Sunday
Aug242008
Turning an idea into a startup
Sunday, August 24, 2008 at 9:22PM
One of the most exciting parts of my job is helping startups. I've started businesses, I've been on startup teams and I've sat across the table from dozens of entrepreneurs as they've poured out their dreams and hopes for a new idea. It never gets old. The act of creating something is a marvelous experience. If you think you've got it in you to start a business I say "GO FOR IT!!!" You'll learn a lot about yourself and as long as you've got a good attitude even the disappointments will one day be remembered as highlights.
I think there are three ingredients to startup success, and I'm writing about them this week because I see a lot of people with good ideas who aren't quite sure what to do next. You can probably go about it a hundred different ways, but this framework has worked for me and my clients. It can work for you too as long as you ACT every day to make it happen.
Ingredient one is a good PLAN. A plan answers a lot of questions. What is your product or service? How will it be delivered? What sets you apart from everyone else? When will you open the doors? Why will you succeed where others have failed? A good plan answers all of these. It budgets the costs you will incur along the way. It quantifies your market, the share of the market you need to be successful and how likely you are to capture it. The plan includes a LOT of stuff. From finance, to marketing, to operations, it seeks to anticipate what you will need and when. Plans are best developed with someone who can push back on your assumptions. You need a devil's advocate to make you examine every angle before you start spending big bucks. Often times a SCORE counselor or your CPA will act in this role. Don't get me wrong, CPA's aren't cheap, but neither is spending $100,000 on inventory that won't sell.
Ingredient two is a TEAM. I should pause for a minute here and explain that there is a difference between starting a business and simply giving yourself a job. A business is something that will eventually run without you on the strength of the processes and people you've put into place. A job is something you don't get paid for unless you show up. A business requires a team. A job requires a time clock. Make sure you understand the difference.
The team often starts to surface while you are developing the plan. If you're lucky you'll have a business partner already on your team. Or maybe you've found an investor with some specific industry experience to help you layout the next steps. In any event you're going to need to start putting some names next to all those to-do lists that came out of the plan. You need to start building your team, and you usually have two choices. Experienced and expensive or hungry and cheap. If your business is like most you will need a mix of both, but that doesn't mean you must add the expensive ones to the payroll.
A team is comprised of more than just employees. Vendors, accountants, attorneys, consultants, suppliers, buyers and customers can all be part of your team. I think it's better to find hungry and cheap employees and get more expensive team members to commit to short-term goals and solutions. With outside parties you can limit the amount of time you're committed to expensive fees. It is great if you can get someone who is experienced, knowledgeable and competent on the payroll early, but most new businesses cant afford it.
The most important aspect of the team is chemistry. I was at a meeting last week and a fellow business owner at our table said "I'd rather hire the desire than the experience any day!" I agree 100%. As a new business founder you face risk, uncertainty, long hours and little short-term reward. If you have a workforce that is eager, willing to sacrifice and passionate you won't feel like you're going it alone. Passion and energy will trump experience every time.
Finally, when putting together a team it is important to decide who you want, first. You need to mentally describe the people you are looking for before you start looking. Age, sex, married or single, children or not, gregarious or introverted, hip and young or mature and wise...you will be amazed how quickly these people start to show up on your door step once you decide exactly what it is that you want. I have had people counsel me to be careful of discrimination when giving such advice. Baloney! There's nothing wrong with finding exactly the person you want.
The third ingredient is MONEY. Whether it's yours or someone else's you are going to need some cash to give this great idea some legs. Part of your plan will involve putting together the budgets and forecasts that help quantify the amount of money you will need. The people you select for your team will also help determine the amount you need. But just as important as the amount of money is the type. You basically have three choices: 1) use your money 2) borrow it or 3) use an investor's money. Each has benefits and drawbacks.
If you use your money you don't have to give up any ownership in the company and you don't have to worry about a monthly loan payment. Unfortunately, this route is rarely affordable for new businesses. For the same reason it is often very risky. If you put most or all of your savings into a new venture and it fails you may be left with nothing. That kind of situation can lead to emotional and desperate business decisions, and that is never good.
If you borrow money it can be more affordable initially, but you'll get stuck with a monthly payment and if you succeed in paying off the loan you will have paid out a lot more cash (in the form of principal AND interest payments) than you originally borrowed. Besides being more affordable on the front end borrowing also has the advantage of allowing you to retain ownership in the company. Banks and other lenders don't want stock in your new company, they just want repayment. This is an important distinction. Many people starting a new venture tell me they want to find investors, but what they really mean is that they need to find a lender.
The last option is to get someone to believe in your idea enough that they invest their money into your company. In return they expect to own a piece of the pie. Most people need to think long and hard about this. Using an investor's money is tempting when you don't have the cash yourself. It can also be more attractive than going to a lender who may not approve you for a big enough loan. But investor money is often the most expensive. Investors expect a return on their investment in the form of future profits. If the company does well they do well. If the company fails they lose everything. That kind of gamble means investors expect a lot more than a lender. Lenders can sell your collateral. Investors get left with nothing. For this reason an investor might demand a 30% return where a lender is satisified with 10%.
To get a sense for how expensive investment money can be assume your business is expected to generate $50,000 of cash and you need $100,000 to get things started. If you borrow the money at 10% you'll have $40,000 left after interest. But if you get an investor that requires 30% return you'll need to give away 60% of your company (30,000 divided by 50,000 = 60%). It gets worse. The lender will eventually get paid off once you return the $100,000 plus interest. Investors stick around forever or until you buy them out. If you think loans are expensive go through a buy out.
Investors also have a habit of sticking their noses into the business. And they have a right to. After all, these are your new business partners. They own the company too and you'd better listen to their suggestions. Not everyone is cut out for this and many founders find themselves at odds with fellow shareholders when it comes to strategic business decisions. It's also the case that many inexperienced investors (friends and family especially) don't truly understand the risk that they are assuming as shareholders. If things don't work out you could be setting yourself up for a lot of awkward Thanksgiving dinners.
If you haven't guessed by now my personal preference is to self fund businesses first, find cheap borrowed money second and go after investors as a last resort. That said, there are times when investors make the most sense, especially if they bring more to the table than money (industry expertise, contacts, sales dollars, etc). Friends and family rarely possess the kind of expertise and non-financial help that you are going to need so I try to discourage people from giving this group an ownership interest. In my mind it's far better to borrow the money from them and repay it at a generous interest rate. And speaking of Thanksgiving, don't close these deals at the family bar-b-q. If you have someone in your family (or a close friend) that is going to give you money INSIST that they sit down with your attorney and CPA and that they fully understand the exact terms of the deal. The last thing you want is Uncle Bob claiming he is entitled to half your millions after you've repaid his startup loan with 15% interest.
There's a lot involved in taking your idea from conception to successful business, many more steps and nuances than are covered here. But if you focus on building the plan, putting the team in place and using the right kind of money you will be better off than the 90% of new business owners who lay awake at night wondering whether they've done the right thing.
I think there are three ingredients to startup success, and I'm writing about them this week because I see a lot of people with good ideas who aren't quite sure what to do next. You can probably go about it a hundred different ways, but this framework has worked for me and my clients. It can work for you too as long as you ACT every day to make it happen.
Ingredient one is a good PLAN. A plan answers a lot of questions. What is your product or service? How will it be delivered? What sets you apart from everyone else? When will you open the doors? Why will you succeed where others have failed? A good plan answers all of these. It budgets the costs you will incur along the way. It quantifies your market, the share of the market you need to be successful and how likely you are to capture it. The plan includes a LOT of stuff. From finance, to marketing, to operations, it seeks to anticipate what you will need and when. Plans are best developed with someone who can push back on your assumptions. You need a devil's advocate to make you examine every angle before you start spending big bucks. Often times a SCORE counselor or your CPA will act in this role. Don't get me wrong, CPA's aren't cheap, but neither is spending $100,000 on inventory that won't sell.
Ingredient two is a TEAM. I should pause for a minute here and explain that there is a difference between starting a business and simply giving yourself a job. A business is something that will eventually run without you on the strength of the processes and people you've put into place. A job is something you don't get paid for unless you show up. A business requires a team. A job requires a time clock. Make sure you understand the difference.
The team often starts to surface while you are developing the plan. If you're lucky you'll have a business partner already on your team. Or maybe you've found an investor with some specific industry experience to help you layout the next steps. In any event you're going to need to start putting some names next to all those to-do lists that came out of the plan. You need to start building your team, and you usually have two choices. Experienced and expensive or hungry and cheap. If your business is like most you will need a mix of both, but that doesn't mean you must add the expensive ones to the payroll.
A team is comprised of more than just employees. Vendors, accountants, attorneys, consultants, suppliers, buyers and customers can all be part of your team. I think it's better to find hungry and cheap employees and get more expensive team members to commit to short-term goals and solutions. With outside parties you can limit the amount of time you're committed to expensive fees. It is great if you can get someone who is experienced, knowledgeable and competent on the payroll early, but most new businesses cant afford it.
The most important aspect of the team is chemistry. I was at a meeting last week and a fellow business owner at our table said "I'd rather hire the desire than the experience any day!" I agree 100%. As a new business founder you face risk, uncertainty, long hours and little short-term reward. If you have a workforce that is eager, willing to sacrifice and passionate you won't feel like you're going it alone. Passion and energy will trump experience every time.
Finally, when putting together a team it is important to decide who you want, first. You need to mentally describe the people you are looking for before you start looking. Age, sex, married or single, children or not, gregarious or introverted, hip and young or mature and wise...you will be amazed how quickly these people start to show up on your door step once you decide exactly what it is that you want. I have had people counsel me to be careful of discrimination when giving such advice. Baloney! There's nothing wrong with finding exactly the person you want.
The third ingredient is MONEY. Whether it's yours or someone else's you are going to need some cash to give this great idea some legs. Part of your plan will involve putting together the budgets and forecasts that help quantify the amount of money you will need. The people you select for your team will also help determine the amount you need. But just as important as the amount of money is the type. You basically have three choices: 1) use your money 2) borrow it or 3) use an investor's money. Each has benefits and drawbacks.
If you use your money you don't have to give up any ownership in the company and you don't have to worry about a monthly loan payment. Unfortunately, this route is rarely affordable for new businesses. For the same reason it is often very risky. If you put most or all of your savings into a new venture and it fails you may be left with nothing. That kind of situation can lead to emotional and desperate business decisions, and that is never good.
If you borrow money it can be more affordable initially, but you'll get stuck with a monthly payment and if you succeed in paying off the loan you will have paid out a lot more cash (in the form of principal AND interest payments) than you originally borrowed. Besides being more affordable on the front end borrowing also has the advantage of allowing you to retain ownership in the company. Banks and other lenders don't want stock in your new company, they just want repayment. This is an important distinction. Many people starting a new venture tell me they want to find investors, but what they really mean is that they need to find a lender.
The last option is to get someone to believe in your idea enough that they invest their money into your company. In return they expect to own a piece of the pie. Most people need to think long and hard about this. Using an investor's money is tempting when you don't have the cash yourself. It can also be more attractive than going to a lender who may not approve you for a big enough loan. But investor money is often the most expensive. Investors expect a return on their investment in the form of future profits. If the company does well they do well. If the company fails they lose everything. That kind of gamble means investors expect a lot more than a lender. Lenders can sell your collateral. Investors get left with nothing. For this reason an investor might demand a 30% return where a lender is satisified with 10%.
To get a sense for how expensive investment money can be assume your business is expected to generate $50,000 of cash and you need $100,000 to get things started. If you borrow the money at 10% you'll have $40,000 left after interest. But if you get an investor that requires 30% return you'll need to give away 60% of your company (30,000 divided by 50,000 = 60%). It gets worse. The lender will eventually get paid off once you return the $100,000 plus interest. Investors stick around forever or until you buy them out. If you think loans are expensive go through a buy out.
Investors also have a habit of sticking their noses into the business. And they have a right to. After all, these are your new business partners. They own the company too and you'd better listen to their suggestions. Not everyone is cut out for this and many founders find themselves at odds with fellow shareholders when it comes to strategic business decisions. It's also the case that many inexperienced investors (friends and family especially) don't truly understand the risk that they are assuming as shareholders. If things don't work out you could be setting yourself up for a lot of awkward Thanksgiving dinners.
If you haven't guessed by now my personal preference is to self fund businesses first, find cheap borrowed money second and go after investors as a last resort. That said, there are times when investors make the most sense, especially if they bring more to the table than money (industry expertise, contacts, sales dollars, etc). Friends and family rarely possess the kind of expertise and non-financial help that you are going to need so I try to discourage people from giving this group an ownership interest. In my mind it's far better to borrow the money from them and repay it at a generous interest rate. And speaking of Thanksgiving, don't close these deals at the family bar-b-q. If you have someone in your family (or a close friend) that is going to give you money INSIST that they sit down with your attorney and CPA and that they fully understand the exact terms of the deal. The last thing you want is Uncle Bob claiming he is entitled to half your millions after you've repaid his startup loan with 15% interest.
There's a lot involved in taking your idea from conception to successful business, many more steps and nuances than are covered here. But if you focus on building the plan, putting the team in place and using the right kind of money you will be better off than the 90% of new business owners who lay awake at night wondering whether they've done the right thing.
Reader Comments (6)
Nice writing. You are on my RSS reader now so I can read more from you down the road.
Allen Taylor
Great post. I will read your posts frequently. Added you to the RSS reader.
[...] Go to the author’s original blog: Turning an idea into a startup [...]
Thanks Joey, Lot of food for thought!
I sincerely appreciate all you have done to date to help me along. I will develop my team (always been one of my strengths in the corporate world) and you are numero ono! Thanks, TED
I follow you always, this post is excellent.
Nice post u have here :D Added to my RSS reader