The real, more complete story of entrepreneurship is not about the famous people in Table 7.2—its mostly about people you've probably never heard of. They have built companies, thrived personally, created jobs, and made positive contributions to their communities through their businesses. Or they're just starting out.
SOURCES: J. A. Timmons, New Venture Creation, 6th ed. (New York: McGraw-Hill/Irwin, 2004), p. 7. © 2004 The McGraw-Hill Companies.
Immigrants also may find conventional paths to economic success closed to them and turn to entrepreneurship.19 For example, the Cuban community in Miami has produced many successful entrepreneurs, as has the Vietnamese community throughout the United States. Sometimes the immigrant's experience gives him or her useful knowledge about foreign suppliers or markets that present an attractive business opportunity. Rakesh Kamdar immigrated to the United States from India to study computer science, but while here, he saw a way he could meet the huge U.S. demand for nursing talent. He set up DB Healthcare to recruit nurses from India to work in the United States. Unlike U.S. competitors that had failed, Kamdar set up meetings at DB's Indian offices, and he invited nurses to attend with their husbands, parents, and in-laws. His staff discussed family and individual questions related to the American jobs. With this strategy, DB Healthcare was earning millions of dollars within a few years.20p. 242
SOURCE: J. A. Timmons, New Venture Creation, 6th ed. (New York: McGraw-Hill/Irwin, 2004), p. 67–68 exhibit 20.13. © 2004 The McGraw-Hill Companies.
What Does It Take to Succeed?
What can we learn from the people who start their own companies and succeed? What talents enable entrepreneurs to succeed? We express these characteristics in general terms with Figure 7.1. Successful entrepreneurs are innovators and also have good knowledge and skills in management, business, and networking.21 In contrast, inventors may be highly creative but often lack the skills to turn their ideas into a successful business. Manager-administrators may be great at ensuring efficient operations but aren't necessarily innovators. Promoters have a different set of marketing and selling skills—useful for entrepreneurs, but those skills can be hired, whereas innovativeness and business management skills remain the essential combination for successful entrepreneurs.
What Business Should You Start?
The Idea Many entrepreneurs and observers say that in contemplating your business, you must start with a great idea. A great product, a viable market, and good timing are essential ingredients in any recipe for success.
Many great organizations have been built on a different kind of idea: the founder's desire to build a great organization, rather than to offer a particular product.23 Examples abound. Bill Hewlett and David Packard decided to start a company and then figured out what to make. J. Willard Marriott knew he wanted to be in business for himself but didn't have a product in mind until he opened an A&W root beer stand. Masaru Ibuka had no specific product idea when he founded Sony in 1945. Sony's first product attempt, a rice cooker, didn't work, and its first product (a tape recorder) didn't sell. The company stayed alive by making and selling crude heating pads.
Many now-great companies had early failures. But the founders persisted; they believed in themselves and in their dreams of building great organizations. Be prepared to kill or revise an idea, but never give up on your company—this has been a prescription for success for many great entrepreneurs and business leaders. Think about Sony, Disney, Hewlett-Packard, Procter & Gamble, IBM, and Wal-Mart: their founders' greatest achievements—their greatest ideas—are their organizations.25p. 244
To spot opportunities, think carefully about events and trends as they unfold. Consider, for example, the following possibilities:28
Franchises One important type of opportunity is the franchise. You may know intuitively what franchising is. Or, at least you can name some prominent franchises: McDonald's, Jiffy Lube, the Body Shop, Dunkin' Donuts, add your favorites here. Franchising An entrepreneurial alliance between a franchisor (an innovator who has created at least one successful store and wants to grow) and a franchisee (a partner who manages a new store of the same type in a new location). is an entrepreneurial alliance between two organizations, the franchisor and the franchisee.32 The franchisor is the innovator who has created at least one successful store and seeks partners to operate the same concept in other local markets. For the franchisee, the opportunity is wealth creation via a proven (but not failureproof) business concept, with the added advantage of the franchisor's expertise. For the franchisor, the opportunity is wealth creation through growth. The partnership is manifest in a trademark or brand, and together the partners' mission is to maintain and build the brand. The Noodles & Company chain of fast-casual restaurants first grew by opening 79 company-owned locations. Management concluded that it could grow at a faster pace through franchising. Establishing standard menus and prices took a year, but franchising has helped the company almost double its revenues in just two years.33p. 245
People often assume that buying a franchise is less risky than starting a business from scratch, but the evidence is mixed. One study that followed businesses for six years found the opposite of the popular assumption: 65 percent of the franchises studied were operating at the end of the period, while 72 percent of independent businesses were still operating. One reason may be that the franchises involved mostly a few, possibly riskier, industries. A study that compared only restaurants over a three-year period found that 43 percent of the franchises and 39 percent of independent restaurants remained in business.35
If you are contemplating a franchise, consider its market presence (local, regional, or national), market share and profit margins, national programs for marketing and purchasing, the nature of the business, including required training and degree of field support, terms of the license agreement (e.g., 20 years with automatic renewal versus less than 10 years or no renewal), capital required, and franchise fees and royalties.36
Although some people think success with a franchise is a no-brainer, would-be franchisees have a lot to consider. Luckily, plenty of useful sources exist for learning more, including the International Franchise Association (http://www.franchise.org), the Small Business Administration (http://www.sba.gov), Franchise Chat (http://www.franchise-chat.com), and the Business Franchise Directory (http://www.business-franchisedirectory.com). In addition, the Federal Trade Commission investigates complaints of deceptive claims by franchisors and publishes information about those cases. Dale Cantone, who heads the Franchise and Business Opportunities unit for Maryland's attorney general, advises people to take their time in investigating business opportunities, consulting with an accountant or lawyer who has experience in franchising.37
The Next Frontiers The next frontiers for entrepreneurship—where do they lie? Throughout history, aspiring entrepreneurs have asked this question. When a business magazine asked prominent investors in new businesses to name the best ideas for a new start-up, their responses included next-generation batteries with enough juice to power cars after a seconds-long charge, longer-lasting tiny batteries to keep cell phones and cameras running for more hours, implantable wireless devices that can monitor heartbeats or blood sugar levels, and online social networking sites that focus on allowing artists and musicians to share and promote their works.38p. 246
One fascinating opportunity for entrepreneurs is outer space. Historically, the space market was driven by the government and was dominated by big defense contractors such as Boeing and Lockheed Martin. But now, with demand for satellite launches and potential profits skyrocketing, smaller entrepreneurs are entering the field. Some of the most dramatic headlines involve space tourism. Zero Gravity already operates flights in converted Boeing 727 jets that simulate the experience of weightlessness by flying up and down like a roller-coaster 10,000 feet above the earth. Famous passengers who signed up for the $3,500 flights have included business owner Martha Stewart and physicist Stephen Hawking.39 Other recent ventures in space have included using satellites for automobile navigation, tracking trucking fleets, and monitoring flow rates and leaks in pipelines; testing designer drugs in the near-zero-gravity environment; and using remote sensing to monitor global warming, spot fish concentrations, and detect crop stress for precision farming.
Homeland security is another newly burgeoning industry. A vast number of companies in a wide range of industries are attempting to benefit—for example, baggage screening, smallpox vaccines, capturing arrival and departure information on travelers, explosives detection systems, and sensors for airborne pathogens. Some of the growth is supported by government investment in security-related technology. For example, the state of Illinois recently gave grants to SSS Research, which develops database software that helps terrorism analysts, and RiverGlass, which develops software that connects databases to find patterns describing high-risk people. In Michigan, the state-funded Venture Michigan I Fund supports investment in Michigan-based start-ups in the security and other growth industries.40
The Internet The Internet is a business frontier that continues to expand. With Internet commerce, as with any start-up, entrepreneurs need sound business models and practices. During the heady days of the Internet rush, many entrepreneurs and investors thought revenues and profits were unimportant and all that mattered was to attract visitors to their Web sites (“capture eyeballs”). But you need to watch costs carefully, and you want to break even and achieve profitability as soon as possible.41
At least five successful business models have proven successful in the e-commerce market: transaction fee, advertising support, intermediary, affiliate, and subscription models.42 In the transaction fee model Charging fees for goods and services., companies charge a fee for goods or services. Amazon.com and online travel agents are prime examples. In the advertising support model Charging fees to advertise on a site., advertisers pay the site operator to gain access to the demographic group that visits the operator's site. More than one-third of online ads are for financial services, and another 22 percent are for Web media. More than half of the ads appear on e-mail pages.43
The intermediary model Charging fees to bring buyers and sellers together. has eBay as the premier example, bringing buyers and sellers together and charging a commission for each sale. With the affiliate model Charging fees to direct site visitors to other companies' sites., sites pay commissions to other sites to drive business to their own sites. Zazzle.com, Spreadshirt.com, and CafePress.com are variations on this model. They sell custom-decorated gift items such as mugs and T-shirts. Designers are the affiliates; they choose basic, undecorated products (such as a plain shirt) and add their own designs, creating the customized products offered to consumers. Visitors to a designer's Web site can link to, say, Zazzle and place an order, or they can go directly to Zazzle to shop. Either way, Zazzle sets the basic price, and the designer gets about 10 percent. Spreadshirt and CafePress let designers choose how much above the base price they want to charge consumers for the decorated product.44 Finally, Web sites using the subscription model Charging fees for site visits. charge a monthly or annual fee for site visits or access to site content. Newspapers and magazines are good examples.p. 247
What about businesses whose primary focus is not e-commerce? Start-ups and established small companies can create attractive Web sites that add to their professionalism, give them access to more customers, and bring them closer to suppliers, investors, and service providers. Traditional companies can move much more quickly than in the past and save money on activities including customer service/support, technical support, data retrieval, public relations, investor relations, selling, requests for product literature, and purchasing. All this is possible even as the costs of computing continue to drop and as more free software tools are being disseminated. As a result, setting up shop online costs less than it ever did.
Munjal Shah's company, Riya, has set up an online shopping service called Like.com, which uses visual recognition software to help shoppers find products that look similar to one another. The search software, Shah says, was based on open-source programs and cost about $50,000; five years ago, it would have been unaffordable. In addition, because current computer chips work more efficiently, the cost to run Riya's Web servers is about one-tenth of what he would have paid a few years ago.45
What Does It Take, Personally?
Many people assume that there is an “entrepreneurial personality.” No single personality type predicts entrepreneurial success, but you are more likely to succeed as an entrepreneur if you exhibit certain characteristics:46
Bill Gross, whom you met in our earlier discussion of “Why Become an Entrepreneur,” exemplifies some of these characteristics. He persevered even after his brainchild, Idealab, seemed to have crashed and burned. The company was launched in the mid-1990s to nurture Internet start-ups as they were being formed left and right. Companies that Idealab invested in included eToys, Eve.com, and Pet-Smart.com. If you haven't heard of them, it's probably because they grew fast and then went out of business because sales couldn't keep up with the hype and the hopes. Today Gross explains that he hadn't intended for Idealab to help exclusively dot-com businesses, but that's what entrepreneurs were all starting in the 1990s. When the Internet boom crashed several years ago, Gross laid off employees and shuttered offices, but he didn't abandon his vision of helping entrepreneurs. Instead of giving up, Gross established stricter criteria for funding companies in the future—and determined that he would choose companies whose activities make a difference. Of the company's near failure, Gross says, “We have a lot more wisdom now,” admitting that he might have needed to learn wisdom the hard way.49p. 248
Compare these qualities and examples of successful entrepreneurs with the description of Richard Branson in the “Management Close-Up: Taking Action” feature. How well does Branson fit the mold of a typical entrepreneur?
Making Good Choices Success is a function not only of personal characteristics but also of making good choices about the business you start. Figure 7.2 presents a model for conceptualizing entrepreneurial ventures and making the best possible choices. It depicts ventures along two dimensions: innovation and risk. The new venture may involve high or low levels of innovation, or the creation of something new and different. It can also be characterized by low or high risk. Risk refers primarily to the probability of major financial loss. But it also is more than that; it is psychological risk as perceived by the entrepreneur, including risk to reputation and ego.51p. 249
SOURCE: Reprinted from Business Horizons, May–June 1997, Sonfield and Lussier, “Entrepreneurial Strategy Matrix: A Model of New and Ongoing Ventures,” Copyright © 1997, with permission from Elsevier.
The upper-left quadrant, high innovation/low risk, depicts ventures of truly novel ideas with little risk. As examples, the inventors of Lego building blocks and Velcro fasteners could build their products by hand, at little expense. A pioneering product idea from Procter & Gamble might fit here if there are no current competitors and because, for a company of that size, the financial risks of new product investments can seem relatively small.
In the upper-right quadrant, high innovation/high risk, novel product ideas are accompanied by high risk because the financial investments are high and the competition is great. A new drug or a new automobile would likely fall into this category.
Most small business ventures are in the low innovation/high risk cell (lower right). They are fairly conventional entries in well-established fields. New restaurants, retail shops, and commercial outfits involve high investment for the small business entrepreneur and face direct competition from other similar businesses. Finally, the low innovation/low risk category includes ventures that require minimal investment and/or face minimal competition for strong market demand. Examples are some service businesses having low start-up costs and those involving entry into small towns if there is no competitor and demand is adequate.
How is this matrix useful? It helps entrepreneurs think about their ventures and decide whether they suit their particular objectives. It also helps identify effective and ineffective strategies. You might find one cell more appealing than others. The lower-left cell is likely to have relatively low payoffs but to provide more security. The higher risk/return trade-offs are in other cells, especially the upper right. So you might place your new-venture idea in the appropriate cell and determine whether that cell is the one in which you would prefer to operate. If it is, the venture is one that perhaps should be pursued, pending fuller analysis. If it is not, you can reject the idea or take steps to move it toward a different cell.
The matrix also can help entrepreneurs remember a useful point: Successful companies do not always require a cutting-edge technology or an exciting new product. Even companies offering the most mundane products—the type that might reside in the lower-left cell—can gain competitive advantage by doing basic things differently from and better than competitors.
Success and Failure
Estimated failure rates for start-ups vary. Most indicate that failure is more the rule than the exception. The failure rate is high for certain businesses like restaurants and lower for successful franchises. Start-ups have at least two major liabilities: newness and smallness.54 New companies are relatively unknown and need to learn how to be better than established competitors at something that customers value. Regarding smallness, the odds of surviving improve if the venture reaches a critical mass of at least 10 or 20 people, has revenues of $2 million or $3 million, and is pursuing opportunities with growth potential.55
Acquiring venture capital is not essential to the success of most start-up businesses; in fact, it is rare. Recent numbers from the Census Bureau say that more than three-fourths of start-up companies with employees were financed by entrepreneurs' own assets or assets of their families. Approximately 1 out of 10 businesses were financed with the owners' credit cards.56 Still, in a recent quarter, venture capital firms invested more than $6 billion in almost 800 deals;57 that's a sizable amount of money, even if the fraction of total new companies is small. And venture capital firms often provide expert advice that helps entrepreneurs improve the odds for success.
To understand further the factors that influence success and failure, we'll consider risk, the economic environment, various management-related hazards, and initial public stock offerings (IPOs).p. 251
Risk You learned about risk in Chapter 3. It's a given: Starting a new business is risky. Entrepreneurs with plenty of business experience are especially aware of this. When Chris McGill was evaluating his idea for Mixx.com, a news Web site that could be personalized based on recommendations by users, he was USA Today's vice president of strategy. To make Mixx succeed, McGill knew he would be leaving a well-paying job for an uncertain future in which he had to line up financing and hire talented people in a turbulent business environment. But McGill also concluded that his experience at USA Today and prior management experience with Yahoo News gave him the knowledge and connections for a successful Internet business.59
Successful entrepreneurs are realistic about risk. They anticipate difficulties and cushion their business to help it weather setbacks. In downtown Seattle, entrepreneurs Ben and Cindi Raykovich saw a risk when a major construction project began disrupting traffic around their store, Sound Sports. The Raykoviches had built their business around serving running enthusiasts who worked downtown and would stop by on their lunch hour or after work. Concerned that the construction would drive away so much business that the store couldn't survive, they opened a second location in the community of Poulsbo. They intend for the second store to supplement revenue, and if they need to close the first store, they can continue to build their business in Poulsbo. Ben Raykovich is hardly cavalier about the situation: “My life is invested in this business. We need to spread out the risk.”60
The Role of the Economic Environment Entrepreneurial activity stems from the economic environment as well as the behavior of individuals. For example, money is a critical resource for all new businesses. Increases in the money supply and the supply of bank loans, real economic growth, and improved stock market performance lead to both improved prospects and increased sources of capital. In turn, the prospects and the capital increase the rate of business formation. Under favorable conditions, many aspiring entrepreneurs find early success. But economic cycles soon change favorable conditions into downturns. To succeed, entrepreneurs must have the foresight and talent to survive when the environment becomes more hostile.
Although good economic times may make it easier to start a company and to survive, bad times can offer an opportunity to expand. Ken Hendricks of ABC Supply found a business opportunity in a grim economic situation: a serious downturn in the manufacturing economy of the Midwest contributed to the shutdown of his town's largest employer, the Beloit Corporation. Hendricks purchased the company's buildings and lured a diverse group of new employers to town, in spite of the economic challenges. In fact, Hendricks has a track record of turning around the struggling suppliers that ABC acquires.61 Another silver lining in difficult economic times is that it's easier to recruit talent.p. 252
Business Incubators The need to provide a nurturing environment for fledgling enterprises has led to the creation of business incubators. Business incubators Protected environments for new, small businesses., often located in industrial parks or abandoned factories, are protected environments for new, small businesses. Incubators offer benefits such as low rents and shared costs. Shared staff costs, such as for receptionists and secretaries, avoid the expense of a full-time employee but still provide convenient access to services. The staff manager is usually an experienced businessperson or consultant who advises the new business owners. Incubators often are associated with universities, which provide technical and business services for the new companies.
The heyday of business incubators came in the 1990s, when around 700 of them were financing start-ups, mainly emphasizing technology. Eight out of 10 shut down following the collapse of the Internet bubble, but the idea of nurturing new businesses persists. Naval Ravikant, for example, is developing a company tentatively named Hit Forge, which resembles the dot-com incubators. Hit Forge hired four engineers with experience in launching successful Internet concepts. The engineers have wide latitude to try ideas, but they work under strict deadlines. They must go from concept to product within 90 days, and any enterprises that aren't growing after a year will be terminated. Unlike the older-style incubator, Hit Forge lets engineers work from the location of their choice, and the engineers retain half ownership in the ventures they develop. Also, whereas incubators in the 1990s might have spent $2 million developing an idea, today's launches might cost just $50,000.62
You Might Not Enjoy It Some managers and employees can specialize in what they love, whether it's selling or accounting. But entrepreneurs usually have to “do it all,” at least in the beginning. If you love product design, you also have to sell what you invent. If you love marketing, get ready to manage the money, too. This last challenge was almost a stumbling block for Elizabeth Busch, Anne Frey-Mott, and Beckie Jankiewicz when they launched The Event Studio to run business conferences for their clients. All three women had experience with some aspect of running conferences, but when they started their company, they didn't fully think out all the accounting decisions they would need for measuring their income and cash flow. With some practical advice, they learned some basic accounting lessons that helped them avoid tax troubles later on.63 If they hadn't been willing to learn new skills, entrepreneurship might not have been the right career path for them.
Survival Is Difficult Zappos cofounder Tony Hsieh says, “We thought about going under every day—until we got a $6 million credit line from Wells Fargo.”64 Companies without much of a track record tend to have more trouble lining up lenders, investors, and even customers. When economic conditions cool or competition heats up, a small start-up serving a niche market may have limited options for survival. Gary Gottenbusch worried when orders slowed at his Servatii Pastry Shop and Deli, located in Cincinnati. As a recession hit Ohio hard, customers were deciding that fancy breads and cakes were a luxury they could go without. Servatii might have closed, but Gottenbusch was willing to change. He kept afloat and even added to sales by cultivating new distribution channels (sales in hospitals), new products (distinctive pretzel sticks), and cost-cutting measures (a purchasing association with other bakers in the area).65p. 253
Failure can be devastating. When Mary Garrison wanted to own a business, she chose the women's fitness industry and decided to buy a franchise from Lady of America Franchise Corporation. But when she held her grand opening, not a single person stopped by. Three months later, she closed. Garrison blames the franchisor for not providing the necessary promotional support, a complaint that Lady of America denies.66
Growth Creates New Challenges Just one in three Inc. 500 companies keeps growing fast enough to make this list of fastest-growing companies two years running. The reason: They are facing bigger challenges, competing with bigger firms, stretching the founders' capacities, and probably burning cash. Consultant Doug Tatum calls this phase of a company's growth “No Man's Land.”68 It's a difficult transition.
The transition is particularly complex for entrepreneurs who quickly face the possibility of expanding internationally. Whether a firm should expand internationally soon after it is created or wait until it is better established is an open question. Entering international markets should help a firm grow, but going global is also likely to create challenges that make survival more difficult, especially when the company is young. For instance, when Lou Hoffman decided to expand his public relations (PR) firm to Japan, to grow alongside existing clients, he was prepared for language and cultural differences but not for the high cost of doing business in that country. He first tried partnering with a translation service, figuring they could share expertise and help each other expand. But the translators really weren't interested in the PR business, so a year later, he was staffing the enterprise from scratch. Then Hoffman decided to open a Chinese office, and in that country, he couldn't find anyone familiar with both Chinese business and the creative business culture that had served his agency well. So he hired a Chinese PR staffer who was willing to spend a year at his California headquarters, just absorbing the business culture. That method worked for the Chinese market but flopped when Hoffman tried it for opening a London office; the British employee didn't want to leave the California lifestyle and return home.69 Of course, the risks tend to be lower when entrepreneurs (or their company's managers) have experience in serving foreign markets.70p. 254
In the beginning, the start-up mentality tends to be “we try harder.”71 Entrepreneurs work long hours at low pay, deliver great service, get good word-of-mouth, and their business grows. At first, it's “high performance, cheap labor.” But with growth comes the need to pay higher wages to hire more people who are less dedicated than the founders. Then it's time to raise prices, establish efficient systems, or accept lower profits. The founder's talents may not spread to everyone else. You need a unique value proposition that will work as well with 100 employees, because hard work or your instincts alone no longer will get the job done. Complicating matters is the continuing growth in customers' needs and expectations.72
It's Hard to Delegate As the business grows, entrepreneurs often hesitate to delegate to other people work that they are used to doing. Leadership deteriorates into micromanagement, in which managers monitor too strictly, to the minutest detail. For example, during the Internet craze many company founders with great technical knowledge but little experience became “instant experts” in every phase of business, including branding and advertising.75 Turns out, they didn't know as much as they thought, and their companies crashed. In contrast, Darren Herman kept his focus on what he knows. While still in his early 20s, Herman took his passion for videogames and his knowledge of marketing and came up with a business idea: IGA Worldwide, which works with advertisers and game developers to place advertising within videogames. Shortly after he had launched IGA, Herman turned over the job of CEO to a more experienced person and named himself “senior business development director,” which means he focuses on spotting new ideas and promoting the company to investors.76
Misuse of Funds Many unsuccessful entrepreneurs blame their failure on inadequate financial resources. Yet failure due to a lack of financial resources doesn't necessarily indicate a real lack of money; it could mean a failure to properly use the available money. A lot of start-up capital may be wasted—on expensive locations, great furniture, and fancy stationery. Entrepreneurs who fail to use their resources wisely usually make one of two mistakes: they apply financial resources to the wrong uses, or they maintain inadequate control over their resources.
This problem may be more likely when a lucky entrepreneur gets a big infusion of cash from a venture capital firm or an initial offering of stock. For most start-ups, where the money on the line comes from the entrepreneur's own assets, he or she has more incentive to be careful. Tripp Micou, founder of Practical Computer Applications, says, “If all the money you spend is based on what you're bringing in [through sales], you very quickly focus on the right things to spend it on.”78 Micou, an experienced entrepreneur, believes that this financial limitation is actually a management advantage.p. 255
Poor Controls Entrepreneurs, in part because they are very busy, often fail to use formal control systems. One common entrepreneurial malady is an aversion to record keeping. Expenses mount, but records do not keep pace. Pricing decisions are based on intuition without adequate reference to costs. As a result, the company earns inadequate margins to support growth.
Even in high-growth companies, great numbers can mask brewing problems. Blinded by the light of growing sales, many entrepreneurs fail to maintain vigilance over other aspects of the business. In the absence of controls, the business veers out of control. So don't get overconfident; keep asking critical questions. Is our success based on just one big customer? Is our product just a fad that can fade away? Can other companies easily enter our domain and hurt our business? Are we losing a technology lead? Do we really understand the numbers, know where they come from, and have any hidden causes for concern?
Mortality One long-term measure of an entrepreneur's success is the fate of the venture after the founder's death. Founding entrepreneurs often fail to plan for succession. When death occurs, estate tax problems or the lack of a skilled replacement for the founder can lead to business failure.
Management guru Peter Drucker offered the following advice to help family-managed businesses survive and prosper.80 Family members working in the business must be at least as capable and hard-working as other employees; at least one key position should be filled by a nonfamily member; and someone outside the family and the business should help plan succession. Family members who are mediocre performers are resented by others; outsiders can be more objective and contribute expertise the family might not have. Issues of management succession are often the most difficult of all, causing serious conflict and possible breakup of the firm.
Going Public Sometimes companies reach a point at which the owners want to “go public.” Initial public stock offerings (IPOs) Sale to the public, for the first time, of federally registered and underwritten shares of stock in the company. offer a way to raise capital through federally registered and underwritten sales of shares in the company.81 You need lawyers and accountants who know current regulations. The reasons for going public include raising more capital, reducing debt or improving the balance sheet and enhancing net worth, pursuing otherwise unaffordable opportunities, and improving credibility with customers and other stakeholders—“you're in the big leagues now.” Disadvantages include the expense, time, and effort involved; the tendency to become more interested in the stock price and capital gains than in running the company properly; and the creation of a long-term relationship with an investment banking firm that won't necessarily always be a good one.82
Many entrepreneurs prefer to avoid going public, feeling they'll lose control if they do. States Yvon Chouinard of sports and apparel firm Patagonia: “There's a certain formula in business where you grow the thing and go public. I don't think it has to be that way. Being a closely held company means being able to take risks and try new things—the creative part of business. If I were owned by a bunch of retired teachers, I wouldn't be able to do what I do; I'd have to be solely concerned with the bottom line. For us to go public would be suicide.”83p. 256
Executing IPOs and other approaches to acquiring capital is complex, legalistic, and beyond the scope of this chapter. Sources for more information include The Ernst & Young Guide to Raising Capital, the National Venture Capital Association (www.nvca.org), VentureOne (http://www.ventureone.com), and VentureWire (link to this publication from http://www.venturecapital.dowjones.com/).
Increasing Your Chances of Success
Planning So you think you have identified a business opportunity. And you have the personal potential to make it a success. Now what? Where should you begin?
The Business Plan Your excitement and intuition may convince you that you are on to something. But they might not convince anyone else. You need more thorough planning and analysis. This effort will help convince other people to get on board and help you avoid costly mistakes.
The first formal planning step is to do an opportunity analysis. An opportunity analysis A description of the good or service, an assessment of the opportunity, an assessment of the entrepreneur, specification of activities and resources needed to translate your idea into a viable business, and your source(s) of capital. includes a description of the good or service, an assessment of the opportunity, an assessment of the entrepreneur (you), a specification of activities and resources needed to translate your idea into a viable business, and your source(s) of capital.84Table 7.3 shows the questions you should answer in an opportunity analysis.
The opportunity analysis, or opportunity assessment plan, focuses on the opportunity, not the entire venture. It provides the basis for making a decision on whether to act. Then, the business plan A formal planning step that focuses on the entire venture and describes all the elements involved in starting it. describes all the elements involved in starting the new venture.85 The business plan describes the venture and its market, strategies, and future directions. It often has functional plans for marketing, finance, manufacturing, and human resources.
Table 7.4 shows an outline for a typical business plan. The business plan (1) helps determine the viability of your enterprise, (2) guides you as you plan and organize, and (3) helps you obtain financing. It is read by potential investors, suppliers, customers, and others. Get help in writing up a sound plan!
SOURCE: R. Hisrich and M. Peters, Entrepreneurship: Starting, Developing, and Managing a New Enterprise, table, p. 41 Copyright © 1998 by The McGraw-Hill Companies.p. 257
SOURCE: J. A. Timmons, New Venture Creation, 5th ed., p. 374. Copyright © 1999 by Jeffry A. Timmons. Reproduced with permission of the author. © 1999 The McGraw-Hill Companies.
Key Planning Elements Most business plans devote so much attention to financial projections that they neglect other important information—information that matters greatly to astute investors. In fact, financial projections tend to be overly optimistic. Investors know this and discount the figures. In addition to the numbers, the best plans convey—and make certain that the entrepreneurs have carefully thought through—five key factors: the people, the opportunity, the competition, the context, and risk and reward.86p. 258
The people should be energetic and have skills and expertise directly relevant to the venture. For many astute investors, the people are the most important variable, more important even than the idea. Venture capital firms often receive 2,000 business plans per year; many believe that ideas are a dime a dozen and what counts is the ability to execute. Arthur Rock, a legendary venture capitalist who helped start Intel, Teledyne, and Apple, stated, “I invest in people, not ideas. If you can find good people, if they're wrong about the product, they'll make a switch.”87
The opportunity should provide a competitive advantage that can be defended. Customers are the focus here: Who is the customer? How does the customer make decisions? How will the product be priced? How will the venture reach all customer segments? How much does it cost to acquire and support a customer, and to produce and deliver the product? How easy or difficult is it to retain a customer?
It is also essential to fully consider the competition. The plan must identify current competitors and their strengths and weaknesses, predict how they will respond to the new venture, indicate how the new venture will respond to the competitors' responses, identify future potential competitors, and consider how to collaborate with or face off against actual or potential competitors. The original plan for Zappos was for its Web site to compete with other online shoe retailers by offering a wider selection than they did. However, most people buy shoes in stores, so Zappos cofounders Nick Swinmurn and Tony Hsieh soon realized that they needed a broader view of the competition. They began focusing more on service and planning a distribution method that would make online shopping as successful as visiting a store.88
The environmental context should be a favorable one from regulatory and economic perspectives. Such factors as tax policies, rules about raising capital, interest rates, inflation, and exchange rates will affect the viability of the new venture. The context can make it easier or harder to get backing and to succeed. Importantly, the plan should make clear that you know that the context inevitably will change, forecast how the changes will affect the business, and describe how you will deal with the changes.
The risk must be understood and addressed as fully as possible. The future is always uncertain, and the elements described in the plan will change over time. Although you cannot predict the future, you must contemplate head-on the possibilities of key people leaving, interest rates changing, a key customer leaving, or a powerful competitor responding ferociously. Then describe what you will do to prevent, avoid, or cope with such possibilities. You should also speak to the end of the process: how to get money out of the business eventually. Will you go public? Will you sell or liquidate? What are the various possibilities for investors to realize their ultimate gains?90p. 259
Selling the Plan Your goal is to get investors to support the plan, so the elements of a great plan, as just described, are essential. It's also important whom you decide to try to convince to back your plan.
Many entrepreneurs want passive investors who will give them money and let them do what they want. Doctors and dentists generally fit this image. Professional venture capitalists do not, as they demand more control and more of the returns. But when a business goes wrong—and chances are, it will—nonprofessional investors are less helpful and less likely to advance more (needed) money. Sophisticated investors have seen sinking ships before and know how to help. They are more likely to solve problems, provide more money, and also navigate financial and legal waters such as going public.91
View the plan as a way for you to figure out how to reduce risk and maximize reward, and to convince others that you understand the entire new venture process. Don't put together a plan built on naïveté or overconfidence or one that cleverly hides major flaws. You might not fool others, and you certainly would be fooling yourself.
Nonfinancial Resources Also crucial to the success of a new business are nonfinancial resources, including legitimacy in the minds of the public and the various ways in which other people can help.
Legitimacy An important resource for the new venture is legitimacy People's judgment of a company's acceptance, appropriateness, and desirability, generally stemming from company goals and methods that are consistent with societal values.—people's judgment of a company's acceptance, appropriateness, and desirability.92 When the market confers legitimacy, it helps overcome the “liability of newness” that creates a high percentage of new-venture failure.93 Legitimacy helps a firm acquire other resources such as top managers, good employees, financial resources, and government support. In a three-year study tracking business start-ups, the likelihood that a company would succeed at selling products, hiring employees, and attracting investors depended most on how skillfully entrepreneurs demonstrated that their business was legitimate.94
A business is legitimate if its goals and methods are consistent with societal values. You can generate legitimacy by visibly conforming to rules and expectations created by governments, credentialing associations, and professional organizations; by visibly endorsing widely held values; and by visibly practicing widely held beliefs.95
Networks The entrepreneur is aided greatly by having a strong network of people. Social capital A competitive advantage in the form of relationships with other people and the image other people have of you.—being part of a social network, and having a good reputation—helps entrepreneurs gain access to useful information, gain trust and cooperation from others, recruit employees, form successful business alliances, receive funding from venture capitalists, and become more successful.96 Social capital provides a lasting source of competitive advantage.97
To see just some of the ways social capital can help entrepreneurs, consider a pair of examples. Brian Ko, an engineer who founded Integrant Technologies, got useful advice from his investors, including private investors, a bank, and venture-capital firms. One adviser taught Ko that acquiring patents during the start-up phase would help the company stay competitive during the long term, so Integrant spent the money to file applications for 150 patents in six years, positioning the company to protect its ideas as it gains market share and competitors' attention.98
Tim Litle has developed several successful innovations and businesses as a result of relationships with business school classmates and customers. Early in his career, a friend in politics wanted to target letters to different groups of citizens, and Litle worked with him to figure out how to do that now-common application with computers. He, the politician, and two other partners eventually built a business to provide the same service to marketers.99p. 260
Top-Management Teams The top-management team is another crucial resource. For example, Sudhin Shahani's start-ups include MyMPO, whose digital media services include Musicane, which lets musicians sell audio and video files and ringtones online at storefronts they create for themselves. The company's head of marketing was singer Will.i.am.100 Having a musician in that top spot may help Musicane build client relationships with other artists. Also, in companies that have incorporated, a board of directors improves the company's image, develops longer-term plans for expansion, supports day-to-day activities, and develops a network of information sources.
Advisory Boards Whether or not the company has a formal board of directors, entrepreneurs can assemble a group of people willing to serve as an advisory board. Board members with business experience can help an entrepreneur learn basics such as how to do cash-flow analysis; identify needed strategic changes; and build relationships with bankers, accountants, and attorneys. Musicane has an advisory board whose members include Bob Jamieson, the head of BMG Canada.101 Jamieson can contribute inside knowledge of the music industry to complement Shahani's business training, as well as giving the organization credibility to investors and to musicians who might be interested in selling online.
Partners Often, two people go into business together as partners. Partners can help one another access capital, spread the workload, share the risk, and share expertise. One of the strengths of JLW Homes and Communities, the Atlanta construction business described earlier in this chapter, is that the three founding partners bring different areas of expertise to the business. Gregory Wynn was a master homebuilder, Komichel Johnson was a financial expert, and Robert A. Jones III was a successful salesperson. Johnson explains the advantage this way: “We don't all agree on the same issues, and we've had some heated arguments. … But we realize that through communication and laying out the facts, that we can overcome any issues that may arise within our organization.”102
Despite the potential advantages of finding a compatible partner, partnerships are not always marriages made in heaven. “Mark” talked three of his friends into joining him in starting his own telecommunications company because he didn't want to try it alone. He learned quickly that while he wanted to put money into growing the business, his three partners wanted the company to pay for their cars and meetings in the Bahamas. The company collapsed. “I never thought a business relationship could overpower friendship, but this one did. Where money's involved, people change.”
To be successful, partners need to acknowledge one another's talents, let each other do what they do best, communicate honestly, and listen to one another. That's what the partners in JLW Homes did when they turned down a chance to build a project they were understaffed for completing. Johnson, the financial expert, believed the company would make a good return, and Jones, the salesperson, was eager to move ahead, but homebuilder Wynn said the company was unprepared for a project of that size. Johnson and Jones bowed to Wynn's experience and were later glad they did.103 Partners also must learn to trust each other by making and keeping agreements. If they must break an agreement, it is crucial that they give early notice and clean up after their mistakes.
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