Starting a new business from scratch

Ross Woods, 2013,15

 

This ebook describes the stages of starting a new business from scratch, as well as pointing out some of the pitfalls along the way. You will see that many of the lessons of the small business also apply to the large business, and vise versa.

 

Small businesses

Stage One

Everybody who starts a new business is an optimist. They take a risk and believe that they can survive or even succeed. However, many people starting new businesses make the mistake of being overly optimistic. They believe "People will obviously love my product so I'll easily sell lots and make lots of money. I know I'll have to work hard, but it won't be unreasonable."

So where's the balance? A few kinds of small business start with enough good clients. They can afford to be optimistic, because they have leap-frogged the pioneer stage. In most cases, however, they need to take the attitude that this will probably be tough and they're willing to learn as much as they can. A good business plan will probably work, but any success often takes much longer than planned.

When starting something new, it's normal to look like you don't know what you're doing and haven't yet actually decided what is it yet. It's actually fairly true:

• Even though you have a very focussed idea of what you want to do, it's not yet proven in the field. You're still grappling with the marketplace and learning what works and what doesn't.
• You're still establishing your systems for how you'll do things, and you probably won't get it right first time.
• Although you anticpated that you have all the skills you'll need, you probably don't.
• You are still developing a constituency of clients and supporters.

In the beginning of pioneering a new small business:

1. You work very long hours for little pay.
2. You can't afford to hire staff and you'll have to do everything yourself. (When your business can afford it, your first employee will probably be a bookkeeper.)
3. You will probably use up most of your capital.
4. You don't have a strong financial record so banks won't lend you money.
5. You make mistakes, which cost you time and money. For example:
1. A business model that doesn't quite work
2. Poor choice of location or target markets
3. Unprofitable goods/services
4. Wastage
5. Unforeseen risks that result in losses
6. You have to work hard to establish a constituency of regular customers.
7. You have to put up with bad clients (time-wasters, fussy, slow payers, non-payers, hard negotiators).

 

Later on

1. You're working very hard, but earning enough to live on.
2. The business has enough money to cover regular outlay.
3. You can afford to hire a bookkeeper, and perhaps some other help.
4. You have enough capital to make sure you can take an unexpected expenditure.
5. You have a strong enough financial record to get a small business development loan.
6. You don't make so many mistakes, so your business is more profitable.
7. You have a constituency of regular customers.
8. You have much fewer bad clients.

 

The mature business

1. You're working very hard, but can take time off if you want. (Later on, you can even hire a manager to run the business.)
2. The business is accumulating assets.
3. You can hire staff to cover all regular labor needs.
4. You have enough capital to fund growth.
5. You have access to finance if you want it.
6. You have enough experience to avoid all ordinary mistakes relating to your business plan.
7. You have a constituency of regular customers.
8. Your clients tend to buy products at a fair price without wasting your time.
9. You could sell your business if you wanted.
10. The business still needs to be well-run. Even large, wealthy businesses can go broke.

 

The main reasons why

The main reasons why small businesses go broke are, first, that they are under-capitalized and, second, they take on paid employees too early.

The main reasons why a business stays small is that the owner works too hard in the business (making stuff, selling stuff) and not enough time on the business as its manager (monitoring finances, evaluating the business model, etc.)

 

Large businesses

The next view below is John Nesheim's view of how to start a company. It is based on several premises:

• The company will depend on venture capital (VC), and will probably need to hand over a substantial proportion of control to the VC firm.
• It will be a high-tech company.
• It will require a staff of substantial size to become productive.
• It will be created as a public company.
• The process aims to eventually raise capital through a Public Share Offering (IPO) of shares.

Start: Get the idea and the vision
You are the main person here and it might take a while. You'll need to be creative, but it won't cost you any money. The main risk is that you might lack commercial realism. At the end of this stage, you should have a clear idea and an inspiring vision.

The kitchen table
Take several months to firm up your dream in discussions with friends and fellow founders. You'll need help to maintain confidentiality (your bigest risk is leaking the secret), exercise business judgmnet, examine your technology, and think strategically. The only cost will be the time of several people. At the end, you should have a god idea of the risks and rewards, and the trade-offs you might have to make.

Founders' commitment
It can take one or two months to get a firm commitment from key people. Some of them might get cold feet, but you need to end up with a "yes or no" commitment form the key people.

Pullout from employer
Key people need to leave their jobs, and It takes some nerves to go out and live on savings. They might need a lawyer's help if they have had access to sensitive IP. What you need to achieve is a legally clean separation and the main risks are that their current employers might make a counter-offer to keep them on, or might try to sue them over sensitive IP issues.

Write a business plan
Take several months to write a business plan and get it good enough to attract funding. You will pobably need help from a lawyer, an accountant, and perhaps a consultant. You might also need a patent lawyer if you have patentable ideas. You'll need good finance and marketing advice.

Assemble your management team
Your goal at this stage is to recruit enough experienced, competent people to fill all the key roles. It will be difficult to select the right people and figure out the kind of offer that will attract them. It will take considerable timeto interview people. Your main risks are compromise, good people won't come unless you have solid funding, leaked secrets, and distractions from your business plan. Most funders need to see you have a convincing management team before they will fund you.

Raising seed capital
The goal is to get a lead investor to commit to providing funding. You will need to know whom to contact (and perhaps who would be the best person to refer you), coaching in how to give your presentation, and judgement in how to price your company and get a good deal.

Closing capital and incorporation
Your goal at this stage is to get the cash into your bank account. You will need some good negotiating tactics and help from your commercial banker. You will need to pay some legal fees for incorporation. But if you don't get the cash, you'll have to go back and start over.

Finding a home
Next, you'll need to rent suitable premises for at least the next year.

Start-up
You can finally hire people and get started making your first product, or at least the prototype. That can take from 6 to 18 months. Watch the "burn rate", that is, how fast you are using up your seed capital. You can also have problem with "product slips," that is, delays in getting the prototype and production systems right.

Secondary capital
The CEO's main job is to get more capital. If you are short of cash and can't reduce your burn rate, your next option is probably to skip a payroll. If you run out of capital altogether, there is a very high risk of bankruptcy.

Launch first product
You need to get launch your product and get customers to actually buy it. You still have to watch your burn rate, and your marketing needs to be good. You can't really afford a flop.

Raise working capital
After your first quarter of profitability, you can seek further funding for growth. You main risk is that you have you use up your equitey rather than cheaper loans.

Initial public offering (IPO)
Your IPO goal is to give your funding capitalists five to ten times their initial investment, make your founders into millionares, repay your employees for their dedication, and generate an image as a successful company.

(Based on John L. Nesheim, High Tech Start Up; The Complete Handbook for Creating Successful New High Tech Companies. (New York: The Free Press, 2000) pp. 24-27.)

 

A variation

Some business do not follow Nesheim's stages, especially if they can raise their own seed capital and key people can maintain their other jobs. Their stages look like this:

1. Get the idea and the vision
2. The kitchen table
3. Write a business plan
4. Founders' commitment
5. Raise seed capital
6. Build a working prototype
7. Incorporation
8. Start-up
9. Assemble your management team
10. Find a home
11. Launch first product
12. Raise secondary capital
13. Pullout from employer
14. Sell pre-release shares
15. Initial public offering (IPO)