The most common definition of business suggests it is the “organized effort of individuals to produce and sell, for a profit, the goods and services that satisfy society’s needs” (Pride, Hughes, & Kapoor, 2013). In a manufacturing-driven society, this definition might be valid, yet it arguably emphasizes an outward-in approach to product and service development and in doing so has potentially set a generation or more entrepreneurs off on the wrong foot. So many entrepreneurs believe that the “thing”—the product or service—they have created will “satisfy society’s needs” without giving enough thought to understanding what society needs, values, and expects. The focus on the thing poses one of the most significant long-term barriers to success for entrepreneurs.
Entrepreneurs devote too much time and energy to the perfect execution of the product or service at the outset. In fact, many entrepreneurs invest—maybe even over-invest—in the thing before they understand if there’s an actual market for the thing. Not long ago, I spoke with an entrepreneur who had an idea for a new technology product and a pool of funds to develop the product. He was searching for a developer to help get this product off the ground but had not thoroughly researched the market opportunity for what he was about to create. Moreover, he had done little more than cursory research on his target customer. His focus was on product execution, rather than customer understanding. Unfortunately, this approach is all too common with startup entrepreneurs. A good product or service—one that meets a customer's desires—will be far better than a great product or service that misses that mark.
Steve Jobs once said, “Customer’s don’t know what they want until we have shown them” (Isaacson, 2011). To Jobs’ point, when new ideas for products and services are solicited from customers, those ideas tend to mirror competitive products in the marketplace or be derivations of products or services already available (Furnham, 2000). However, this should not suggest that knowledge of the target customer and customer input is without value. In fact, one might argue that Jobs and his team developed their products based on a clear understanding of the needs, values, and expectations of their target customer. Apple’s customers, for example, have come to expect the most innovative products, of the highest quality, that enable a short learning curve, efficient use, and support the simultaneous engagement with other products (Hyungu, 2013). Apple’s focus on delivering products to that target customer, and then taking care of that customer with committed customer service, elicits profound loyalty to the company and its products.
Customers are the only thing that matter to a business. Regardless of the product or service offered, if there are no customers, there is no business. It is surprising how many entrepreneurs start their business with an idea of a product or service and a detailed plan for execution of that offering, without a clear understanding of the customer. The customer’s needs, values, and expectations are never thoroughly researched, and the thing, as developed, misses the mark with the intended audience.
All of this is not to say that the thing—the product or service—is not essential. It is. However, a product or service is only relevant in the context of the customer’s needs, values, and expectations. A product and service placed at the center of the business, particularly in today’s business environment, may work in the near term but is not sustainable. The customer must be at the center of the enterprise for a business to have long-term success.
Perhaps a more appropriate definition of a business for our current environment might be “the organized effort of individuals to satisfy society’s needs, by producing and selling goods and services, for a profit.” Changing this definition might encourage entrepreneurs to focus first on the customer, and make product execution and delivery the second step in the business development process. Putting the prospective customer first might well make all the difference between success and failure of the next entrepreneurial venture.
What do you think? Should the customer needs, values, and expectations trump sheltered product development?
Furnham, A. (2000). The Brainstorming Myth. Business Strategy Review, 11(4), 21-28.
Hyungu, K. (2013, September). To Be A True Industry Leader: Apple Inc. and Microsoft Corporation in Consumer. Leadership & Organizational Management Journal, 2013(3), 114-130.
Isaacson, W. (2011). Steve Jobs. New York, NY, USA: Simon & Schuster.
Pride, W., Hughes, R., & Kapoor, J. (2013). Business (12th ed.). Cengage Learning.
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 financials inside and out. Your customer acquisition costs, cost-of-goods, operational costs, cash flow, inventory turn, and revenue growth are all key. You should also understand where improvements can be made within the operation that will increase revenue and profitability.
Investors want to know you are intimately associated with your money before they will invest theirs. They will also want to know how and when they might see a return on their investment. Often, they will ask “What if” questions about your financials and financial projections to look at the best case, the probable case, and the worse case business scenarios. With tools to run these scenarios in place, and having run various scenarios yourself, will not only help the investor understand the possible outcomes, but it will help you gain a better understanding your business financials.
3. Sales. Sales. Marketing. Sales.
Sales will tangibly show an investor that your business may be a viable investment. If your company has sales, it demonstrates that there is some market opportunity for the product and services your business offers.
Sales numbers can also tell an investor a lot about a business. If a company has been operational for two months, for example, and sold 50,000 units of a $19.99 item, it might suggest that the entrepreneur has found the right market for the product. Conversely, if those 50,000 units were sold over three years, there could be many different underlying problems that would likely to give the investor pause.
Marketing is essential, too. Knowing how to reach your target market best and demonstrating it by consistently driving new customers to the business is vital. Keeping the customer acquisition cost low and the sales conversion high should get the attention of investors.
Know that few investors will invest much in an unproven idea. Investors want to see that the business has sales and steady growth. Operations can be improved, and costs can be reduced, but sales are necessary to keep the company going. Investors want to invest in winners and sales provide one measure of possible long-term success.
4. Be realistic with your valuation.
Most of us overvalue our businesses when seeking investment. Not everyone has $1,000,000 valuation. In fact, few startups do. There are many ways to arrive at a business valuation and the more common formal method discounts the cash flow over a period and then compares the ROI of the investment with a risk premium to the safest investment in the market. It can be complicated to calculate, and few entrepreneurs take the time to learn how to best value their company.
Too often entrepreneurs opt to look at sales numbers and factor some fuzzy math. Some might argue, for example, that steadily increasing sales from $250,000 to $800,000 over the last three years and being “on track for $1,500,000 this year” puts the value of the company at $1,000,000. Maybe, but highly unlikely. The cost of goods and operating costs need to be factored into the valuation.
Investors consider risk and opportunity in the valuation of a company. If the opportunity is excellent, but the risk is high, the investor will often want more equity to offset the associated risk. This includes those situations where the investor will need to invest not only money but time and energy into the business to see his or her return. The risk-reward factor is important, but financial fundamentals are the baseline measure for any entrepreneurial investment.
5. Understand how to scale.
Many entrepreneurs think having a product or service that they are selling is, in fact, a business. While in the strictest sense of the word this might be true, investors are looking for a “business operation” in which to invest, not a corporate structure. It is not enough to have chosen to incorporate and have made a few sales.
It is important to remember that most investors seek opportunities where the business has some structure that will enable it to scale. Scalability is key to maximizing an investment return. Investors look for companies that already have, or are implementing, systems and operations for scalability. For this reason, many investors will not invest in service businesses because they are more difficult to scale than, say, an online retail store, or maybe even a manufacturing business. Scalable companies not only have the potential to reduce costs, but they might also increase revenue and, in turn, profitability.
6. You are your pitch.
Having a solid business pitch is essential, but it’s about more than just the business. Clearly and succinctly communicating your business operation, what products and services it offers, how those products and services are delivered, who the customers are, and what problems your offerings solve for customers is essential. Equally important is your background and experience as it relates to the business, and what the company has accomplished to date. And, as mentioned above, your knowledge of the business financials are an essential part of the pitch. But investors value other things, too.
Keep in mind that when pitching, you are not only pitching your business, you are pitching yourself. It is good to be professional and prepared, but don’t come across as aloof or too argumentative. Have passion, but be realistic. Tenacity is good, within limits. How you conduct yourself in the pitch, and in “real life” will factor into the investor’s decision, too. Be humble, kind, and honest. Listen and be coachable. And be personable. Investors are investing in you, particularly in the early stages. You need to be as investable as your business.
7. Know your own limitations.
An entrepreneur’s passion generally drives the startup idea. Quite often that passion is driven by a desire to solve a problem. Yet, sometimes those who are motivated to solve a problem may not be or have the desire to be, a great business person. You may have created a great product, but you may not have the business knowledge or experience to grow the business opportunity. If an investor sees the value in the product, he or she might choose to invest; however, the equity ask might be 50% or more. The higher equity asks stems from the investors understanding of what needs to be done to turn your idea or product into a business. Such offers are always worth considering.
Investors willing to make an investment in you to help you build structure and sales of your product likely deserve a higher equity stake. In such situations, investors may well be bringing more to the table than you might be. In these circumstances, it is essential to consider your strengths, weaknesses, and interests, and then determine the real value you bring to the opportunity. This is the time, to be honest with yourself. Don’t forget that 40% of a company making money is worth a lot more than 100% of a company that is not making money.
8. Investors bring strengths and weaknesses.
Each investor will have his or her own strengths and weaknesses. They know them, and you must know them, too. Whenever possible, learn more about an investor, his or her likes, and dislikes, how they have invested in the past, what they’re looking for in an investment, and what they feel they can bring to the table. Knowing this will help you choose the best investor match for your business, and enable you to tailor your pitch to the investor.
As an entrepreneur, it is just as important for you to how you might leverage the strengths and downplay the weaknesses of a given investor in your venture. Choosing the wrong investor can be the kiss of death for an entrepreneur. Finding the best match is critical for success.
Although not every investment pitch will be made to a Shark like those on the show, entrepreneurs can learn from watching others pitch and listening to the questions asked by the investors. I watch little television these days, but I do try to catch Shark Tank each week, and when I’m traveling, I am guilty of binge-watching reruns of the show on CNBC. I am so surprised when I hear entrepreneurs tell me they have not seen the show. I think they’re missing out. I learn something every time I watch Shark Tank. If you’re an entrepreneur, I know you will, too.
P.S. In my personal opinion, sometimes Kevin “Mr. Wonderful” O’Leary is right. Licensing is the answer. But then, I’m a licensing guy, too. 🙂
Featured Image Source: Getty Images/Phillip Faraone
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 assumptions. Assumptions are the most important part of the model and where entrepreneurs should put the bulk of their time.
Here’s one way to build an interactive pro forma:
- In a spreadsheet program, create a new workbook with four tabs. Label each tab as follows: Assumptions, Cash Flow Statement, Income Statement, and Balance Sheet.
- On the Assumptions Tab, list all of your assumptions about the business. Depending on the business one might choose product pricing, sales figures, monthly costs of operation, depreciation, taxes, insurance, etc. Make sure everything that could affect the business costs or revenue structure is included.
- On the Cash Flow Statement tab, include the beginning cash balances, your sources of cash, and the uses of cash for each month. Use the assumptions to drive the revenue (sources) and expenses (expenses) on this tab. Note that the cash that’s left over at the end of each month becomes the Beginning cash balance for the following month. The Cash Flow Statement shows how the business will use the money it receives each month.
- The Income Statement tab pulls data from the Cash Flow Statement tab but formats it differently. The Income Statement in a pro forma shows whether the business is profitable for a period by looking at the revenue and expenses based on the original assumptions (and cash flow).
- The Balance Sheet pulls data from the Cash Flow Statement and the Income Statement to provide a look at the assets, liabilities, and equity of a company at a point of time. It helps the entrepreneur better understand what the company owes (liabilities), what it owns (assets), and the equity held by shareholders.
The above points are over-simplified. The idea is to give an overview of the process. Each entrepreneur should develop his or her own pro forma to understand the specifics of his or her business better.
This said I have provided an example interactive pro forma workbook for an online publishing business for readers to download and explore. Some may have the skills and abilities to create a similar model, but others may need the help of a financial professional.
Using an interactive pro forma will help an entrepreneur get a better handle on his or her business by allowing the exploration of What-If scenarios what might impact the business. It is much better to explore these scenarios in advance of launch and develop contingency plans than it is to encounter the problems in “real time” without possible solutions waiting.
A few notes on this model:
- This is an example for use as is. It is not supported in any way. It is not intended to be a tool to use without customization based on the specifics of an entrepreneurial venture.
- This interactive pro forma is only an example to give the reader an idea of how such a tool can be developed. It is not based on a real business. I compiled this model for a graduate class, but I have developed similar models for entrepreneurial ventures. Each business venture is different, and so is the pro forma that is prepared for that venture.
- On the Pricing Assumptions tab, all of the “Bold Blue” text areas can be changed to demonstrate how the interactivity might work. No other data can be changed.
- The best way to explore this model is to look at the other statements before changing anything, then change one thing and see what effect it has on the model.
- In this workbook, I have included an additional tab to for calculations of revenue and expenses based on the pricing assumptions. This worked easier for me to build the calculations, but others might do it differently.
- Formulas can be seen in each of the cells (mouse over it), but only the values in the “Bold Blue” text area can be changed.
Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur (3rd ed.). New York: McGraw-Hill Education.
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