The quintessential business startup strategy

What is a business plan? Do you need a plan before you start a business? How do you prepare yourself to enter a marketplace and compete? I will show you the importance of planning your startup strategy and how to prepare it effectively. Once you have a reliable plan you can execute your startup strategy with confidence.

Planning is certainly necessary to achieve success, regardless of what you do in life. You want your decisions to be calculated… they should only be made after performing proper due-diligence to know exactly what you are getting into ahead of time. You must avoid being blind-sided by the unexpected.

Risk, hazards, and many pitfalls exist on the path to business ownership.

What does plan really mean? It is defined as a scheme or method of acting, doing, proceeding, making, etc., developed in advance. If you are a military General, will you go to battle without a plan? Of course not! So why would you go into business without one? The marketplace is quite a battle-field out there with many foes who are ready to fight (compete) with you.

Knowledge and experience are your weapons, and if they are sharp, you will compete well. The problem is strategy. Knowing where to start and how to proceed. Eight-out-of-ten businesses fail after 18 months, statistically. The primary reason for failure by the intelligent entrepreneurs is lack of proper planning. You can overcome just about any obstacle in life if you fully understand it, and then devise an effective strategy to overcome it. Be a calculated decision-maker and your chances of success will be high.

You have a good business idea and you wish to find investors, open a location, develop a product, or market a service. Stop and prepare a good plan of action first. It does not need to be extensive or formal, but it certainly needs to be comprehensive. Put in the effort and cover all of the angles. Consider this action-plan your battle-plan, since you will need it to compete.

All of this may sound quite involved, and even discouraging since you just want to get out there and do business, BUT… you won’t be out there long if you get squashed by your competition. The businesses that belong to the 20% club… those two-out-of-ten companies that survive beyond 18 months, most certainly involve themselves with this kind of research and planning. You WILL need to compete with them.

Pre-plan preparation

Fully educate yourself regarding your industry, your target audience (demographics), your competition and the economic conditions. Anticipate how your customer base will react to your idea, and how your competition will make their moves when you enter the market. Document the weaknesses of your competitors and target them. The knowledge you gain from this research will be used to form an effective tactical plan which will allow you to anticipate outcomes and to be prepared for pitfalls.

All of this preparation will be used to define your business model. That is, the purpose and process of your new venture. Your business model will also include customer base definition and distribution-channel identification… how you will receive goods and how you will deliver products to your customers.

Study your industry

Who are the suppliers and vendors you will use and what kind of bargaining power can you bring to the table? You always need to keep costs as low as possible to improve profit margin, so arm yourself with an understanding of how well you can negotiate deals. If you understand the potential market-share you can achieve, and you can back that up with tangible fact and figures, you may be able to convince them to sweeten the deal in your favor.

How competitive is your industry? Analyze what makes the successful businesses tick and understand exactly what the poor performers are doing wrong. Really dive into expected profit margins in your market since tough competition tends to drive those margins down. Learn how profitable your competition really is.

What is the market structure of your industry? Determine the number of firms that exist in your industry and how large they are. The market entry conditions must be fully understood. That is where and how companies typically do business (meet and connect) with their customers.

Determine the product or service differentiation in your field. Know how many types of products or services there are and what kind of differences exist. Understanding and defining your market structure will prepare you to operate tactfully in your industry.

Challenge the status quo…the existing state of affairs. Maybe you can come up with a new way to do business in your industry. But be careful and cautious since mindsets are difficult to change. You will need some good vision to pull this off. The rewards can be exponentially higher, but there is much more risk.

Understand your target audience

What are the demographics… what makes them tick? To start, the SBA (Small Business Administration) provides many such market research tools. Local economic indicators are available for your geographic area of interest which includes income and employment statistics along with others. Visit the Bureau of Economic Analysis to find a barrage of economic indicators that will provide key data about the region you wish to do business in. Or you can use this to find a good target region. There is a wealth of other tools and resources there including business training, financial support, and a broad network of affiliates ready to help.

You will need to know how your target audience reacts to your idea. Perform Qualitative research using focus groups and Quantitative research using surveys and questionnaires to perform effective market studies.

After you have collected the market study data, it’s time to really get to work preparing and interpreting the data. Put all of the right KPIs (Key Performance Indicators) into your market research outline. Then, evaluate and prioritize the KPIs that you used in the market research data collection stage. Be objective in your approach to interpreting the data.  You need to avoid statistical bias as you proceed with this process.

Now that you understand what the public thinks about your company, product or service, you need to make any necessary adjustments for marketability. Make your idea marketable, and then your advertising will have the potential to be very effective.

For an in-depth explanation showing how to perform all of this market research, please read Effective Marketing Strategies. There is much more to this than I will detail here, and a deep understanding of marketing will really make the difference

Identify and evaluate your competition

Investigate them. Discover who and how loyal their customers are. Determine the yearly sales volumes of your competitors. Detail their strategies. Read customer feedback and gain insight from resources like Better Business Bureau about your competition. Study indicators like longevity so you can determine how long each competitor has been in business. Review their history to understand what changes they have undergone over the years and why.

That was quite a list! Knowing who your competitors are and what makes them tick will allow you to survive as you compete with them. I will compare your competitors to sharks. If you dive with sharks, you need to have a properly designed cage to ensure they can’t bite through it. Also, you need to understand sharks and fear them without being afraid, if you wish to swim with them not using a cage. Same with business. You can swim with your competition if you understand and have a healthy fear of what they are capable of. A nice thought may be… we are much smarter than sharks!

I will soon publish a blog post detailing how to Identify and evaluate your competition, so stay tuned, there is more to come! For a short but informative post that will help with this topic right now, read: Competitive Analysis from Entrepreneur

Product or service differentiation

How are your products or services different from the competition? What makes them better?  If you plan to enter the market with another version of an existing product, there needs to be an advantage to yours. Quality, functionality, price, or appearance, just to name a few factors that can vary. First you need to identify the existing differentiation among what is already in the market. Then you need to perform a good comparative analysis to provide confidence there is ample differences or advantages.

Pre-plan-prep is all about becoming an expert in each of these areas, and the level of difficulty should not be very high… it just takes some research and study. Keep good notes for reference, and update them regularly as changes occur. The insight you gain from all of this will provide good visibility into what kind of strategic moves you can make to gain market-share.

Put your strategies into your startup plan

Now you are ready to start creating your winning plan. Having performed all of the due-diligence you should now be an expert in your industry. An effective tactical strategy to start a business will be vital to the success of your startup. Do this part correctly, and you will ensure your position in the 20% club!

Creating a formal business plan, which is also important, will not be the focus here. That is an important process in itself and will be covered soon in another post. It is the strategy in the plan, the meat and potatoes of the plan, that I will be covering here. The actual action you will take to start a business, laid out informally, as a guide for you to follow as you execute.

Keep it cheap

Set rules to follow when you execute your startup plan in order to keep costs down. Use low-cost or free resources throughout your operation like free trial software versions which you can evaluate while starting your business. Utilize your home office and garage vs. renting a space. Identify every area of spending required during your startup venture and document it.

When your plan is complete, list everything you will need to buy. Brainstorm each item to come up with ways to save money. Take your list, which is basically a shopping list, to second-hand stores and start saving. Be frugal in all you do. The good stuff can come later when the profits roll in.

Position your product

Establish the positioning statement about your product or service.  This statement is of the utmost importance and should shed light on the unique value your product or service offers. What benefits will you bring your customers? Also, it will define the target demographic which will focus the advertising specifically on them.  The product or service category must be clearly defined by this statement, and that will prevent any confusion about what you are selling.  In this positioning statement, you must prove to your audience that they can trust you and what you have to offer them.  The final statement you develop must be short, concise, and deliver impact in each of these areas.

There is one key difference between a positioning statement and a tagline. Taglines are outward facing. They are simple, compelling statements viewed by the customer. The positioning statement is internal, and will be used to define all advertising and even internal operations. You can use the position statement to test all new ideas, to ensure they match up with what you are really going for.  A fun example is from Harley Davidson:

The only motorcycle manufacturer that makes big, loud motorcycles for macho guys (and “macho wannabes”) mostly in the United States who want to join a gang of cowboys in an era of decreasing personal freedom.

That is a clearly defined identity for sure!

Their tagline:

American by birth. Rebel by choice.

This fits well and sounds compelling to their target demographic, right?

Here is a simple template you can use to set up your own positioning statement:

  • For (target customer)
  • Who (statement of need or opportunity)
  • (Product name) is a (product category)
  • That (statement of key benefit)
  • Unlike (competing alternative)
  • (Product name)(statement of primary differentiation)

Once you have this statement completed, allow it to fully sink in, so it becomes instinct.  That way, you’ll always be able to answer correctly when you question any idea, to see whether it seems to fit into the identity of your company or product line.

Build a winning brand

Having a consistent company theme throughout your organization causes customers to become accustomed to the environment that is conveyed to them from all of the points of contact at your company. This called cross-channel customer experience. Familiarity can be achieved from your customers and that is very powerful. It will heavily contribute to brand recognition and appreciation.

Keep your staff excited about your products and services. Be a motivational speaker for your company!  Your staff will be more responsive to you and your customers.  When your customer gets the feeling that you and your staff are excited about what your company has to offer, that excitement can spill over… especially when it’s consistent across all points of contact with your company.

Brand building is the process of creating deep connections and forming an emotional relationship with your customers. This is not easy and it takes much time. Read Gaining Customer Loyalty for an in-depth dive into what it really takes to make customers stick with you.

Use charitable causes and missions to your advantage

By aligning with one or more, you will start to establish brand recognition and trust in the marketplace. Be authentic and truly care about the community. The public will call you out on it if you are not genuine, and that will destroy all that you have created. When you show that you care by contributing to a charitable cause, public support for your brand will grow nicely.

Targeting specific demographics

Never target the general population, that is a recipe for failure. Narrow your focus on who will actually pay for your products or services, your target audience. You already identified them in the pre-plan-prep, so now put this into your plan of action.


There is no need to discuss all of the many, many forms of advertising out there. You see it all around you, on the streets, on television, online, and you hear it on the radio. The forms of advertising you chose will be based on your industry and what you can afford. More than that, which form of advertising will be most effective for your business. Choose the variety that provides the best bang-for-the-buck. Be sure to start small, so you can optimize your ads affordably.

One defining factor used to determine your advertising budget is the cost of customer acquisition. This number is derived from a simple equation:  Money spent to bring them in divided by the number of customers you receive. The equation gets more complex when you add customer loyalty and repeat business, but those factors lower the cost of customer acquisition.

Before you advertise, you must first be fully prepared to sell. You and your sales staff must truly understand your product or service, and be ready to deal with the public when they inquire about it. Ineffective answers to inquiries after advertising simply wastes the time, effort, and money that went into finding customers in the first place. After you have sales people in place that can really sell and close deals effectively, you will be ready to advertise your products or services.

A successful advertisement will compel your target audience by creating a desire and revealing a nice way to satisfy that desire. Appeal is very important but can be very difficult to determine. Usually, ads, after much evaluation and improvement, need to be tested.  Good statistics must be kept with every ad design iteration and then compared to the previous version. This is a very involved process but will allow you to tailor your advertisements for your target audience to maximize their appeal. Set a tone which caters to your customer’s wants and needs, and helps shape their associations, feelings, perceptions and attitudes to your brand when they think of products or services related to your industry.

One rule to consider for any advertising campaign, if your small business is unknown, is to be seen multiple times in order to gain trust from the public. It is human nature for people to slowly gain trust in something or someone simply by having reoccurring contact. The first time they see an ad from your company, they will probably disregard it. They don’t know who you are.  But after seeing an ad from you multiple times, if they have an interest in your product, their confidence will begin to build and they may finally inquire about your product. Knowing this,  just be patient. Repeat your ad campaign over and over until you really start seeing results.  After that, like magic, your phone may really start ringing off-the-hook, or your in-box will start to fill with inquiries.

As I stated before, there are many, many forms of advertising out there. Find the one that will be most effective for each dollar you spend on it.

Plan your market entry

Now that you fully understand your target audience, your negotiating power with suppliers and vendors, your competition, and you are an industry expert based on your research, put a plan together for how you will enter the marketplace. Just detail all of this out, and thoughtfully plan how you will execute in each area. This thought process is of the most important, now that you have a differentiated product that is ready for market. Document it well and commit it to memory. You don’t want to be caught off-guard.

Remember… challenge the status quo. The rewards you will receive if you can change the way business is done in your industry will be wonderful if you can mitigate the risk. Put it into your plan and test it!

Customer service strategy

To the customer, your company will only be as good as the last time they had contact with you. Small businesses, not having universal brand recognition, must provide stellar customer service along with a stellar product in order to stay on top of the customers mind. Good memories don’t stick in the mind of your customers as well as bad ones do.  This provides an on-going challenge… keep the good memories flowing to your customers!

There is a strong bond that can be achieved with your customers when you provide them with repeated good memories… customer loyalty.  Customer confidence comes from the trust you establish with them, but customer loyalty is the bond that keeps them coming back. Use the examples below to provide the kind of customer service that demands loyalty from every customer.

For a great level of detail on how to provide the best customer experience, and what type of actions to avoid to prevent those bad memories, read Gaining Customer Loyalty.

Exit strategy

Sometimes major setbacks occur that may put you out of business, like the death of a key stakeholder, or your own illness. Be sure to start and then contribute to a retirement fund. Purchase some of the many types of insurance. To list a few: Employee liability, commercial auto, general liability, property, worker’s compensation, professional liability and data breach.

There are many types of insurance that an agent would love to sell you, so get the information about what is available, and what each one covers, but then be shrewd. Insurance is a service, even if much of it is mandatory, so treat is as a product and weight the cost vs. value for each type. Don’t over-insure. First, comply with what is required by law, and then go with your instinct, based on research and shopping around.

If you plan on selling your company after reaching a certain mile-stone, like gaining a specific amount of market-share, put that into your plan so you know when and how to start advertising your business.

Select a team (staff)

You will have to wear many hats… perform many jobs as a startup business owner. But you can’t do everything. Plan to hire key staff members that can help you get to then next level, time and time again. Lay out the details for this in your plan so you can anticipate what kind of help you will need based on your own talents and short-comings. Think through and document what stage you expect to need this help and write up your plan to convince them to join you, since you probably won’t be able to provide a competitive wage at first.

Monitor changes in the market (customer needs, new competitors, and new technology)

This is something that should never ever stop. Changes occur often, in every industry, so stay on top of them and make adjustments to stay competitive. Anticipate changes before they occur and you will be able to change course on a dime, out-witting your competition.

Line up customers before you open your business

Getting your products out to your market ahead of time will allow you to get feedback and testimonials that you can use in your advertising when you open your business. Provide free samples of your products in a creative, promotional way.

Set new trends with your idea

Following market trends is safe but strategically setting new market trends will truly make you stand out. Put your vision to the test with this one!

Manage your strategic action business startup plan like a project which has timeframes, milestones, commitments and good communication and understanding. Use good resource allocation so key players get their piece of the project and assign key deliverables. Project management is key to successful execution of a business startup plan. Be calculating and tactical every step of the way.

(article by G.Hixon)


How to start a Startup

Here is a literal and actionable guide on how to start up.


Based on a much longer eponymous essay by Paul Graham, I reinterpreted it so it makes sense when you don’t know where to start:

  • Live in the future. Most of us live in the past or the present. It is easier to analyze what already succeeded and think of ways to replicate the success. It’s thinking by analogy. It is a valid way to think, except that this isn’t the way to create a big startup. Big startups are based on ideas of two kinds – obvious and hard, like Elon Musk’s SpaceX; and non-obvious and hard, like Uber. If you don’t see the obvious and hard or the non-obvious, there is a name for it – “Schlep Blindness”. SpaceX is an obvious idea because the only other enterprise that could send people to Mars, NASA, had no plan to do so at the time SpaceX started. So it is obvious. Because it is obvious and no one else is doing it – a reasonable assumption is that it is impossible. Yet if you live in the future, it will also be obvious to you that humanity will either go to Mars (or another planet) or go extinct at some point. More likely we will find a way to leave this blue pebble. So the impossible must be possible. With UberPool, the idea that at any given point in time there are at least two people going from about the same location to about the same destination is non-obvious. It requires at least three assumptions. It is hard because you would have to gather and store mountains of data about where people actually go in a city. That kind of data analysis is only becoming available now. But Uber thought of it when they offered their first ride back in 2009. They were living in the future.
  • See what is missing in the world. You probably noticed that before Uber, taxi rides weren’t enjoyable. You probably noticed that before SpaceX people were less interested in space. But that is already the past. What is missing now? More importantly what is missing from your life now?
  • Write it down. No matter how smart you are, you will not remember all your insights. Your conversations with others, random observation, and shower thoughts that are worth following up on. Write these done or lose them. Daydreaming has value. Einstein had another name for it – thought experiment.
  • Make a prototype. Most of your thoughts, even the best ones, will never see the light of day sadly. You will forget them into oblivion even if you write them down. The only exceptions are those thoughts you prototype. Makethem physical if they can be – program them, design them, do anything that makes them more than just thoughts. Most people will stop right here. So if you do this, you are already ahead of the imaginary curve.
  • Show the prototype to 100 people. Now you will need to step out of your comfort zone and seek out people who will critique your prototype. Ideally, these are both people you already know and complete strangers. Why 100? Because you need a breadth of perspective and hopefully a pattern to recognize from all the feedback.
  • Iterate. Although a few people will get it right on the first try, the odds are you will not. So prepare to redo everything from scratch. This is your “founder MBA”, except it is free.
  • Find a co-founder. When the prototype starts making sense, go find another person who will pour a decade of their life into this project because it will change the world and they probably don’t have a more meaningful thing to do in life at the moment.
  • Register your business. Split equity. Finally, an easy step. Get a lawyer who will register your company. Give your co-founder as much equity as will make them work their hardest, while you keep as much as will make you give it your all.
  • Look for funding and build version one. Unless you have enough savings to build version one, go find an investor. While you are doing that build version one. You have to keep building because there is no guarantee about when or whether you find an investor. Don’t assume that you will just because other startups are getting funded. Assume the worst, and build your product.
  • Launch. By the time there is even an iota of usefulness in your product, launch it. Extra features, better interface, faster load time and other optimizations probably won’t save it, if the core features have no use.
  • Follow up with users. Are users coming back? Find out why they are not.
  • Launch again. Launch as many times as it takes. At some point, if at least a few dozen people are coming back on their own, you probably made something valuable.
  • Get to 1,000 users. This may not seem like a lot, but the first 1,000 users will show the weaknesses of what you have built. You probably will have to recruit them manually. How manually? Take their computer and open your website for them. Whatever it takes.
  • Grow. Paul Graham encourages startups to grow at least 5% a week. If you grow that much, within 4 years you will get to 25 million users. In other words, you will be one of the largest startups.
  • Success – whatever that is. You can IPO, sell your company to another or stay private by convincing investors that there is a bigger liquidity event coming. Even now, though, you may or may not have made the world better. WebVan IPO’ed, but quickly disappeared. Think about what kind of a dent in the universe you want to leave with your startup.

(article by A.Vital – Inspired by Paul Graham’s essay “How to Start a Startup”)

Financial Modeling & Business Valuation for Startups

(presentation by E.Kasznik)

What are the top five reasons why startups fail?

Having handled 700+ corporate and personal insolvencies, I would make the following observations as the top 5 reasons why startups fail:

1 – Lack of capital

Cash is King

Most business owners that I have dealt with, start a business not pre-planning the funding requirements necessary to:

  • Obtain key infrastructure (such as: plant and equipment) by inception; and
  • Have sufficient cash flow to fund the day-to-day operations.

I have used the ‘aeroplane analogy’ many times to demonstrate this point.

Imagine saying: “We have a new fighter jet for you to test, it is only missing two (2) ailerons, apart from that, it is good to go”.

The lack of foresight to see and obtain the capital requirements of the business, goes hand in hand with the fact that the most unsuccessful business owners simply have no business plan at all (this is elaborated further below as it is considered one of the key reasons for startup failure).

Having only 95% of the necessary capital to start your business is not enough. You need 100%. Just as an aeroplane needs 100% of its infrastructure to fly.

Small home-based businesses, obviously need less capital than a restaurant or airfreight transport company.

2 – Expanding too soon

It is very easy for a business owner to think that because of a few ‘early day successes’ that they have nailed their product mix sufficient to expand to a new office, factory, warehouse, geographical location or some other superfluous area.

Expansion needs to be fully costed and properly funded.

Imagine saying: “Hey, our new software, that will revolutionize social media, requires 100 users to reach the break-even point. We currently have 20. I think we need to move to an upmarket city location so we look good to our customers”.

Not that accounting is a blood sport, but I would think you would be shot on the spot.

Expansion also requires infrastructure, not only from a plant and equipment perspective, but also from a personnel perspective too.

Do you have the right team to manage the expansion? Are your team trained to handle the rapid growth as you achieve scale?

Some of the most tragic expansions I have seen, is where a business that has yet to get their business model right in the location they originally founded, all of a sudden expands their business into another geographic location that stretches logistic capabilities and dramatically increases overhead expenditure.

What is your response time if things go bad? How soon can you or your business react to the good and/or the bad? Can your business afford to pay for multiple locations?

3 – Heavy reliance on debt funding

A man in debt is so far a slave” [Ralph Waldo Emerson]

As soon as a loan is drawn down to start a business (a loan which is most likely secured against the family home), you are on the ‘debt clock’.

Debt payments are now cemented in time and you need your business to get to the break-even point (BEP) as fast as possible. Not achieving your BEP or, not achieving your ‘critical mass’ (some people prefer to use the term ‘scale’) in time, may mean further borrowings to keep your statup afloat.

The most obvious places to obtain further funding, are from personal credit cards followed secondly by refinancing the mortgage on the family home.

Then there are the family members, your best friend in the whole world (at least when they are getting their money back) and so on and so forth, until you have no further capacity to borrow and interest repayments kill your precious cash-flow.

Too many times a failed business leads to the loss of the family home and potentially, the loss of the family (i.e., separation/divorce).

4 – Poor strategic management

A fish rots at the head

I have seen time and time again, a person who was great at their trade craft (say, plumbers, builders, accountants, chefs etc.) make a move to their own business. While they are great (if not fantastic) at their particular trade, they are not groomed nor educated for business. Business is its own wild animal. One wrong move and it can eat you alive.

I have often wondered why the governments of the day do not instil a ‘business owner test’ to those wishing to start their own business. Pass the test and you can be in business.

Then again, I think about all the money us Insolvency Practitioners (and our lawyer friends) make from failed businesses … that thought quickly goes away.

“Knowing how to operate within a business is mutually exclusive to know how to operate a business”.

5 – No business plan

If you fail to plan, you plan to fail” [Benjamin Franklin]


Hope is not a strategy” [Rudy Giuliani]

Imagine saying: “Hey, lets chuck a couple of guys in a scuba suit, put them in a fast plane and see if we can touch the moon?”

A mission to the moon requires meticulous detail and planning.

Think about the family holiday. There are a few key stages that the holiday goes through before coming to fruition:

  • First stage – Concept: “Lets go on holidays to Disney World”.
  • Second stage – Basic planning: “I think October is the best month based on lower crowd numbers, lets fly to Orlando and rent a car”.
  • Third stage – Detail: “We fly American Airlines from gate 52, on 29 January 2015 at 8:35am, staying 9 nights at the Caribbean Resort. A Honda Civic is available on arrival in bay 28.”

Most failed business owners stop planning at the Concept Stage. Yet, when it comes to our holidays, meticulous details are planned for.

Why not use the same mantra for your business? I mean, at the rate at which small to medium business fail, its only going to make you or break you.

The other key element to the business plan is to get you explicitly stating your ‘Why’.

  • Why are you in business?
  • What need are you satisfying?
  • Why has it not been done before?
  • Why can you deliver a better result than your competition?
  • How will you obtain your ‘first mover advantage’?

Planning your business forces you to seriously think about all areas of your business and not just the fluffy parts of your business like “sales” or “profit”.

Meticulous details like: operations, employee ramp-up, funding and forecast financials and logistics are needed to be considered.

But you only need to do this if you want to give yourself a fighting chance. If not, leave your business concept on the napkin you used at the local bar.

(article by C.Baskerville)

How to start a startup?

Interesting insights on how to start a startup [Infographic]?


Italian startups distribution

Italia. Land of quattrostartups


How funding works – Splitting the equity pie with investors

A hypothetical startup will get about $15,000 from family and friends, about $200,000 from an angel investor three months later, and about $2 Million from a VC another six months later. If all goes well. See how funding works in this infographic:


First, let’s figure out why we are talking about funding as something you need to do. This is not a given. The opposite of funding is “bootstrapping,” the process of funding a startup through your own savings. There are a few companies that bootstrapped for a while until taking investment, like MailChimp and AirBnB.

If you know the basics of how funding works, skim to the end. In this article I am giving the easiest to understand explanation of the process. Let’s start with the basics.

Every time you get funding, you give up a piece of your company. The more funding you get, the more company you give up. That ‘piece of company’ is ‘equity.’ Everyone you give it to becomes a co-owner of your company.

Splitting the pie

The basic idea behind equity is the splitting of a pie. When you start something, your pie is really small. You have a 100% of a really small, bite-size pie. When you take outside investment and your company grows, your pie becomes bigger. Your slice of the bigger pie will be bigger than your initial bite-size pie.

When Google went public, Larry and Sergey had about 15% of the pie, each. But that 15% was a small slice of a really big pie.

Funding stages

Let’s look at how a hypothetical startup would get funding.

Idea stage

At first it is just you. You are pretty brilliant, and out of the many ideas you have had, you finally decide that this is the one. You start working on it. The moment you started working, you started creating value. That value will translate into equity later, but since you own 100% of it now, and you are the only person in your still unregistered company, you are not even thinking about equity yet.

Co-founder stage

As you start to transform your idea into a physical prototype you realize that it is taking you longer (it almost always does.) You know you could really use another person’s skills. So you look for a co-founder. You find someone who is both enthusiastic and smart. You work together for a couple of days on your idea, and you see that she is adding a lot of value. So you offer them to become a co-founder. But you can’t pay her any money (and if you could, she would become an employee, not a co-founder), so you offer equity in exchange for work (sweat equity.) But how much should you give? 20% – too little? 40%? After all it is YOUR idea that even made this startup happen. But then you realize that your startup is worth practically nothing at this point, and your co-founder is taking a huge risk on it. You also realize that since she will do half of the work, she should get the same as you – 50%. Otherwise, she might be less motivated than you. A true partnership is based on respect. Respect is based on fairness. Anything less than fairness will fall apart eventually. And you want this thing to last. So you give your co-founder 50%.

Soon you realize that the two of you have been eating Ramen noodles three times a day. You need funding. You would prefer to go straight to a VC, but so far you don’t think you have enough of a working product to show, so you start looking at other options.

The family and friends round: You think of putting an ad in the newspaper saying, “Startup investment opportunity.” But your lawyer friend tells you that would violate securities laws. Now you are a “private company,” and asking for money from “the public,” that is people you don’t know would be a “public solicitation,” which is illegal for private companies. So who can you take money from?

  1. Accredited investors – People who either have $1 Million in the bank or make $200,000 annually. They are the “sophisticated investors” – that is people who the government thinks are smart enough to decide whether to invest in an ultra-risky company, like yours. What if you don’t know anyone with $1 Million? You are in luck, because there is an exception – friends and family.
  2. Family and Friends – Even if your family and friends are not as rich as an investor,  you can still accept their cash. That is what you decide to do, since your co-founder has a rich uncle. You give him 5% of the company in exchange for $15,000 cash. Now you can afford room and ramen for another 6 months while building your prototype.

Registering the company

To give uncle the 5%, you registered the company, either though an online service like LegalZoom ($400), or through a lawyer friend (0$-$2,000). You issued some common stock, gave 5% to uncle and set aside 20% for your future employees – that is the ‘option pool.’ (You did this because 1. Future investors will want an option pool;, 2. That stock is safe from you and your co-founders doing anything with it.)

The Angel round

 With uncle’s cash in pocket and 6 months before it runs out, you realize that you need to start looking for your next funding source right now. If you run out of money, your startup dies. So you look at the options:

  1. Incubators, accelerators, and “excubators” – these places often provide cash, working space, and advisors. The cash is tight – about $25,000 (for 5 to 10% of the company.) Some advisors are better than cash, like Paul Graham at Y Combinator.
  2. Angels – in 2013 (Q1) the average angel round was $600,000. That’s the good news. The bad news is that angels were giving that money to companies that they valued at $2.5 million. So, now you have to ask if you are worth $2.5 million. How do you know? Make your best case.  Let’s say it is still early days for you, and your working prototype is not that far along. You find an angel who looks at what you have and thinks that it is worth $1 million. He agrees to invest $200,000.

Now let’s count what percentage of the company you will give to the angel. Not 20%. We have to add the ‘pre-money valuation’ (how much the company is worth before new money comes in) and the investment

$1,000,000 + $200,000  =  $1,200,000  post-money valuation

(Think of it like this, first you take the money, then you give the shares. If you gave the shares before you added the angel’s investment, you would be dividing what was there before the angel joined. )

Now divide the investment by the post-money valuation $200,000/$1,200,000=1/6= 16.7%

The angel gets 16.7% of the company, or 1/6.

How funding works – Cutting the pie

What about you, your co-founder and uncle? How much do you have left? All of your stakes will be diluted by 1/6. (See the infographic.)

Is dilution bad? No, because your pie is getting bigger with each investment. But, yes, dilution is bad, because you are losing control of your company. So what should you do? Take investment only when it is necessary. Only take money from people you respect. (There are other ways, like buying shares back from employees or the public, but that is further down the road.)

Venture Capital round

Finally, you have built your first version and you have traction with users. You approach VCs. How much can VCs give you?   They invest north of $500,000. Let’s say the VC values what you have now at $4 million. Again, that is your pre-money valuation. He says he wants to invest $2 Million. The math is the same as in the angel round. The VC gets 33.3% of your company. Now it’s his company, too, though.

Your first VC round is your series A. Now you can go on to have series B,C – at some point either of the three things will happen to you. Either you will run out of funding and no one will want to invest, so you die. Or, you get enough funding to build something a bigger company wants to buy, and they acquire you. Or, you do so well that, after many rounds of funding, you decide to go public.

Why companies go public?

There are two basic reasons. Technically an IPO is just another way to raise money, but this time from millions of regular people. Through an IPO a company can sell stocks on the stock market and anyone can buy them. Since anyone can buy you can likely sell a lot of stock right away rather than go to individual investors and ask them to invest. So it sounds like an easier way to get money.

There is another reason to IPO. All those people who have invested in your company so far, including you, are holding the so-called ‘restricted stock’ – basically this is stock that you can’t simply go and sell for cash. Why? Because this is stock of a company that has not been so-to-say “verified by the government,” which is what the IPO process does. Unless the government sees your IPO paperwork, you might as well be selling snake oil, for all people know. So, the government thinks it is not safe to let regular people to invest in such companies. (Of course, that automatically precludes the poor from making high-return investments. But that is another story.) The people who have invested so far want to finally convert or sell their restricted stock and get cash or unrestricted stock, which is almost as good as cash. This is a liquidity event – when what you have becomes easily convertible into cash.

There is another group of people that really want you to IPO. The investment bankers, like Goldman Sachs and Morgan Stanley, to name the most famous ones. They will give you a call and ask to be your lead underwriter – the bank that prepares your IPO paperwork and calls up wealthy clients to sell them your stock.  Why are the bankers so eager? Because they get 7% of all the money you raise in the IPO. In this infographic your startup raised $235,000,000 in the IPO – 7% of that is about $16.5 million (for two or three weeks of work for a team of 12 bankers). As you see, it is a win-win for all.

Being an early employee at a startup

Last but not least, some of your “sweat equity” investors were the early employees who took stock in exchange for working at low salaries and living with the risk that your startup might fold. At the IPO it is their cash-out day.

(article by A.Vital)

How to build a billion-dollar startup in 11 quotes

Stanford is offering a class in startups taught by some of the most successful tech founders in the valley.

The class was packed on day one, as famed investor Sam Altman revealed some of the secrets he teaches aspiring startups at incubator YCombinator.

The whole first lecture is worth watching, whether you’re itching to start your own company or just interested in tech culture. You can find it below.

For your convenience, though, here’s the best advice in 11 quotes.

1. You should never start a startup just for doing so. There are much easier ways to get rich… the specific passion should come first and the startup, second.

Both Altman and Moskovitz make a compelling case that startups are a very poor strategy for making money. Moskovitz shows a graph of how it’s far more likely that a smart person can be employee 100 at a billion dollar company and make just as much (if not more) than someone who starts their own company

In Silicon Valley there are much quicker paths to becoming a millionaire than risking 10 years of your life on an unproven idea.

2. The world needs you to do it. If it’s not something the world needs, go do something the world needs.

Moskovitz echos the common theme that startup founders should be inescapably passionate about their idea. Unless you feel you cannot live without building this product, you may not live through your company’s hard times, and you definitely won’t be able to recruit employees to follow you.

3. Most great companies start with a great idea, not a pivot… if you look at the track record of pivots, they don’t become big companies.

Altman dispels the myth that startup founders can go into a company with a mediocre idea and then evolve into a polished winner. He says that major pivots nearly always fail. And successful pivots are usually a change in direction closer to the problem that the founders meant to solve initially.

4. The idea should come first, and the startup second… if you have several ideas that all seem pretty good, work on the one that you think about most often, when you’re not trying to think about work.

I once heard that LinkedIn’s Reid Hoffman asked his friends about a few ideas and his friends advised him on LinkedIn (good call!). In other words, it’s not uncommon to want to solve many problems. But solve the one that you can’t stop thinking about.

5. You need a market that’s going to be big in 10 years… this is one of the biggest systematic mistakes that investors make, they think of the growth of the startup itself, they don’t think about the growth of the market.

Peter Thiel advises companies to try to create a monopoly. Own an entire sector. The only way to become a rich monopoly is to own the largest chunk of a sector that will be big in 5-10 years.

6. In general, it’s best if you build something that you yourself need… you’ll understand it better than if you have to understand it by talking to a customer.

This one is self-evident, if contentious. Silicon Valley gets a lot of guff for creating products for privileged yuppies. Altman seems to think this is the only way a good startup can begin.

7. If it takes more than a sentence to explain what you’re doing, it’s almost always a sign that it’s too complicated.

Keep it simple, stupid.

8. More important [to success] than any particular startup is getting to know a lot of potential co-founders.

Be a social butterfly. It’s hard to run a startup without any founding friends. Facebook, Paypal, and Google all had co-founders with very good relations, and many of them met through socializing.

9. When really successful startup founders tell the story of their early days, it’s almost always sitting in front of the computer working on their product or talking to customers. That’s pretty much all the time. They do little else.

In the early days, Altman advises founders not to hire a press team or sales reps. A good founder does everything him or herself so he or she can understand the product and how the customers want it to be better. I’m always surprised at how serial entrepreneurs with one previous exit under their belt act when they begin a new company: They can afford all the support they need, but they’ll take all the time in the world to hear about a customer complaint.

10. It’s better to build something that a small number of users love than a large number of users like.

To grow a company by word of mouth, customers need to love the product. Like doesn’t cut it.

11. The best ideas often look terrible at the beginning… the truly good ideas, don’t seem like they’re worth stealing.

Obvious and compelling ideas are most likely already being built by large companies. Startups thrive in the spaces that seem crazy but are secretly brilliant.

(article by G.Ferenstein)

If SaaS is a bubble, how could it burst?

SaaS isn’t in a bubble. The best SaaS companies are scaling and growing revenues faster than ever.  Much faster.  This is a secular trend of webifying all basic business processes and we’re only in about the 3rd inning here.  Only about 5-10% of core business processes than can be webified, are webified today.  And even in those markets, we still see acceleration (e.g., Salesforce at $5 billion in ARR still growing +-35-40%).

When revenues keep growing faster and faster, calling it a “Bubble” makes no sense.  This isn’t tulips or eyeballs we’re talking about.  It’s revenue.
However, we are in a phase where valuations have grown from 2-5x where they were 5 years ago.  And back then, those valuations seemed expensive compared to traditional software.

When valuations fall after the next correction, the entire way many SaaS companies are funded today will have to radically change.  And it will change fast.
So what will happen, is:

  • That there will be a Nasdaq correction at some point.  Maybe ’16, Maybe ’17.  Maybe next quarter.  It is inevitable and always comes.  So it has always been.
  • When a correction comes, my operating assumption is that multiples in SaaS might revert to 4-5x or so ARR for Very Good SaaS Companies — and Pretty Good SaaS Companies may become structurally unfundable.
  • This will lead to a crumbling of the segmentation of the venture market, where firms have segmented around $10m, $20m, $40m, $100m type ARR ranges, that each invest 8-15 months after each other at 2x step ups.
  • This will lead to the failure of a number of high-burn SaaS start-ups that can’t correct.  There are many SaaS start-ups burning $500k or more a month, or $1m a month or more later stage, that cannot sustain that growth without large infusions of annual capital. Venture Capital is Nasdaq on steroids.  All that mega-late-ish-round funding in the prior bullet point will evaporate because the valuations won’t support it anymore.
  • This won’t really impact medium-to-low burn SaaS start-ups that much.  We didn’t even see any big impact at an operational level after Lehman brothers and the 60%+ drop in the markets.  Because the markets kept growing.

This is what I see.  But, I see no clouds on the horizon.

No bubble (A Passion for Research):

The growth is there, and it’s epic (Salesforce):

But, huge multiple expansion for Best-of-Breed SaaS players (chart from here: SaaS Multiples: Recovery or Bubble?) will lead to a 50-70% Valuation Deflation as measured by multiples when market corrects:

And then, probably, a little time will go by … and we’ll see reinflation.

Startups: Do I need to stop my startup after knowing that the same thing has been started by some other big company?

Yes, yes you do.

Just like those Stanford students who were going to start a search-engine company but were put off by the fact that Altavista was already popular, or the Harvard kids who decided that Sixdegrees was all the social network everyone needed.

Let me add this for those who haven’t had their coffee today: I refer above to the people who started Google and Facebook, and the real answer is “no“!

If you want to continue the discussion…