message, they can relate immediately to the pain they are feeling and see clearly how your product will alleviate that pain.

2. Is the industry right?

If you want to do a thorough analysis of whether the industry is “right,” check out Porter’s Five Forces. But as a start, make sure you have a thorough understanding of your competitors, your potential partners, and your differentiators.

Competition

Few things turn off investors more than hearing entrepreneurs claim that they have no competitors. Every new company has competitors. If you really are the first to do something, then how are your target customers surviving currently? Here are some examples:

  • You’re “first” to provide on-line retail sales of gourmet food. Your indirect competitors include storefront retailers and catalog retailers of gourmet food. And your future competitors include on-line retailers of non-gourmet food (because they have all the logistics in place to add SKUs for gourmet food and thus become direct competitors).
  • You’re first to provide regular helicopter service from Denver to Colorado’s ski resorts. Your competitors include airlines, van shuttle services, rental car companies, and so on, all of which satisfy your target market with this capability using different means.

The way to determine if a company is a competitor is to imagine being a potential customer. If the customer could make a list of companies (including yours) and evaluate the pros and cons of each alternative (including price, convenience, safety, etc.), then those companies are competitors.

Partners

Look upstream and downstream on your supply chain. Who will you need to work with? Have you established those relationships yet? How easily will it be to establish? Can they control you (e.g., with price changes)? Or can you control them?

Differentiators

Think again about that list of competitors that a potential customer could create. What makes you special? Nobody cares about what you think makes you special! What will a potential customer think make you special when compared with the alternatives?

3. Will it make money?

In his February 20 article, Martin Zwilling explained how critical it is for you to use a financial model to determine if your company will be financially successful given the assumptions you currently believe to be true. I couldn’t agree with him more.

After creating such financial models for many dozens of startups, I would add that it takes many precious hours to create and debug such a model.

I would recommend that you use an online tool that has already considered and built in all the elements you must consider to be successful. Such tools allow you to enter your key assumptions one time, and they create your entire financial model. Then when any of your assumptions change, you just have to change one number, and your new financials are instantly created for you.


 

Offtoa Screen1


Martin provides 5 great examples of such “assumption changes” that are typical:

  • What if customers don’t want to pay the price for your product that you though they would?
  • What if the market size ends up being different than you expected?
  • What if your sales growth is different than expected?
  • What if your investors offer you an investment amount different than your expected?
  • What if your customer acquisition cost changes?

In reality, there are hundreds of such assumptions that could change.

4. Will it need money?

Another benefit of assumptions-based financial modeling is the automatic creation of monthly pro forma cash flow statements. You can easily scan the bottom row of these statements to determine exactly how much investment money you will need and when.

In summary

To prepare yourself for investors, you should thoroughly validate your business before you enter the shark tank. This article summarizes the key elements of such a validation. To summarize, here is the checklist:

☐ Is your total available market large enough?

☐ Is your initial target vertical market focused enough?

☐ Is it easy to find leads?

☐ Is it easy to convert leads into customers?

☐ Do you know your competition?

☐ Have you lined up your business partners (suppliers and distributors)?

☐ Are your differentiators unique and compelling?

☐ Will your startup make money?

☐ When your assumptions change, can you instantly see the financial effects?

☐ How much money do you need?

ABOUT THE AUTHOR:

Alan DavisDr. Al Davis has published 100+ articles in journals, conferences and trade press, and lectured 2,000+ times in 28 countries. He is the author of 6 books, including the latest, Will Your New Start Up Make Money? He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting their business strategies to optimize financial return for themselves and their investors. Formerly, he was founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003.

ABOUT OFFTOA

Offtoa is a subscription-based SaaS that leads you, the entrepreneur, through a series of questions and transforms the assumptions you provide into a complete set of pro forma financial statements, including even a capitalization table and expected internal rates of return for the investors. Armed with this intelligence, you and your team are able to demonstrate to investors that you know your finances, understand your market, and have a winning proposition.

If you decide to subscribe to Offtoa because you read this blog, send me an email at adavis@offtoa.com and I’ll email you a coupon good for 50% off your first month’s subscription. This offer good only until May 31, 2015.

Needle in a Haystack photo by James Lumb (Creative Commons).

 

To Plan or not to Plan: That is the Question!

SignsI have been an executive in startups since the mid-1980’s, and still am. I have always proactively planned every business in detail, but the last “business plan” document per se I wrote was in 2001. How is this possible?

I want to address some basic questions:

  • What is the difference between planning a business and writing a business plan?
  • What should you include in your planning?
  • In what format should you document your plan?
  • How much detail? What is the right time horizon for business planning?
  • Why do you need to plan your business?

What is the difference between planning a business and writing a business plan?

A business plan is a polished, organized, physical document that describes every aspect of your proposed business and its environment. It usually cover 5-7 years from inception, ramp-up, through to exit. Although occasionally requested by investors, these days it is usually requested only by academics in “business plan competitions.”

Business planning, on the other hand, is the activity of lowering your risk by studying and understanding every aspect of your proposed business and its environment.

What should you include in your planning?

At a minimum, you need to thoroughly understand:

  • The macro market, that is, demographics of the general market you are aiming for. If you are creating a fast food restaurant for diabetics, how many diabetics are there? And are their numbers growing or shrinking?If you are creating a company to provide assistance to early-age retirees, how many individuals are retiring early? And are their numbers growing or shrinking?When tracking dimensions of a macro market, you could measure it in terms of number of customers, number of dollars spent for products like yours per year, or number of products like yours sold per year.

    Great demographics for your macro market are helpful to the success of your start-up. However they are neither necessary (after all, Starbucks succeeded quite well in its North America expansion efforts in the early 1990’s even without a dramatic increase in the number of coffee drinkers) nor sufficient (even terrific growth of a market cannot compensate for sheer management incompetence).

  • The micro market. As an entrepreneur, you need to focus on a specific target market that you can penetrate successfully. By aiming for a specific (usually narrow) target market, you can create a marketing campaign aimed directly at that market and its unique pains.Members of that market then quickly see how your solution addresses their pains and become easy converts and thus customers. On the other hand, if you aim for a more general market, your marketing campaign will have to address more general pains by necessity, and will then be successful at converting a lower percentage of leads. You want all odds in your favor when you start a company.Meanwhile, start with just one target market; if you start with two, you’ll double your marketing costs (or you’ll halve the effectiveness of your marketing by watering down the message).

    The research you need to do concerning possible micro (aka target) markets includes characteristics such as size, growth rate, accessibility (i.e., how easily can you find potential customers?), ease of conversion (i.e., do potential customers “feel the pain” vs. do you have to first convince them that they have a pain? how easily can you convince them that your solution to their pain is by far the best solution available?), and so on.

    As a general rule, having an unfavorable micro market is considered by most experts to be a showstopper. If your target market is not already focused on trying to solve the problem that your product solves, you are fighting an uphill battle.

  • Your competition. Almost every prospective entrepreneur I have come across understands the need to identify “the competition,” but many limit themselves to direct competition, i.e., those companies providing products similar to the start-up’s, which address the market’s needs in a similar fashion.Don’t ignore substitute competition, which customers can choose to address their need in an entirely different fashion. For example, in the electronic note taking industry, over 200 small companies compete with 2-3 very large companies for customers. They are all direct competitors.But this industry suffers from substitute competition from at least two sources: (a) pen and paper, and (b) standard word processors on tablets. Business planning for a start-up in the electronic note taking industry must acknowledge the reality that a very large percentage of the total available market will not be purchasing any company’s electronic note taking software product.
  • Threat of entry. Ideally, (a) you want it to be easy for your start-up to enter the industry, and then (b) once you enter, you want it to be incredibly difficult for others to enter and subsequently compete against you.Concerning point b, when planning your business strategy, what can you do now to make it more difficult for others to copy you? For example, do you have intellectual property that you can protect with patents, copyrights, trademarks, and trade secrets?Can you enter the market quickly enough so that your large market penetration deters others?

    Can you establish contractual relationships with either suppliers or distributors that make it impossible for them to work with competitors?

    Can you provide such good service that no customer would want to change to a competitor?

  • Your Differentiators. What makes you special? Why is your product better than the competition? Saying that you will have a “better user interface” will not cut it; everybody says that. What specific value does your product provide that the market will appreciate and that the competition does not already provide?Here are some examples:
    • We are the only e-tailer that provides restaurant chef-quality gourmet ingredients to the home chef.
    • We are the only manufacturer of a catheter that C4-C5 quadriplegics can use for self-catheterization.
    • We enable online purchasers to donate to their favorite non-profit at no cost to them.
    • We deliver products to your door using drones within 4-hours of ordering.
    • We provide Wal-Mart prices without the long check-out lines.
  • Your Marketing and Sales Strategy. If you haven’t already done so, read Eric Ries’ The Lean Startup. In it, you will discover only three ways to create revenue:
    • You can pay for new customers. So, how do you plan to make the market aware of your products? How will you convert leads into customers? What will you do explicitly to retain customers?
    • Current customers can refer new customers? So, what will you do to encourage referrals?
    • Current customers can buy more. So, what will you do to encourage customers to increase their purchasing?
  • Pro Forma Financials. Income statement, cash flow statement, and balance sheet. Maintain all your assumptions that drive these financials in a list.
  • Cap Table. Only needed if you are interested in investors.

In what format should you document your plan?

This is a matter of taste. I strongly recommend against printing all your plans, polishing them, adding an introduction, table of contents, etc., and binding the document. The problem with this approach is that every one of the planning components is constantly evolving. If you polish and print it, it will be out of date by the following week. This is why I say I am against business plans, although I am for business planning.

Personally, I maintain a series of electronic company folders; each has a corresponding physical notebook containing selected key excerpts. Each folder contains all information I have collected on one aspect of the business. They combine “plan” and “actual” and are:

  • Market and Industry. This folder contains all my macro and micro market analyses and competitive analyses (old as well as latest in chronological order). It also contains copies of any related articles or reports others have written.
  • Marketing and Sales. This contains copies of marketing and sales plans (strategic and tactical). [Once the company starts, I add ad copy, brochures, web page designs, and so on.]
  • Equity. Initially, this contains just the projected cap table. [Once the company launches, it will also have copies of private placement memoranda, investor subscription agreements, accredited investor questionnaire forms, the stock option plan, all stock options granted, updated versions of the cap table, and so on.]
  • Board. Initially, this contains articles of incorporation and the bylaws. [Once the company launches, it will also include updated bylaws, board meeting minutes, and actions by written consent.]
  • Organization. Initially, this contains the organization chart and hiring plan. [Once the company launches, it will also contain employment contracts and updated organization charts and hiring plans.]
  • Financials. This contains pro formas by month and year for 5 years. At the front, I maintain a list of all assumptions, including all expenses (by year and by category), customer acquisition cost, sales cycle, average order size, periodicity (how often each customer will purchase), retention rate, viral coefficient, viral cycle length, and many of the items from the above folders. [Once the company launches, I add actuals.]

I also maintain a 10-minute slide presentation that captures the essence of some of the above.

How much detail? What is the right time horizon for business planning?

You should be as lean as possible without being irresponsible. Here are my thoughts on the specific parts of planning:

  • Analysis of Market. I believe that you must understand your market as thoroughly as possible or you are being foolhardy. The lean community might argue that truly revolutionary products create their own markets and it is impossible to understand the market until you test its behavior with your minimally viable product (MVP) in hand. The right answer lies somewhere between these two extremes.For example, let’s say your idea is to create fast food restaurants for diabetics. I would argue that it is important to fully understand both the demographics and the dietetic needs of diabetics before endeavoring down this path.On the other hand, you will not be able to determine exact recipes or menu items until test marketing (i.e., creating MVPs), and you won’t understand the risks associated with attracting diabetics to your restaurants when their family members are not diabetics without experimenting.
  • Analysis of Competition. Absolutely essential.
  • Threat of Entry. It is never too early to start planning for how you will protect yourself. If you delay, it may be too late.
  • Differentiators. Here, time horizon is important. You have to perform a delicate balancing act between what you believe are long-term differentiators for the majority of the market and what you believe are short-term differentiators for early adopters.The only sensible approach is to build a series of successively larger MVPs, learning as you go, adapting to what the market is telling you. All the time, however, you must acknowledge that you may not know if you are accommodating the needs of just early adopters or if they are indeed representative of the market majority.For planning purposes, do two things:

    (1) define what you believe are long-term differentiators. After all, without these, it is unclear why you should even be in business.

    (2) define a series of experiments to validate which features, delivery mechanisms, prices, promotions, marketing mechanisms, sales techniques, suppliers, and so on (collectively called differentiators), are most effective with the market.

  • Marketing and Sales Strategy. As stated above, you will have three components of your marketing and sales strategy: paid, referrals, and organic. As part of your plan, you should calibrate all three of these components with your goals. See Five Steps to Get and Keep Your Startup on Track. Once the company starts, you will revise these goals with actuals.
  • Financials. You are lean and are taking one step at a time. However, you still have a responsibility to verify that you are stepping in a direction that could yield great financial results. Create your pro forma income statement, cash flow statement, and balance sheet annually for at least 5 years, and monthly for at least the first two years.

Why do you need to plan your business?

The reality is that investors place their bets on startups less than 3% of the time[1]. The other 97% of their money goes to businesses that have already been through rounds of funding and have demonstrated that a market is willing to buy their product.

But when they bet on a startup, they demand a detailed plan for the business.

They won’t necessarily ask for a business plan per se, but they will perform due diligence. And when they do due diligence, they will be asking every possible question about your market, industry, product, marketing and sales, financials, governance, equity structure, intellectual property, and so on, so you need to have all this information somewhere.

If you are not planning on having investor money, why would you do anything less? After all, you are an investor in your own company, with time and money.

ABOUT THE AUTHOR:

Dr. Al Davis has published 100+ articles in journals, conferences and trade press, and lectured 2,000+ times in 28 countries. He is the author of 6 books, including the latest, Will You New Start Up Make Money? He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting their business strategies to optimize financial return for themselves and their investors. Formerly, he was founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003.

If you’d like to learn if your great business idea will make money, take a look at Will Your New Start Up Make Money?

[1] http://www.forbes.com/sites/dileeprao/2013/07/22/why-99-95-of-entrepreneurs-should-stop-wasting-time-seeking-venture-capital/

“A-Team & B-Product” Trumps “B-Team & A-Product”

Many aspiring entrepreneurs are in love with their business ideas and expect investors to fall in love with their ideas as well. When they receive a “no” from potential investors, they think the investors “just don’t get it.”

What don’t they get? The entrepreneurs think the investors don’t get how great the business idea is.

Unfortunately, most investors will pass on the opportunity to invest in what appears on the surface to be a terrific business idea led by a less-than-stellar team. On the other hand, seasoned investors will often invest in a “fairly good” idea led by a fantastic team.

Why should this be? The reason is that most startup businesses fail regardless of how terrific they seem at first glance. That is where a great team is essential.

A-Team Will Prosper

MrTThe A-Team will prosper for two reasons.  The first reason is that they’ll see the signs of failure much earlier than the inexperienced team. The second reason is that they’ll pivot the company (perhaps even repositioning it with entirely different products or aiming it for entirely different markets) quickly toward new fertile ground.

B-Team Will Stagnate

Meanwhile, a B-Team is more likely to stay with the original business idea even when all signs indicate that it won’t work.

Is This Fair?

Is it fair to inexperienced teams that investors reject them? Well, it all depends on your perspective. From the perspective of an inexperienced team, it may seem unfair. From the perspective of the investor, it makes sense.

Does this mean you have to succeed before you can succeed? If investors prefer to invest in experienced teams, what do you do if you are either (a) a solo entrepreneur, or (b) a member of a totally inexperienced team?

If you lack experience:

  • Team with others who have “been there before.” Perhaps the most difficult thing for a newbie to understand is that you are much better off with 10% of a $100M company than 100% of a $100K company. Just do the math!
  • Compete for a spot in an accelerator like TechStars. Competition for entry is fierce, but you will learn a lot and some investors will consider your experience to be as good as having “been there.”
  • Bootstrap. Plan to grow slowly with little or no investment money. Learn the tricks of The Lean Startup by Eric Ries, especially the creation of a series of minimally viable products.
  • Put your idea on hold and join an experienced team pursuing their dream.

Although I talk about how I am in my fifth startup, “my” first startup wasn’t in any way “mine.” I joined a very experienced entrepreneur, in his venture. I gained relevant experience via association with him and his company.

And, in fact, “my” second startup wasn’t “mine” either. I joined other more experienced serial entrepreneurs as an investor and founding member of the board of directors.

From these two experiences, I gained the stripes (and scars and street cred and . . .) to then start leading teams in new ventures.

Don’t expect investors to write checks for you because you have a great business idea and no experience to demonstrate that you have the ability to make it succeed.  There are many ways for you to gain the experience you need to become investor-worthy.

Al Davis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and the author of six books.

Mr. T photo courtesy of Paul Townsend (Creative Commons).

4 Simple Questions Every Entrepreneur Must Answer

QuestionsEvery entrepreneur must answer four simple questions. The answers to these questions will help you stay focused on what is important. And if you are trying to raise money, these are precisely the questions investors want answered.

The questions are:

  1. What problem are you solving?
  2. How will you solve it?
  3. Who is going to solve it?
  4. What deal are you offering investors?

Let’s look at these questions one at a time.

What Problem Are You Solving?

Most successful businesses are successful because they address a clear and compelling pain that a group of potential customers feel. For example, you might be providing a solution to any number of problems, for example:

  • “a woman stands a 1-in-7 chance of dying in childbirth,”[1] in the West African country of Niger
  • 170,000 C6-C7 quadriplegics in the US are unable to self-catheterize using current intermittent catheters
  • 750,000 start-ups/year have headaches finding ideal office space
  • Many renters & commercial lessees want the benefits of solar power but cannot build solar panels on their roofs

Notice that in all these cases, we are talking about the problem, not the solution. It is important to always understand the problem and start the discussion or presentation with the problem, not the solution.

How Will You Solve It?

Once you have convinced listeners that a problem exists, you have their attention. Now it is time to tell them about your unique solution. Customers must see your product (or service) as a better solution to their pain than alternatives offered by the competition.

The word competition is used here in the broadest possible sense.  It includes companies that directly compete with your company (e.g., Avis if you are Hertz), companies that indirectly compete with your company (e.g., bus companies if you are a rental car company), and the status quo (e.g., people who are not traveling because of the lack of transportation options).

Better can be mean lower priced, or more convenient, faster, cleaner, greener, more exclusive, more reliable, and so on. These latter qualities are called differentiators.

In short, how will you solve the problem better than others?

Who is going to solve it?

If you have come this far, your listeners are convinced that you are addressing an important problem and you have a figured out a great way to solve it. That’s great! The next thing the listener wants to know is whether you have the ability to pull it off.

So, the question is: Who are you? Why should anybody believe that you will succeed? Nobody will doubt that you believe you will succeed. But do you have credibility with others? Here are two points to ponder:

  • Most investors will invest only in teams, not individuals
  • Most investors will invest in teams who have succeeded before

What should you do if you are by yourself? Simple answer: Get a team. You can’t do it all yourself anyway.  What should you do if you have not “been there before?” Simple answer: Team with others who have. I talk about how I am “in my fifth startup.” But I wasn’t the founder of “my” first startup; I joined it after its first year. I used that experience as leverage to become a key player in “my” later startups. I hope you see the reason I put “my” in quotations; every one was started by a team of individuals, each member bringing a unique set of skills.

What deal are you offering investors?

Now that you have convinced the listener that there is a problem, that you know how to solve it and that you and your team can solve it, only one challenge remains: can you convince the investors that it is worth it for them to invest?

The standard form to describe the “deal” you are offering investors is called a cap table. A cap table describes precisely who owns shares of the company currently and how many.  It also describes who will own shares of the company after the investment that you are seeking and how many. It shows you are not hiding anything.

In Summary

In summary, answer these four questions (usually in this order). If you can’t answer them, you probably don’t have a viable company! If you can answer them convincingly, you should have an easier time raising investment money.

Good luck!

Alan DavisDavis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and the author of six books.

 


[1] Kristof, Nicholas, and Sheryl WuDunn, Half the Sky: Turning Oppression into Opportunity for Women Worldwide, New York: Vintage Books, 2009.

Many pricing strategies for the entrepreneur

In earlier posts, I have discussed how differentiation and lowering your costs may affect pricing strategy. I have just a few more com­ments to make about pricing strategies:

  • Penetration pricing strategies. In early stages of a start-up, you need to convince your­self and others that you are viable and scalable. If the only way you can sell product entails losing money on every sale (i.e., price does not cover cost of goods sold), your company is a non-starter. So, make sure you do not set prices below cost of goods sold in an attempt to penetrate the market. So called penetration pricing rarely works for start-ups.
  • Covering your fixed costs. Let’s say you can capture sales from com­pe­ti­tors by under­pricing them, and your price is higher than your COGS, so you do have positive gross profit. Make sure you under­stand the sales volume you must achieve in order to cover all your other (fixed) expenses, so the company can achieve break­even. If raising the price slightly is necessary to make you profitable, but reduces your sales volume and thus makes you unprofitable, you may need to adjust other assumptions (like your target market, your sales model, etc.), or you may not have a viable business.
  • The long tail. Made popular by Anderson [AND06], the long tail is a business strategy in which much of a company’s revenues relies on selling low-volume (perhaps customized, perhaps expensive, perhaps exclusive) pro­ducts to niche customers while simulta­neously selling high-volume (per­­haps low price, perhaps free, perhaps low margin) products. The claim is that if inventory costs are near zero (e.g., for storing music or software) and/or if customization costs are near zero (e.g., with the appropriate pro­prietary software in some cases or with mass customization in other cases), that selling small quantities of a very large number of unique products can be as profitable as selling massive quantities of identical popular products.
  • Low price as sole business strategy. Many companies, especially ones selling com­mo­dity products similar or identical to competitors, compete based on low price. The sec­ret to competing this way is to have lower costs than competitors. To have lower costs than competitors, you must either have a lower cost of goods sold (i.e., a cheap­er source of supplies), or lower operating expenses. As a general rule, a start-up is not going to compete with established companies with identical products and customer experience using just a low price strategy. You simply do not have the scale.
  • Dangers of low pricing strategies. Although no business stra­tegy is without pitfalls, relying on low price as your only strategy comes with a unique set of dangers: (a) you will likely have very small margins, so the slightest increase in your costs will make you unprofitable; (b) if you are new to entrepreneur­ship, you likely have missed some significant expenses in your cal­cu­lations; once those expenses appear, your low prices may no longer be feasible; (c) estab­lished companies struggle with cash flow all the time; even if you can remain profitable, you may not have enough cash to stay afloat; and (d) if you have in fact figured out a unique way to reduce your costs, what will happen when your competitors figure out the same way?
  • Low pricing as part of a business strategy. Just about every start-up that succeeds competes with a differentiation strategy (using some combination of unique products, better features, better customer service, more convenient shopping, etc.), and it may or may not offer low prices. Prices could be set low initially (to help convert early adopters) or could be set high if the value of the additional product or service is significant (see next paragraph).
  • Value pricing strategies. Value pricing means establishing a price for your product based on what you believe the customer gains as a result of having your product (regardless of what it costs you to produce the product). When you sell a product, you are making an ex­change of a product for $x of cash. You want two goals to have been fulfilled after the transaction:

–      Goal #1: You want customers to feel that they would rather have the product in their possession than $x in their pocket. This is the essence of value pricing.

–      Goal #2: You would rather have $x in your bank (and the happy customer in your list of customers) than the product in your inventory.

The above extracted from my latest book, Will Your New Start Up Make Money? Buy your copy in Kindle or paperback formats at http://www.amazon.com/Will-Your-Start-Make-Money-ebook/dp/B00JOOZQNE.

Driving Revenue Growth via Viral Strategies

In The Lean Startup [RIE11], Eric Ries points out that only three techniques exist to drive revenue to a company:

  1. Paid. You can spend money with marketing and sales efforts to “buy” customers. See my earlier blog at https://www.offtoa.com/wp/?p=179.
  2. Sticky. You can enhance the customer experience so that current customers purchase more or return more often. See my earlier blog at https://www.offtoa.com/wp/?p=182.
  3. Viral. You can add specific features that encourage current customers to refer others to become customers. This is the subject of the current blog entry.

Whereas sales strategies focus on spending money to attract new customers and sticky strategies focus on retaining existing customers, viral strategies focus on generating new customers by relying on efforts of existing customers. Most social networking sites depend on the viral spread of their customer base; Facebook users, for example, share with their friends, who then become Facebook users. Any company that incorporates a referral program (where a current customer is rewarded for referring a new customer) is using a viral method as part of their business strategy. Other examples are Tupper­ware, where customers sell products to new customers at Tupperware parties; and Skype, where customers encourage colleagues to join so they can communicate. 

The above extracted from my latest book, Will Your New Start Up Make Money? Buy your copy in Kindle or paperback format at http://www.amazon.com/Will-Your-Start-Make-Money-ebook/dp/B00JOOZQNE.

Driving Revenue Growth via Sticky Strategies

Sales and marketing strategies (as described in my previous blog) focus on spending money to drive new customers to buy product. Sticky strategies are designed to increase the lifetime value of each existing customer (called CLV, customer lifetime value). These strategies include concepts such as (1) upselling, where you make efforts to convert customers buying lower priced goods and services into those buying higher priced goods and services; (2) enhanced customer experience, so fewer customers cease being customers (i.e., the goal is to raise retention rate), and (3) rewards programs, to reward customers for frequent purchases.

Freemium pricing is a special case of upselling in which you offer some services for free and entice a subset of them to upgrade to a richer set of features at a premium price. The philosophy is three­fold: (a) once some customers see how great the subset of features are, they will want the full set, (b) once customers experience what a great company it is, they will want to do (real) business with you, and (c) you have access to the non-paying customers’ eyeballs and contact information, and so you can carefully “sell up” to them.

Treacy and Wiersema [TRE93]’s concept of customer in­ti­macy is another technique for maximizing long term value of customers, as opposed to deriving the most out of any one transaction with customers. Start-ups can create strong customer loyalty by implementing cus­tomer intimacy as one of their core practices. Established companies with this strategy include the Broadmoor Hotel, Nordstrom, and Whole Foods.

The above extracted from my latest book, Will Your New Start Up Make Money? Buy your copy in Kindle or paperback format at http://www.amazon.com/Will-Your-Start-Make-Money-ebook/dp/B00JOOZQNE.