I’ve been reading meditations from Mark Nepo’s The Book of Awakening every morning for several years. A few weeks ago, the reading from September 27 in the book struck a chord with me relative to the challenges of fear and panic in entrepreneurship. Here is that meditation and my takeaways:
“Few situations can be bettered by going berserk.” – Melody Beattie
It was the philosopher Michael Zimmerman who told the story of being a boy in school when someone passed him a pair of Chinese handcuffs, a seemingly innocent thimble-like casing with an opening at each end. It was passed to him without a word, and, of course, through curiosity, he slipped his left forefinger in one end and then his right in another.
Mysteriously, what made them handcuffs was that the more you tried to pull your fingers out, the tighter they held you. Feeling caught, he panicked and pulled harder. The small cuffs tightened. But suddenly, it occurred to him to try the opposite, and as he leaned his fingers into the problem, the small casing slackened, and he could gently and slowly work his fingers free.
So many times in life our pulling in panic only handcuffs us more tightly. In this small moment, the philosopher as a boy reveals to us the paradox that underscores all courage: that leaning into what is gripping us will allow us to work our way free.
I can personally identify with this story.
I have learned the hard way that panic begets panic. I know this to be true through all my life and business trials. I also know that the majority of the times I have panicked, especially as an entrepreneur, it has involved matters of money. But, it’s often not really about the money itself. It’s more about what the money represents—a lifestyle, security, safety, and the like, and losing those things strikes a chord of fear in us. Panic always comes from fear, doesn’t it?
As the handcuff story above tells us, the more fearful we become, the more we entrench...
The things happening in America right now trouble me in ways I cannot yet verbalize. I cannot help but think that the lack of critical thinking is at the root of many of our cultural challenges. This article in Edutopia, Overcoming Obstacles to Critical Thinking by Randy Kasten strikes a chord. I believe we need to start teaching critical thinking skills much earlier. Maybe we should start in elementary school. Would you agree?
I’ve been shaking up my podcast listening lately. Among my new favorites are:
- How I built this with Guy Raz. An interview show with successful entrepreneurs and others about how they built their movements.
- Longform. Another interview show, but this one is with non-fiction writers who discuss their writing.
- The Good Life Project Podcast. Jonathan Field’s interview-focused podcast exploring what it takes to live a good life.
- Self-made man. Mike Dillard’s podcast about men who are striving for greatness.
I finished Tyler Cowen’s The Complacent Class a few months ago. I’m still distilling my takeaways, and I will likely write a few posts about my thinking on his theories. In, It’s time to think differently about entrepreneurship, I did reference his thinking on cultural segregation and the possible impact on entrepreneurship.
With the required reading for my graduate classes, I’m finding it hard to get into reading much of anything other than magazine articles. Still, next up on my reading list are:
- The Jesuit Guide to (Almost) Everything: A Spirituality for Real Life by James Martin
- The Vanishing American Adult: Our Coming-of-Age Crisis–and How to Rebuild a Culture of Self-Reliance by Ben Saas
In case you missed it.
I just finished an 8-week graduate class in Advanced Entrepreneurial Finance. I’ve written a lot about business finance from an entrepreneur’s perspective. If you’ve missed those posts and are interested in reviewing them, they’re listed below. I have also included in several of those posts downloadable example spreadsheets for creating pro formas, calculating financial ratios, and determining customer acquisition costs.
The new season of ABC’s Shark Tank started a few weeks ago. If you are not familiar with the show, it’s a business “pitch show.” Each week several entrepreneurs pitch their businesses to a group of investors (also known as “Sharks”) hoping to secure funding for their venture. Although it is dramatized, like all reality shows, I am a fan because it aligns with my own experience as an entrepreneur and I believe aspiring entrepreneurs can learn a few lessons from the interactions those pitching on the show have with the Sharks.
Here are just a few of my Shark Tank takeaways for aspiring entrepreneurs and those looking to grow their business through outside investment:
1. Know your true opportunity.
Too many entrepreneurs go into business chasing what they perceive to be a market opportunity only to learn that the market is not significant enough to warrant an investor’s interest. Think about where the business could go, without being too unfocused, to grow. But be realistic. Just because there are millions of dog owners in the market does not mean you will sell every one of them your new dog product.
It is also critical to have a keen knowledge of your competition. You should consider how easy it might be to knock-off your product or service offering, or otherwise, move into your market. This is especially true if your competition is larger than you and the market opportunity is right. Competitors with deep pockets can be a startup killer. It is essential to understand how your business is realistically different.
Keep in mind that, investors want to maximize their returns. If you’re targeting a market that has limited potential, there’s little chance you’ll be funded if the investor doesn’t see a market opportunity you may be missing. Invest the time to understand the true opportunity before seeking outside investment.
2. Live and breathe your numbers.
Your business financials are the lifeblood of your company. Investors will want to know your...
Any business that holds and manages inventory does so with the goal of selling that inventory to produce revenue for the company. The key is to maintain just enough to meet demand, but not so much as to have money tied up in inventory for a period longer than necessary. No business holding inventory desires to have more, or less, inventory than is needed to meet customer demand at any given time because failure to meet customer demand will negatively influence sales and profitability. These factors make inventory management one of the most significant challenges any business, but particularly a small business, can encounter.
Depending on the kind of business, there can be many different types of inventory. For example, manufacturers will likely have an inventory of raw materials, work-in-progress inventory, and finished goods inventory at a minimum. A retailer might have merchandise inventory, a service business might have an inventory of hours available to resell, and a magazine or online publication might have an inventory of space that could be filled with advertisements. How each business type manages its inventory may be a little different, but each has the same purpose in mind: To maximize cash flow.
Demand forecasts are an integral part of inventory management. If the business demand forecasts are incorrect, it can be a significant blow to cash flow. For example, if the business assumes the demand will be high, and the assumption is erroneous, it may have too much cash tied up in inventory assets, which in turn would restrict cash flow because the product on hand is not selling as predicted. Conversely, if the business predicts the demand will be low, and the assumption is incorrect, it may not have enough inventory to meet customer expectations, resulting in lost sales and therefore tighter cash flow.
One of the simplest ways to manage physical inventory is to measure productivity and turnover (Traster, 2007). The idea here is to determine how often during the year the business can convert its inventory assets into cash (learn more about inventory turnover and other financial ratios here). Assessing the most appropriate turnover...
In an earlier post, Financial Ratio Analysis and the Entrepreneur, I shared some insights on Financial Ratio Analysis and how investors and lenders may consider and use financial ratios to determine whether to invest or lend to an entrepreneur. Entrepreneurs should also understand how to use financial ratios in the regular course of business operations. Each financial ratio has a purpose, and when compared to industry benchmarks, a ratio can provide insights as to a venture’s performance as well as help set stretch goals for business improvements and growth.
The most common financial ratios used by investors and lenders include:
These ratios indicate the long-term solvency and highlight the extent long-term debt is used to support the venture. Leverage Ratios include:
- Debt-to-Equity Ratio which measures how much debt is used to run the business.
- Debt-to-Asset Ratio which measures the percentage of the company’s assets that are financed by creditors.
Learn more about Leverage Ratios and how to calculate them here.
These ratios measure the businesses ability to cover its debt and provide a high-level overview of financial health. Liquidity Ratios include:
- Current Ratio which estimates the company’s ability to generate cash to meet its short-term commitments.
- Quick Ratio which measures the ability to access cash quickly for immediate demands.
Learn more about Liquidity Ratios and how to calculate them here.
These ratios offer insights into operations and help to spot problem areas related to inventory management, cash flow, and collections. Efficiency Ratios include:
- Inventory Turn-over which examines how long it takes inventory to be sold and replaced within a year.
- Average Collection Period which looks at the average number of days it takes customers to pay for goods or services.
Learn more about Efficiency Ratios and how to calculate them here.
These ratios evaluate the financial viability of a venture and provide a measure of comparison and performance to the venture’s industry. Profitability Ratios include:
- Net Profit Margin which measures how much a company earns after taxes relative to sales.
- Operating Profit Margin which measures earnings before interest and taxes (EBIT).
- Return on Assets which provides insights on how well management is using the company’s resources.
- Return on Equity which measures how...
Lenders, and often investors, will calculate one or more financial ratios when reviewing an entrepreneur’s financial statements to gain a quick understanding of the health of the business before determining whether to lend or invest. Within an industry, there will be “good” and “bad” benchmarks against which the venture will be measured (Rogers, 2014). Investors and lenders will consider the particulars of a business and likely weight the importance of the ratios differently when comparing to the industry benchmarks.
Many financial ratios could be applied, but the following appears to be most common types (BDC Staff, n.d.):
Leverage Ratios. Leverage Ratios provide an indication of the long-term solvency and highlight the extent long-term debt is used to support the venture.
Liquidity Ratios. Liquidity Ratios measure the businesses ability to cover its debt and provide a high-level overview of financial health.
Efficiency Ratios. Efficiency Ratios provide insights into operations and help to spot problem areas related to inventory management, cash flow, and collections.
Profitability Ratios. Profitability Ratios evaluate the financial viability of a venture and provide a measure of comparison and performance to the venture’s industry.
There are other ratios, of course, and as mentioned before investors particularly have ratios they rely on more based on their experience and industry knowledge. For example, a recent interview with an investor uncovered a preference for knowing the Customer Acquisition Costs. Customer Acquisition Costs are not often viewed as part of a Financial Ratio Analysis, but such factors are often important measures for both investors and entrepreneurs alike.
The entrepreneur, investor, and lender can gain useful information and financial trends on a business venture when using Financial Ratio Analysis. However, it is important to note that financial ratios have little meaning without comparison (Peavler, 2017). For example, a company can compare its ratios to those average ratios of their industries, but the best and most accurate comparisons come from using benchmark companies—high performing companies within their industry. Comparisons against these companies can create and encourage stretch goals for a business.
While Financial Ratio Analysis does provide numbers for performance...
Entrepreneurs often look to friends, family, their bank account, and even credit cards when funding a startup, but many perhaps overlook this startup funding option: The strategic alliance.
A strategic alliance is a cooperative arrangement between two or more businesses for the mutual benefit all involved businesses. The idea is that each involved entrepreneur or business entity brings something to the alliance which enables a greater opportunity for near-term successes for all parties than the parties might achieve individually. While it is possible one company might invest in another to gain access to products and services more quickly that it might develop the same for itself, the more likely scenario is one in which two companies with complementary services align to improve long-term revenue generation opportunities.
For example, one entrepreneur with design experience might align with another entrepreneur with software coding experience to form a structured partnership to pitch new software projects to a prospective client or develop a software-as-a-service (SaaS) application to offer to a broader customer base.
Another example might be a larger company that needs support products or the services provided by a startup and agrees to partner to gain access to that startup’s offering. More specifically, a mapping software company may find it has difficulty selling its software for certain business applications. It could partner with a business consultant who understands how to apply business thinking to the software tools to help a prospective customer better understand the software’s value. When a sale occurs, the consultant helps implement the software and train the client.
There are challenges to strategic alliances, of course, particularly among startup ventures. The biggest obstacles appear to be a difficulty in finding suitable cooperating partners, an inability to assess the upside and downside of the alliance accurately, the challenge of properly structuring the arrangement, and the fear that cooperation might result in an expropriation of business (Hsu, 2007). Moreover, some alliances can pose a challenge to future investment funding if investors have a conflict with one or more of the alliance partners, or if cash flow rights to alliance partners dilute the opportunity for investors...
The following is an interview with Gregg Smith, Founder, Evolution Corporate Advisors, for my Advanced Entrepreneurial Finance graduate course. Gregg and I have known each other since about 2010. We discuss entrepreneurial investment from an investor’s perspective
Q. Tell me little about yourself and Evolution Corporate Advisors as it may relate to or support the financing of entrepreneurial ventures and small businesses.
A. I spent ~20 years on Wall Street as an investment banker, with most of my career spent helping growth stage companies execute private placements. I have completed over 120 private placement transactions for clients in the healthcare, technology, consumer & retail, energy and other sectors. I have also (conservatively) reviewed more than 1,000 business plans and met with 100s of management teams and entrepreneurs. I have seen many success stories of small companies I financed that were sold for >$10 billion, and many I financed that failed.
Q. When considering an investment, which is more valuable to an investor, experience in an industry vs. experience as an entrepreneur? Why?
A. Many outsiders have come to existing, “old world” antiquated industries and completely disrupted the norm—all with no prior in-depth industry experience. I would rather back a highly successful entrepreneur who has succeed elsewhere in a new industry, than back an industry insider who does not have any meaningful record of success. Also, many outsiders have a fresh perspective on things that don’t live with every day and may innovate and/or solve a problem that is not obvious to the industry insider.
Q. In your experience, which is more important in early state financing, the fit with the entrepreneur, the apparent accuracy of the pro forma assumptions, or the expected potential of the business? Why?
A. In the more than 120 transactions I completed, I have only had one client meet their first quarter projections after closing a deal. Things are very difficult to predict, and everything in life ends up costing more and taking more time than one anticipates. The same holds true with even the most sophisticated management teams using their best judgment to project where their business will be in one-quarter...
A conversation with an investor this week brought out that Customer Acquisition Cost is a key to his investment decision-making process. It occurred to me that many new entrepreneurs may not consider how important such a metric is for their venture, whether or not they are seeking investment. Customer Acquisition Cost is not just a measure to determine the average cost to acquire a customer; it is also used to determine the overall health of the business, the marketing budget, and the effectiveness of marketing and sales programs. For an investor, it will demonstrate the short- and long-term viability of the venture.
Let’s examine Customer Acquisition Cost in a little more detail.
CUSTOMER ACQUISITION COST
Calculating the customer acquisition cost (CAC) is not difficult. Start by totaling all of the marketing and sales costs for a period, and then divide those costs by the number of new customers acquired for the same period. Easy enough, right? Except that many entrepreneur’s—myself included—may miss costs in the calculation and do not get an accurate number against which to measure the customer acquired.
For a more detailed analysis of CAC, I think about spend and acquisition by channel. For example, in the chart below, I list the number of channels and further categorize them in measurable and non-measurable buckets. Measurable channels are those from which a customer’s purchase is trackable to the marketing or sales campaign, either through a link, a promo code, a special call-in number, or a sales order tied directly to a salesperson.
Non-measurable channels are channels which do not provide for an easily trackable source for a specific sale but are likely to contribute in some way to sales in general and should be calculated as part of the overall CAC. Brand campaigns might fall into this category, as would most promotional activities such as an entrepreneur’s speaking engagements, and networking events, to name a few. By adding the costs together and then dividing by the number of customers acquired for the period we arrive at an Average Customer Acquisition Cost.
Startup entrepreneurs face a daunting challenge in forecasting cash flow, profitability, and return on investment. It can be so overwhelming that many just ignore the numbers and jump right into developing a product or service. Certainly, a refined product or service is a critical early step in launching the entrepreneurial venture; however, understanding the financial aspects of the business, including the inputs to the product or service development is paramount to forecasting cash flow and business profitability, is equally important.
In business, particularly in the start-up phase, “pro forma” financial statements provide a way for the entrepreneur and potential investors to see the financial forecast of a business given a set of assumptions. The pro forma financials will include a set of assumptions on which the numbers were based, a cash flow statement, an income statement, and a balance sheet statement. Together, these statements provide an approximation of business performance considering the assumptions. Most investors place little value on the numbers a start-up provides because the core assumptions may be inaccurate (Rogers, 2014). And if the assumptions are inaccurate, the financial performance will change. One of the best ways to understand how assumptions change the financial performance of a business is to build an interactive pro forma.
The interactive pro forma will allow an entrepreneur to quickly change assumptions and easily see the possible financial impact on the business as those assumption flow through the other financial statements. Once set up, it allows an entrepreneur to play a “What-if” game with assumption inputs and watch how those changes affect the business performance. The interactive pro forma is also a great tool to use when seeking outside investment. If the assumptions are challenged by an investor, they can be modified in real-time, and those modifications flow out to the other statements. This provides an instant view of the new business financials once new assumptions are in place.
Spreadsheet tools make building an interactive pro forma easy, although it does take some knowledge of the tools and a few hours to set up the models. Most of the time spent should be given to considering the...