Do economic cycles of boom and bust affect the number of start-ups? Most analysts have linked entrepreneurial activity to economic growth as though it was a given … and conversely, believed that when recession struck, start-up activity slowed substantially. A recent study by the Ewing Marion Kaufman Foundation concludes that both theories are pure bunk. And as though that bombshell was not enough, the Kaufman study goes on to explode several other theories about what factors stimulate new business formation.

Do start-ups increase in proportion to the availability of venture capital? Nope. Kaufman Foundation researchers Dane Stanler and Paul Kedrosky dispel that myth as well. The authors note that the doubling of start-ups from the period 1960-1978 to the decades since may indeed have been due to the advent of the personal computer and the expansion of the venture capital sector. (One wonders if the baby-boomers coming of age may not have contributed to this step-change as well.) However, the constancy of recent start-up data belies the influence of venture funding. Start-up activity fluctuated by only 3% to 6% each year between 1977 and 2005; but the data shows that venture investment varied by as much as 500% during the same period.

Do tax or bankruptcy law changes, technological advances or entrepreneurship education affect the number of new ventures? No again! The report, Exploring Firm Formation: Why is the Number of New Firms Constant?, also finds no correlation between start-up activity and tax policy or any of these other factors; so much for the theories of our most vocal politicians. Instead it documents the same steady half-million start-ups per year, give or take a 3 to 6 percent. The authors discuss a few possible explanations for the unexpected constancy, some rather arcane, but they do not seem to buy into any of them.

Common sense suggests that certain of the factors discussed in the Kaufman report must have at least some influence on the number of start-ups, even if they do not affect substantially the total for a given year. For example, limited amounts of available venture investment must surely delay some particular start-up decisions. I have been involved in a few such decisions. Similarly, high interest rates and tight credit must also have an effect on many decisions, especially those involving sole proprietorships and mom-and-pop operations. So perhaps a study with greater granularity would reveal that while the total number remains relatively constant, the mix of start-up types changes, maybe even substantially. Perhaps in recessions when venture funding declines, a fall in interest rates turns entrepreneurs toward credit sources. It could also be that more innovation-based entrepreneurs test their business innovations when the economy is booming, and that more laid-off workers start enterprises when unemployment is high during recessions. I suspect that the “mix” of different kinds of start-ups changes a great deal even though the total number may not change much.

The Stangler and Kedrosky study does not encompass the current Great Recession, of course, it is too soon. Yet surely this anomalous economic epoch will surely add some telling figures. The investment portfolios of the wealthy individuals and institutions that comprise the limited partners of venture firms declined substantially since 2007 and venture investment has fallen by 40% or so since then. At the same time, credit tightened historically and unemployment soared into double figures. Will start-up totals for this period continue the constancy that Kaufman reports? And if not, how will it vary? Will the limitations on available capital drive start-up numbers down, or will necessity and cheap assets power them up? Or will past constancy persist despite alterations in the mix? Only a study based on more granular data could reveal that. I doubt that such data is available or could be economically derived, though that information could prove useful to an economy so reliant on small businesses to create jobs.

Idea stage entrepreneurs are told by many sources that they need a business plan. When they ask for loans, banks tell them this. When they seek advice, mentors or advisors ask to see their plan. And certainly when they speak with many companies or individuals who write business plans for a living, they will hear the same.

However, there are situations where writing a business plan is simply premature and can be a waste of time and money. It may be more appropriate to start by taking a hard look at the key financials, market or the intended business, and your own situation. This is what business planners refer to as a feasibility study or feasibility analysis.

For example, a new client I recently spoke with told me of her need for a business plan. Upon deeper examination, I found that she felt uncertain about some of the fundamental elements of her idea. Questions remained such as: “Is there a sufficient potential market of people to sell to?”, “Will suppliers provide products at a price that makes the business model work?”, and “Will key partners be interested in signing on?”

The fact is that most of these questions can and should be answered before a full business plan is created. The entrepreneur can save a great deal of money by doing this legwork early on. The strategy is then fine-tuned based on the answers. Sometimes he or she will realize that the idea should be scrapped altogether!

A feasibility study is a way of asking “Does this business idea really make sense?” before creating an investor-grade or loan-ready business plan for it. Most feasibility studies for small businesses require at least three components, each answering the following questions:

1. Market feasibility: Is there a true need in the market for the solution the business will provide? Is there room for the business to create a competitive advantage against the existing competitors and substitutes?
2. Financial feasibility: Can the product or service be produced at a price that covers costs and allows for sufficient profit? Can the business be launched for an amount of capital which can reasonably be raised and recouped?
3. Personal feasibility: What time commitment must the entrepreneur put in to get the business off the ground (or even planned successfully)? What skills or experience does the entrepreneur lack? Can these be lacking skills made up for by bringing on a partner, employee or consultant?

To study market feasibility requires some preliminary market research and competitor research, as well as consultation on the differentiation strategy for the business. A carefully written, presentation-quality report is not needed at this time as it is only the entrepreneur and his partners that must be convinced at this point. The work can and should be carried out by the entrepreneur and consultant as a team for the best results.

To study financial feasibility requires basic financial modeling with rough, top-down estimates and some research on some large, actual costs. It does not require a full set of financial statements yet. However, this work lays the groundwork for those statements to be developed later on.

And to look at personal feasibility, the entrepreneur needs to think clearly about his own strengths and weaknesses. The entrepreneur must be objective about himself and a trusted advisor can be a great benefit to him in this process.

If you are at a loss as to how you should study these three areas, a consultant can set you on the right path or partner with you in the process. When you get these questions out of the way first, the business plan you eventually create will be more compelling and less expensive than it would have been otherwise.

Summer is winding down and Labor Day is behind us. Although the recession technically started in December 2007, many of us did not feel the full effects of the financial crisis until the sudden collapse of 158-year-old Lehman Brothers one year ago today. This has been a year that none of us will soon forget. The outlook remains uncertain, but the future seems brighter than our immediate past.

Many economists are seeing signs of a so-called jobless recovery. A jobless recovery is a situation where the economy resumes growth, but employers remain reluctant to hire. The pattern could be similar to the aftermath of the 2001 recession, which was followed by two years of low employment. As of August, the unemployment rate was at 9.4%, and the underemployment rate – which includes part-time workers who cannot find full-time work – was at 16.8%.

Historically, high unemployment has translated into forced entrepreneurship. To paraphrase Plato, necessity is the mother of invention. Indeed, many successful companies such as Microsoft, Hewlett Packard, GE, FedEx, and Trader Joe’s were started during recessions (for more, see 14 Big Businesses That Started in a Recession and Defying Gravity).

With this in mind, we’ve collected a few resources to help entrepreneurs succeed in this tough environment:

1. The Best Industries for Starting a Business Right Now: As consumers and businesses cut back in some areas, they continue to spend in others. Here are brief profiles of 18 markets with great potential for today’s entrepreneurs.
2. Starting a Business When the Economy is Down: This talk by serial entrepreneur Michael Jones discusses several key issues that startups must address.
3. Is Starting a Business Brave, Smart, Stupid or Nuts?: It depends on who you are and who you ask. People are different, and it has to be right for you.
4. How We Got a Loan: Banks have tightened their lending standards, and many are turning away small businesses. This story of how one company managed to get a loan may give you some ideas. The key lesson learned is that it isn’t going to be easy, even if you are thoroughly prepared, but it can be done.
5. Startup 101: How to Build a Startup: Bernard Lunn, another serial entrepreneur, has published an online book that covers a lot of the important aspects of entrepreneurship. Although geared towards web technology startups, the majority of the information here applies to any technology venture. Lots of excellent advice for first-time entrepreneurs, and quite a few important reminders even for folks with several startups under their belts.
6. Finding the Path to Success by Changing Directions: When what you’re doing isn’t working, it’s time to consider new strategies. It’s all about staying responsive to the marketplace. The best line in the article: “It was like people were smacking us around with a fish trying to get our attention about this high cost of storage problem.”
7. Meeting Short Term Cash Needs: If your business is generating revenue but is facing a short-term cash crunch because your revenue can’t keep up with your existing debts, the SBA has a new program that can help. The American Recovery Capital, or ARC Loan Program, provides up to $35,000 to help you stay current on the principal and interest payments on your other existing loans. The ARC loans are interest only for the first year, and amortizing over the next five years. To be eligible, you must demonstrate that your business was profitable in one of the past two years – this is not a program for startups.
8. Six Ways to Speed Up SBA Loan Approval: The American Recovery and Reinvestment Act made SBA loans easier and cheaper to get, but these special provisions will expire by the end of the year. If you’re thinking about applying for one of these loans, you need to act quickly.
9. To Slim Down, Businesses Team Up: Creative alliances can mean lower costs while allowing everybody to focus on their core strengths. This is a simple strategy that any entrepreneur can employ.

We can measure success in many ways. In business, one important measure is the value of the company. That’s because a company’s value is a composite of all of the quantitative and qualitative factors that comprise a company: revenues, expenses, risks, growth prospects, quality of the management team, competitive advantages, strength of the intellectual property, and so forth.

In general, we want to do the things that increase the value of the business, and we want to avoid doing the things that reduce it. The problem is that we often lose sight of the big picture, and get mired in everyday distractions.

One useful technique for keeping your eyes focused on what really matters is Cayenne Consulting’s Venture Value Scorecard™. It’s human nature to prioritize the metrics that get measured, so the simple act of keeping track is often enough to have a significant positive impact.

The Venture Value Scorecard is a one-page summary of your company’s achievements and assets: the factors that contribute to the value of your organization. It should be updated monthly so that you have a regular reminder of where you’re making progress, and where you may have become complacent.

You can structure your Venture Value Scorecard any way you like, but I suggest organizing it into the following sections:

• People: A strong team is obviously central to value creation. Your Venture Value Scorecard should highlight your recent successes in recruiting highly qualified team members to fill the most important gaps in your organizational structure. You can also use this space to keep track of innovators (R&D personnel) and rainmakers (sales & marketing personnel).
• Products: You obviously can’t create value without a viable product (or service) to sell. This section of your Venture Value Scorecard should summarize the important advances you have made recently in research and product development.
• Customers: A company’s only sustainable source of cash is sales, so you need to keep track of your business development efforts. You should inventory your best accounts and prospects, as well as the status of any pending major sales.
• Partnerships: Relationships with larger firms not only confer legitimacy to your business; they can be an important source of intellectual property, distribution channels, and marketing clout. You should document the status of your partnership negotiations so that you can easily gauge progress.
• Competitive Advantages: Your ability to create value depends on your ability to grow and protect your market share. This requires the continuous development of competitive advantages, whether through intellectual property, new innovation, exclusive distribution partnerships, key endorsements, brand building, corporate culture, or other factors. Keep track of what you’re doing to develop and enhance your sustainable competitive advantages.
• Net Income: The five factors listed above all contribute to something that is directly measurable: net income. Part of your Venture Value Scorecard should be devoted to summarizing your income statement. Detail isn’t important; tracking your progress is. Items that paint a big picture include revenue by major product area, cost of goods, and operating expenses by category. If you have a lot of non-cash items such as amortization or depreciation, or if you have unusually long receivables cycles, you should also include adjustments to reconcile net income to cash flow.
• Assets: Your assets add to your venture’s value, so any recent or pending changes in your assets should be recorded in your Venture Value Scorecard. These assets include things like cash (say, from a pending investment), facilities, inventory, and other property.
• Liabilities: Your liabilities detract from your venture’s value. Any recent or expected reductions in your liabilities should also be recorded in your Venture Value Scorecard.
• Risks: Unexpected events can kill a firm (of any size), and can therefore detract from its value. This is an opportunity to demonstrate that you recognize the greatest sources of risk facing your company, and that you’re taking prudent steps to mitigate the greatest hazards. Use your Venture Value Scorecard to summarize your major risk management initiatives.
• Other: Every company is different, so you’ll need to customize the Venture Value Scorecard for your own circumstances. I suggest you try to figure out the 3-5 key metrics that are used to judge the health of companies in your industry, and keep track of these somewhere in your scorecard.

As noted earlier, your Venture Value Scorecard should be updated monthly. Keep an archive of your old scorecards. That way, you can go back and review the progress you’ve made. I think you’ll be pleased by the momentum you maintain by keeping score.

© 2009 Cayenne Consulting LLC. The Venture Value Scorecard™ is a trademark of Cayenne Consulting LLC.

Entrepreneurs are, by definition, risk takers. Thus, strong risk management is an important source of competitive advantage. Although over half of all startups fail within their first five years, you can beat the odds and build a thriving and rewarding venture by learning to recognize and manage risks.

“What Kills Startups” provides a framework for identifying, thinking about, and mitigating the biggest risks ahead of you. So roll up your sleeves and dig in!

• Read the HTML version of “What Kills Startups?”
  
• Read the PDF Version of “What Kills Startups?”
  

When you’re done reading, please come back to the blog to leave your feedback – we look forward to hearing your thoughts!

Valuing a business is always an imprecise science, even with large-cap public companies. For example – Is the true value of a large public company based on its market price? It’s book value? It’s potential worth if broken into parts that have more perceived value than the whole? The answer is that there are many ways to determine the value of a company. Perhaps the best way to understand the “value” of any business, large or small, is to look at who’s doing the valuing and for what purpose. For example, we’ll wager that you would value your family business differently for estate purposes verses for a sale of the business.

Regardless of how a business is valued, there are both quantitative and qualitative factors that play a role in a comprehensive appraisal. Many of the elements that go into a business valuation can be classified into three categories:

• “Hard numbers” such as historical profits, assets, cash flow, and liabilities are always important in determining the worth of a business.
• “Soft figures” such as income and cash flow projections can be very important to a buyer or investor interested in the company
• “Intangible assets” such as patents, brand names, quality or reputation of management, location, recipes, customer lists, or goodwill often contribute to the overall value of a business.

There are many reasons to value a business, and “the reason” for the valuation is typically an important factor in deciding how an appraisal will be performed. This is why in many instances, more than one value can be correct. As indicated above, two of the more common reasons to value a company are for a sale or for estate tax purposes. Other purposes for performing a valuation might include acquiring insurance coverage of various types, attracting a new investor or seeking a credit facility from a bank or finance company.

The key considerations that go into any valuation include:

• Company, competitor, and industry information. How is your business performing and how does it compare to your competitors? What is the state of your industry? Is your business in a growth industry or a declining one?
• Analysis of historical financial statements. Ratio analysis such as return on equity or gross margin is often helpful.
• Projected financial statements going out three to five years can be particularly significant, especially if they are recast to reflect the business without owner compensation. By recasting statements, the value can be estimated as if the business were under different ownership or managed under different circumstances.
• Using a method of valuation that is appropriate for the purpose of the valuation.

Three popular approaches to value a privately held company include:

• Balance Sheet Approach. This is the easiest way to value a business. It will more often than not, however, produce the lowest valuation. A company’s book value is simply a firm’s liabilities subtracted from its assets. Banks and insurance companies are often valued on this basis. Many analysts believe that using an “adjusted book value” formula will produce a more accurate picture because this method takes into account the fair market value of assets and liabilities rather than a firm’s “historical book.” Liquidation value is another way of using a company’s balance sheet to arrive at a value. In this method, you simply calculate what’s left after the assets are sold and the debts are paid. What’s left is the value.
• Market Comp Approach. In this approach, private companies are compared to comparable public companies. For example, if a similar public company is valued at say, 23 times current earnings, then that yardstick can be applied to estimate the value of the private company. When using multiples, private companies are usually adjusted downward because of the lack of liquidity in exchanging shares for cash. Non-financial comparisons might include companies with similar products, markets, or industry criteria. Financial comparisons might include size (revenues), EBITDA, cash flow, price to book, price to earnings, or M & A comps.
• Discounted Cash Flow Approach. Simply stated, this means that an analyst capitalizes an anticipated income stream or cash flow in the future. This is accomplished by discounting a company’s future income or cash flow at an assumed opportunity cost of capital, which takes into account the risk or uncertainty in future cash flows. This is called bringing future anticipated income to “present value.” This approach will generally, but not always, produce the highest value.

Most companies are valued for the purposes of a sale, merger, or investment. For this reason, we must mention the concepts of fair market value and investment value. Fair market value is the value established between a willing buyer and a willing seller – it’s just that simple. And even though a seller and buyer may arrive at fair market value in entirely different ways, in essence, it doesn’t matter. Investment value on the other hand, is generally regarded as FMV adjusted (upward) for the special benefits that a buyer accrues from acquiring the new entity. These benefits might include cost savings or added purchasing power.

The good news is that regardless of the valuation method employed or how the value is determined, no one can claim, “You’re Wrong.” But, do keep in mind that not everyone will necessarily agree with your assessment, and may question the underlying assumptions that led to your valuation. For serious valuations, there are a number of professional services providers throughout the United States that specialize in valuing private companies.

I spent nine years running a US subsidiary of a Germany company. Their obsession (at least the group I worked for) with metrics gave me an appreciation for the power of metrics to elevate the performance of individuals and organizations.

The terms “metrics” and “performance indicators” are used synonymously. Most companies use some level of financial metrics for performance reporting to stakeholders. The focus of this article is on using metrics for performance improvement.

The value of written goals has been discussed in hundreds of business and self help books. What is often missing or understated is the critical process of quantitatively tracking the progress towards achievement of the stated goals. Without the appropriate metrics, there is no accountability and little chance of goal achievement.

Metrics create an environment of accountability throughout the organization. An organization that closely tracks performance indicators or metrics creates a culture where goal achievement is the norm and where there is no room for mediocrity.

These performance indicators also provide a way to convey corporate goals to the organization in a tangible form and get buy-in at all levels. It also sets an example that the company management is holding itself accountable for success.

How do you know what performance indicators you should be tracking in your business?

1. Start with your strategic plan and the goals you have set for the organization. List the general topics that relate to the goals i.e. customer service, asset utilization, financial performance, market share, employee retention, etc.
2. List critical success factors for each topic that if achieved, will directly contribute to attaining each goal.
3. Define a specific metric for each critical success factor that will track progress towards its achievement.

Just as the attainment of goals can be chunked down into components that can be delegated in the form of individual objectives, the associated metrics can likewise be used to create accountability for groups or individuals and thus align effort within the organization.

Metrics are important for reporting performance to stakeholders and for making fact-based decisions. The real power of metrics comes from creating the accountability that drives performance improvement. Consider adopting the “metrics obsession” like my friends in Germany. It will do wonders for your business.

“We promise according to our hopes, and perform according to our fears”
– Abraham Lincoln

Jerry S, one of our friends in the medical device market, was recently asked a question that many others out there have also probably had:

I have an idea for a medical appliance that I do not believe is currently on the market. I have no engineering background and have no idea where to start to get this idea evaluated, mocked up, and potentially marketed.

I know there are web sites that promise to promote inventions but I’m squeamish about them. Does anyone have any ideas of where I might go to get the idea looked at and potentially developed? (If it helps any, the idea is in the area of respiratory care.)

Here’s what Jerry had to say in response:

I can give you the perspective of a medical device inventor with almost 40 years in the medical device industry.

First you need to come up with a sufficiently vague description of your invention so that you can talk about it without losing key patent rights here or abroad. For a “ball-park” quick estimate of the viability of this idea, you can follow these steps.

You need to see if the idea is for a “must-have” or “nice-to-have” product. If it’s the former, talk to several potential customers about what the product does, how it would help the patient, why it’s better than existing products, how much the potential customer would be willing to pay for the device, whether there are similar products already cleared for marketing by the FDA, whether the use of those other products in a medical procedure has been assigned a CPT (Common Procedural Terminology) code by the AMA (American Medical Association), how long it will take to perform this procedure, whether insurance companies (called third party payers, and including Medicare) will pay (reimburse) the healthcare provider for performing the procedure and how much the reimbursement is in, say, Manhattan, NY (one of the highest reimbursed regions in the US.) You may have to guess at the manufacturing cost of a device you have not designed yet, but if there is a similar device on the market and it’s not too complex, you could guess that cost as less than 20% of the selling price.

If your idea is for a single-use disposable device, you will need to calculate if its delivered cost is significantly less that the “technical component,” or TC, of the reimbursement amount. Finally you will need to calculate if use of your disposable device is worth the doctor’s time, especially if you are going to try to influence them to use a procedure involving your device instead of another procedure using a competitor’s existing device; you calculate the “return on time” (R.O.T.) by dividing the professional component (PC) of the reimbursement by the time to do the procedure. If you are likely to achieve at least as good a clinical result as existing equipment but with a higher R.O.T. then doctors are more likely to use your invention.

If your idea is for capital equipment that the doctor buys, then you need to calculate how many times a week that equipment will be used, how much the total reimbursements (TC + PC) will be per week, and calculate how many weeks it will take the doctor to break even. Many doctors in private practice are happy to break even in a year. You will still need to calculate the R.O.T. for your device versus the competition (where now you use both components of the reimbursement in the calculation) and show the doctor an advantage.

Again, this is very rough estimate, given that your product idea is not a costed-out design. But if the quick analyses above indicate that you will have an advantage over your competition and that you can generate enough revenue to support a company (or other options), it will be worth taking the next step and consulting a patent agent or attorney to protect your idea, and the folks that can turn the idea into a product.

Of course, Jerry didn’t have much information to base his answer on, but he offers a lot of great insights for entrepreneurs considering the feasibility of a medical device venture.

We were recently asked an interesting question:

I am looking at few strong competing product ideas for our next product. The factors I am already looking into are:
1. Expected short term and long term business potential
2. Competitor products, their market and platform valuations
3. Barrier to entry for new competition
4. Key applications where this platform can be applicable

The IP is probably not defendable but I will anyway check with my lawyers.

I am having a hard time evaluating proper business potential of an idea in Web 2.0 space.

How would you generally compare ad based revenue model with subscription based web service model?

Here’s my initial response to the question:

Your best bet, in my opinion, is to cheaply implement and release free beta versions of all of your product ideas, and let the user community decide which one(s) you want to devote further resources to. Don’t let the revenue model slow you down – you can resolve this once you have a user community. Don’t waste your time on trying to do a lot of quantitative analysis before you launch, since this is at best a guessing game prior to launch. Just focus your resources on creating something of use to users, and get validation of your concept from the market – almost everything else (apart from IP issues, in certain circumstances) – is putting the cart before the horse.

In other words, Just Do It.

There are four basic types of business plans, each serving a different purpose and audience. How you prepare your plan depends in part on the type you are preparing:

• The “Idea” Business Plan: This is basically an extended executive summary, anywhere from 5-10 pages in length, in which you brainstorm and set down the broad outlines of your venture: what problem you are solving; how big the problem is; how your venture solves the problem; why your solution is substantially better than competing solutions; how you will sell it; what resources (people, money, partners, etc.) you require to make it happen; etc. The purpose of the Idea Plan is to help you decide whether or not you have a worthwhile venture. If yes, you can use the Idea Business Plan to recruit co-founders who share your vision and get everybody on the same page. As your founding team develops, this document may go through many changes as new team members make their contributions.
• The “Operating” Business Plan: This is a thick 3-ring binder that develops over time and never stops evolving. As the name suggests, it contains the myriad details and benchmarks documenting exactly how you plan to operate your business. It contains items like the detailed operating budget, detailed market and competitor research and analysis, product design specs, sales prospect lists, partner acquisition strategies, intellectual property strategy, and anything else that guides the growth of the venture.
• The “Equity Funding” Business Plan: This is used to persuade potential angel, venture capital, and corporate investors to take a closer look at your company. It is typically 20-25 pages in length, and expands on and refines the issues covered in the Idea Plan. The objective is to get a potential investor to invite you to meet with them, nothing more. It conveys excitement, opportunity, and competence without using any hype. It is flawless and beautiful to look at. Equity investors swing for the fence, and you need to help them visualize hitting that home run.
• The “Bank Funding” Business Plan: This is used to obtain a bank loan. Bankers are generally very conservative. They want their 10% and get their money back at the end of the loan. Bank funding is usually only available if you either have a solid operating history with positive cash flows or can put up collateral to cover the loan (for a startup, this means your house). The Bank Funding Plan focuses on persuading the banker that you can satisfy these needs through historical financial ratios, assets, etc.

So, as you sit down and start your plan, give some thought to what you are really trying to achieve. Avoid the temptation to prepare a plan that tries to be all things to all people.