During lunch time discussions at a software company I worked at, “early retirement” was a popular topic (see my previous posts #7, #8, and #9). Another favorite topic was, “how to get rich”. Both topics, I think, were driven by a realization that an average employee’s trajectory was not going to lead to freedom (from employment) any time soon. The most common dream was to start a tech company; successes like Google, Zynga, Facebook were the inspiration. A few hardy souls from my company did quit their jobs to become founders or first employees at startups. No one walked out rich and free from these startups — except for one startup that is still getting funding — so there is still hope. Most people went back to employment, their only reward was accelerated ageing for their intense efforts.
My view is that such “big-bang” tech startups require equally big-bang ideas and a just right environment (such as right place and right timing) to be successful. However the idea of setting up a business to earn good money is basically sound. Now, as Maslow said, “if the only tool you have is a hammer, everything looks like a nail”; people with a software background tend to only think of jobs involving writing software or show interest in business ideas only for tech startups. Probably the same thing holds in other fields too. But the world has many diverse opportunities available today, and one should not ignore other niches where it may be easier to set up a good, sound, business. Another point to note: it is perfectly all right to have a less lofty goal than starting a billion dollar company. The idea is to replace income from a job with a more satisfying alternative. But running your own business sounds scary. Why would it be more satisfying? Well, here are some reasons: greater income potential, being your own boss, time flexibility, joy of creating something that you own..
The main thing I want to emphasize is that your startup doesn’t have to be based on a unique idea that you thought up. It could be a very well-known concept – the crucial question is, can you work it well and enjoy the end result.
Now suppose you are open to the idea of setting up a business, and then a friend tells you about a business opportunity. How would you evaluate it? This article illustrates the process. It first provides a checklist of the kind of things one should look for, followed by a description of the evaluation process. Note: this checklist is only to illustrate the process.
Secondly, this discussion is about small scale businesses which one or two founders may set up. Running a large scale business is a different discussion altogether.
Business Proposal Checklist
This checklist will use a running example of a hypothetical ice-cream parlor franchise business “ICPF“.
Where is the Money?
Profitability, of course, is the most important thing to consider. Profitability is estimated by projecting revenues and expenses for the next few years. Generally, there may be non-trivial initial set up costs that pull cumulative profitability into negative territory, but over time, the gap between revenue and ongoing costs should steadily pull it up till it crosses over into positive territory. This crossover point is called break even and is an important milestone. Past the break even point, one can look at yearly profits of a steady business as the figure of merit. Next, let’s look at costs – there are upfront setup costs, and, continuing running costs.
What steps have to be completed before customers will come and buy? Where will the initial investment come from?
- Acquiring a place of business (i.e. shop or office) — cost of purchase / rental down payment.
- Furnishing the place of business. ICPF will need a counter, chairs and tables, AC, lighting, decor
- Equipment. ICPF will need point of sale terminal, computer, freezers, mixers
- Branding and Marketing. ICPF may put out flyers in newspapers, work the social media, host special events.
- Regulatory. ICPF will need food seller’s license, shop license, etc.
- Franchise fees. ICPF has to pay up a few million Rupees up front. No refunds!
- Cost of capital. The initial investment will have a real or notional interest payment. Includes cost of working capital.
- Input costs. Costs incurred per item produced, or raw material costs. ICPF may buy milk, sugar, flavoring. Or it may pay the franchise for bulk supplies. Input costs also include spoilage, storage costs.
- Operating expenses. Costs not linked to turnover. Rentals, salaries, utilities, stationary, advertising, insurance, … generally a long and varied list.
- Franchise costs. These may be a flat fee, a percentage of sales, or a combination.
- Salary of owner. Owner has to support himself and his family too.
Revenue is incoming money arising from business operations. Normally the major source of revenue is goods or services sold. ICPF revenue comes from sale of ice cream to customers. But there may be other sources too. For example, surplus cash may be invested.
What are the Hassles?
Running a business can involve a bigger set of hassles than in a job. Here are some of them:
This goes by the name of “regulatory and compliance environment”. Basically, various authorities want to control your actions and also extract money from your business. To implement this, they have an army of inspectors. You, as business owner, will have to deal with these agencies and their inspectors without losing your cool. ICPF may have to follow food regulations, shop safety and cleanliness rules, worker related regulations, and of course there are various taxes.
Revolt of the Minions
Perhaps there are employees, contractors, consultants needed to help run the business. You need to make sure they deliver as expected, and don’t create grief. Somewhat different handling could be required for professionals, supervisors, and labor. ICPF may have to watch for pilferage.
Cash Flows versus Revenues and Expenses
There is an important difference between revenues / expenses and cash flows, which is to do with timing. For example, a product is shipped on the 1st, but the payment comes on the 20th. Of the next month. This sales revenue was generated on the 1st, but its cash inflow came later. So even a profitable operation could face a cash crunch due to such delays. Similarly, suppose sudden additional orders worth 100,000 clams come in. They require 60,000 clams of input costs up front, but payment would come after 3 months — so you have find an extra 60,000 clams for three months.
Thus you need a plan to cover for delay in collections, and to meet cash flow requirements for variation in sales both upwards and downwards. ICPF may have decreased ice cream sales in winter months but rent and salaries have to be paid in that season too.
You, the business owner, have ultimate responsibility regarding any mishaps that may happen in running the business. There could be accidents, food poisoning, lawsuits for wrong advertising, etc. Are there prevention plans in place? Are there contingency plans in place, or will everybody run around like headless chickens when something bad happens?
What are the Risks?
An employee basically only has to keep the boss happy. A business owner has to keep many different people happy. Secondly, the game keeps changing, so one has to keep making adjustments, keep anticipating the future, in order to survive and thrive. There are many stories where a single factor caused a business to go bankrupt. Do you have the creativity, determination, and mentors to prevail over adverse conditions? Some specific risks are:
If there is a good business model, there are sharp people wanting to take away your business. What are the barriers to entry for new competitors? How loyal are your customers? Your employees? Is there some essential secret sauce that cannot be copied? Is there patent protection for key inventions?
Is there existing competition? What is your edge over them, and can you maintain that edge?
Can a bigger competitor kill you with economies of scale? Can a smaller competitor take bites into your market due to its agility or better cost control?
Can some disruptive technology make your business obsolete? Can ICPF prevail when a new Starbucks opens next door?
Are you dependent upon a single supplier? Can geopolitical changes cut off essential raw materials?
Can changes in laws and regulations impact your business? For ICPF, can governmental restrictions on cow rearing raise milk prices?
It may take years for your business to cross break even and settle into a steady profitability. Until then, it is bleeding money. It is also consuming your time and efforts. Do you have the staying power to see it through, or will you give up too soon? Will your family and well-wishers support you or discourage you? If you have loans, will the lenders give up too soon?
There will be mistakes and unanticipated costs along the way. Are there resources held in reserve to handle this (time, money, grit)?
If there are multiple owners, are there checks and balances in place to prevent fights? Are there proper exit processes if owners cannot get along?
What is the Future?
The previous section asked what could go wrong. We should also ask what can go right.
In some businesses, there may be an ideal size, but in many others, the bigger, the better. Is there a strategy for growth in the business? ICPF may have a plan to attract more customers. It may have its eyes on expanding its capacity. It may open new stores in other locations. Can you scale the business properly?
If the business begins to transition into a medium / large business (say beyond 100 employees or associates) do you have the experience, or can you learn a different set of skills that will be required?
Expanding into Adjacent Markets
Can the existing customers buy additional products? ICPF may sell snacks in addition to ice cream.
Can you reach out to more customers, maybe from a different segment? ICPF could open an extra window where children from a nearby school can buy low-priced ice candies from their pocket money.
Can one integrate the supply chain? An ice-cream parlor that is not a franchise could have its own dairy to have total control over its milk supply.
Loyal Customer Base
Does the business offer a unique or superior service or product-cum-service? Will the customers continue to be delighted, to stay loyal?
Longevity & Demand
Is this product or service opportunity inherently short-lived? In the ICPF case, ice cream has been around for more than a hundred years, so one may expect some longevity.
A related issue is “elasticity of demand”. Are the customers price sensitive: will demand fall sharply if prices go up? Similarly, will customers stop buying during an economic recession? If the answers are no, then profit margins should not come under pressure for these reasons.
Businesses might in theory live forever, but business owners won’t. Is this business easy to pass on to others, either by selling out, or through inheritance? In other words, is the business owner replaceable? Can the ICPF owner or its franchise train the next person to take up the current owner’s role? As an opposite example, a fortune teller’s business would likely end with them.
Is it Worth Doing?
Finally, setting up a business requires a different mindset than for an employee. That is, a “do it” attitude instead of a “show up” attitude. Grit and ability to take calculated risks is needed too. There will be lots of learning from mistakes, maybe expensive mistakes, time and effort for many years with no assured paycheck at the end of each month. And of course, there is always the risk of failure. But when successful, the rewards can be many times larger than in a job.
Further, the business owner’s life should become sufficiently balanced (once the business has become stable):
- Limited time spent at work.
- Adequate time for family, for oneself.
- Adequate personal finances.
- Giving to the community.
- Freedom from anxiety; peace.
I can only give a general strategy for evaluation ー the following one makes sense to me. Here are the steps:
- Develop a detailed idea of the end goal (i.e. a stable business of a certain size)
- Develop a detailed idea of the path to the end goal (i.e. how the initial phase will work)
- List of likely risks (what can go wrong) and how to recover from it
- List of resources required at each step of the path, such as funds, know-how, mentors.
- Self evaluation for courage, resourcefulness, perseverance, risk taking, etc. required for success
Finally, this evaluation strategy is only for the purpose of deciding whether to take the jump or not. Once you jump in, you should be prepared to adjust and change as you discover what works and what doesn’t.
So here is my idea of what an ideal business would look like:
- Small initial investment (fully self funded)
- Negligible overheads
- Zero inventories
- Unique or best-in-class offerings
- Easy to develop a loyal customer base
- No competition / high barrier to entry
- Short time to reach break even
- Low cash turnaround time (i.e. cash sales and credit purchases)
- Zero employees / contractors
- Decreasing time commitment of owner
- High growth potential
- Easily Scalable
- Easy to sell or pass on to heirs
Some articles and books on this topic. I liked the ones marked with a [✔]
Evaluate a new business
- [✔] https://yourstory.com/2016/08/12-signs-ideal-business/
- [✔] http://www.migsif.com/index.php/en/91-latest-posts/203-what-is-the-criteria-of-an-ideal-business
Some interesting books in and around the topic of ‘the ideal business’. Although I haven’t read these books yet, they have good reviews.
- Rework by Jason Fried and David Heinemeier
- Inspired: How to Create Products Customers Love by Marty Cagan
- Start Small, Stay Small: A Developer’s Guide to Launching a Startup by Rob Walling, Mike Taber
- The 7 Day Startup by Dan Norris
I really appreciate the detailed reviews and feedback given by Manas Sathe and Ravishankar Rajagopalan.