Saturday, February 28, 2015

Add Real Value To Your Startup With A Financial Model

businessman-unknowns If you think that financial modeling for a new business is arcane magic, limited in value to financial wizards and professional investors, then you have been listening to the wrong advisors. In reality, a simple Excel spreadsheet model customized around your assumptions can save you hours and avoid a wasted expense in validating alternative vendor and marketing decisions.

The way to start is with a sample financial model, freely available from many sources on the Internet, such as this one from Entrepreneur. Another alternative is to build one yourself, starting with a few formulas to extrapolate early revenues and expenses into the five-year projections normally requested by banks and investors.

Don’t try to build the “ultimate” business model, for all possible alternatives, in multiple business domains. For maximum value with the least effort, focus on only the “what ifs” that are the highest priority in your mind for your own startup. In my experience, the top candidates will include the following:

  1. What if you have to cut your targeted price? Pricing is always a tricky issue. Vendor costs are subject to change, customers are fickle, competitors come out of the woodwork and the economy can take a downturn. You need to quickly calculate the long-term impact on profitability of pricing and business model changes.

  2. What if you need to change your market size and volume projections? The manual calculations to translate market assumptions into costs, volumes, expenses and net return are massive. Yet they can be done by a simple financial model in a few milliseconds. Investors will test your savvy by asking where your business breaks.

  3. What if your growth and scaling projections are too aggressive? Most entrepreneurs realize that doubling their revenue each year puts them in a premium category with investors, so that may be your first target. But targets need to be adjusted as the reality of early returns sets in. Projections you know to be wrong won’t help you.

  4. What if investors offer you only half, or double, what you ask for? With a financial model, it’s relatively easy to apply these amounts to your marketing, manufacturing and administrative costs, as well as business volumes, to predict the impact. Your credibility with investors, and your confidence in any request, depends on these answers.

  5. What if your customer acquisition cost assumptions have to change? The cost to acquire a customer, or traffic to conversion ratios, are critical to the success of most startups. This can be projected top down from market share assumptions, or bottom up from actual costs and sales results.

The time to start building your model is even before you incorporate the business and spend real money on building products. Just like planning a long trip with your car, you need to know where you are going before your start, or you probably won’t get there. If you are not computer literate, it’s never too early to find a partner or learn tackle this critical element of every business.

The financial model obviously has to be built in concert that the overall business and pricing model that you are implementing. The most common business models these days include the subscription model, freemium model and ecommerce. Each has a different set of variables for sales, revenue flow, marketing costs and personnel.

Creating a financial model is perhaps the only way for you to see key areas of strength and weakness in your business, before the money is spent and it’s too late to recover. It’s a great learning experience and is not rocket science, so you can do it yourself. But don’t hesitate to ask for help from a professional if you need it.

You may be surprised how clear the relationship appears between product pricing, cost and customer count. You will quickly understand the old adage that if you lose money on every customer, it’s hard to make it up in volume.

Marty Zwilling

*** First published on Entrepreneur.com on 2/20/2015 ***

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Saturday, February 21, 2015

Will Crowdfunding Replace Angel And VC Investors?

Geefunding_crowdfunding Even if you ignore all the hype around crowdfunding, there can be no doubt that it is a real alternative for entrepreneurs to achieve visibility and funding today. According to articles on Entrepreneur last year, there are now almost 1,000 crowdfunding platforms in existence, currently estimated to add more than $65 billion and 270,000 jobs to the economy.

Yet as I mentor entrepreneurs around the country, it still seems to be one of the least understood approaches to startup funding, with more myths than accredited angels and professional venture capital investors combined. The primary challenge seems to be that the crowdfunding term is used to encompass so many different concepts that everyone is confused.

In fact, perhaps the most important model, equity crowdfunding for non-accredited investors, is still not legal in the U.S., despite having been passed into law in early 2012 via the JOBS Act, and still has no scheduled date for availability, waiting for the rules to be finalized by the SEC. Even with this, crowdfunding today means any one of the following five quite different models:

  1. Rewards model. Many platforms, such as IndieGoGo, allow startups to solicit funding commitments from non-professional investors in exchange for a pre-defined reward or perk, such as a T-shirt or other recognition, but no ownership in the company. The crowd gets the satisfaction of helping, with minimal risk, and no expectation of any high return.

  2. Product pre-order model. With this model, a startup pre-sells their product early, at a cheaper price, in exchange for a pledge. A much-touted success was the Pebble Watch on Kickstarter, with orders exceeding $10 million. Of course, there are thousands of other companies that don’t achieve their minimum goal, requiring all contributions to be returned.

  3. Donation good-cause model. This model facilitates donations to charities and creative projects, and has been around for a long time via sites such as Rockethub. No startup ownership or financial return should be expected, but contributors can enjoy the satisfaction of furthering non-profits or causes with a passion to change the world.

  4. Interest on debt model. In this model, often called micro-financing or peer-to-peer lending (P2P), people contribute with the intent to create a pool for all to borrow against. This model been popular in many countries for years, where banks loans are not available, via sites such as LendingClub and Kiva. The allure is the ability to get small loans easily, or excellent returns from the interest, but the risks are high.

  5. Startup equity model. In the U.S., only accredited investors can use crowdfunding sites such as EquityNet to buy ownership in their favorite startup. In Europe, other investors can buy equity, with platforms such as Seedrs. Equity investing is very risky, but huge returns are possible if you pick the next Facebook, but failure means your entire investment is lost.

Beyond these models, the crowdfunding term is often used interchangeably or confused with crowdsourcing sites, such as IdeaBounty, to get your ideas off the shelf and give you the wisdom of the crowds, or IdeaScale to facilitate the outsourcing of application development in an open source call to others on the Internet.

Other popular funding assistance sites for startups, including StartupAmerica and Startups.co are actually matchmaking sites between entrepreneurs and professional investors or banks. These sites often sponsor pitch contests with small cash prizes for funding, as well as other valuable services to support entrepreneurs.

In fact, entrepreneurs can and do gain from any and all of these approaches, either by achieving some funding, or at least testing their approach and the level of public interest in their startup idea. Smart entrepreneurs often learn the most from their failures, using the feedback to pivot their solutions before squandering a large investment from friends, angels or VCs.

Concurrently, I am seeing an upswing in the number of entrepreneurs and startups, with the cost of entry at an all-time low, and the new focus on entrepreneurship in every university and every community development organization. Since there is never enough money to feed the startup beast, I don’t see crowdfunding replacing or crowding out angels or VCs in the near future.

Marty Zwilling

*** First published on Entrepreneur.com on 2/13/2015 ***

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Monday, February 16, 2015

8 Insights For Startups To Attract Angel Investors

angel-wings Most entrepreneurs have found by now one or more of the many popular crowdfunding sites, and have the name and contact information for at least one of the big venture capital firms. But many have no insight or connections to the ethereal angel investment community, which actually funds more startups then all other venture sources combined (over $25 billion annually).

In fact, there are a few key sites to help you find angels, including AngelList and Gust, but these don’t tell you very much about how Angels work, and how to find the right ones for your startup. As an active angel investor, I can tell you what doesn’t work is broadcasting your idea description to flocks of angels, hoping that one will swoop down to anoint you with funding.

A better approach is to first understand who these people are, why and how they invest, and then focus on the ones who are the best match for your particular startup stage, location and industry. Here are eight key insights that will help you find a productive match:

  1. Angels want equity ownership, not causes. By definition, angels are accredited investors, who invest their own money for a percentage of the business. Each has met legal securities minimums for net worth and professionalism, to reduce the risk to entrepreneurs. Their realm fits between crowdfunding and venture capital sources.

  2. Most share expertise as well as money. Angels are typically current or former entrepreneurs who want to bring more than money to your startup. They prefer local opportunities where they can meet and work face-to-face with your team. Thus, angel investments from across the country or internationally are rare.

  3. Individual investments are limited to less than $100,000. Groups of angels may syndicate multiple individual amounts, but if your total request exceeds $1 million, you need to focus on the venture capital alternatives. On the other end of the spectrum, crowdfunding or “friends and family” amounts might be as low as a few dollars.

  4. Angels prefer strong teams to big ideas. That means you need to lead with your credentials, rather than your disruptive technology. Warm introductions from common friends are even better, so networking with potential peers and future investors is highly recommended well before it’s time to ask for money.

  5. Your pitch and business plan are important. Perhaps you can get money from friends and crowdfunding with no plan, but angels look for the extra discipline and effort demonstrated in a written plan. Make sure these cover your business model and exit strategy, so the angels see how both of you will make a reasonable return.

  6. Opportunity sizing and financial projections must be credible. Every investor likes to see opportunities that are large, with double-digit growth. To be fundable, fifth year revenue projections need to be in the $20-$100 million range. Larger numbers are not credible, and smaller ones may make a great business, but won’t attract angels.

  7. Avoid risky or questionable business domains. Don’t expect angels to invest in work-at-home schemes, gambling sites or debt-collection type business proposals. Other notoriously risky or specialized businesses usually avoided by angels include brick-and-mortar retail, restaurants, telemarketing and consulting.

  8. Early stage research and development won’t excite angels. Every angel looks to scale the business after you have funded product design, perhaps with friends and family. Angels need to see a proven business model, with a working prototype and preferably a real customer or two. Look to grants and strategic partners for seed funding.

Above all, remember that angels are really business people, just like you and me. They expect you to always show integrity and respect for their position, just as they respect yours, since they were likely once in your situation. They probably won’t respond well to large egos, failure to do your homework or pressure tactics.

Persistence and passion are seen as virtues by angels, so rejection should be only a temporary setback. The common response of “come back when you have more traction” means exactly that. But before you return to the same angel, remember there are more than 250,000 others in the U.S. alone. That’s the real reason that more startups get funded this way than any other.

Marty Zwilling

*** First published on Entrepreneur.com on 2/06/2015 ***

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Saturday, February 14, 2015

Smart Entrepreneurs Use Resource Constraints To Win

failure-success Most entrepreneur that fail are quick to offer a litany of constraints that caused their demise – not enough money, time, customers, or support from the right players. Ironically, as a startup investor and mentor, I have seen too many failures caused by just the opposite – too much money spent too soon, taking time to get product perfection, and assuming customers will wait.

In reality, resource constraints should be seen by startups a competitive advantage, by forcing them to develop new markets, and to think differently and act differently than existing players. The result, called resourcefulness, allows entrepreneurs to create opportunities in the face of scarcity. It allows them turn resource constraints into stunning new businesses.

In this context, constraints might more reasonably be seen as beautiful by entrepreneurs, just as they are described in a new book, “A Beautiful Constraint,” by renowned marketing consultants Adam Morgan and Mark Barden. I like the way the authors outline how to see and turn constraints from punitive to liberators of new possibilities and opportunities, as follows:

  1. Look for ways to improve productivity. Every startup needs to think hard daily about what problem or challenge is holding back progress, what really matters today, and what entirely new possibilities exist. How many times have you actually made up work to keep an idle person busy? Startups funded by rich uncles rarely think about productivity.

  2. Rethink or reframe the challenge. Constraints are the best motivators for finding new approaches to solving a problem, building a product, or crafting an effective marketing campaign. Perhaps success itself needs to be redefined or reframed. Every entrepreneur needs to avoid locked-in ways of thinking. Let your constraints drive innovation.

  3. Find the benefit in subtraction. Isn’t it amazing how often all the necessary work gets done, even when resources are removed or the budget is reduced in an ongoing project? The benefit of working harder and more efficiently is success despite constraints. Subtraction leads to simplicity, better usability, and easier education of your customers.

  4. Find new ways to augment. The fastest way to grow your business is to find partners who can amplify or sell what you already have, and you can sell what they have. That’s a win-win relationship, which almost always takes less time and money than building something new. Adding priced services is another way to augment a product business.

  5. Create new kinds of solutions. Using the solution technology that you already have, in new ways, takes fewer resources than inventing or sourcing new technologies. That’s why computer makers offer desktops, laptops, notepads, and now even smartphones. Without constraints at the forefront, computers tend to get complex and more expensive.

  6. Build entirely new business models and systems. Pricing constraints and the need to attract consumers drove the invention by startups of the freemium model, subscription model, razor-blade model, and others. Today we see whole new ecosystems and opportunities driven by environmental constraints, safety concerns, and social issues.

Some entrepreneurs never get past the victim stage for constraints. They see every constraint as an inhibitor to their ability to realize their ambition, and an excuse for not persevering. Others proceed to the neutralizing stage, which means they tackle problems as they are encountered, and get some satisfaction by finding a way around each one. It’s still a hard road to success.

The smarter entrepreneurs jump quickly to the transformer stage, where constraints are proactively or responsively used to prompt wholly different and potentially breakthrough new approaches and solutions. They even impose constraints on themselves and their team to stimulate better thinking and new possibilities. Then they size the potential in the constraint.

We live in a world of over-abundance of choices, yet seemingly ever-increasing constraints, driven by a scarcity of time, expertise, and money. How entrepreneurs respond to these will become a larger and larger determinant of startup growth, competitive position, and success. What is your resource constraint mindset and action plan today?

Marty Zwilling

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Sunday, February 8, 2015

4 New Customer Loyalty Rules Drive Business Success

customer-loyalty Many startups and mature businesses have not yet accepted the fact that customer satisfaction and loyalty in this “always connected” age are about more than product and service quality. They are all about how customers broadcast their pleasure or unhappiness to others. With incredible ease, they can influence thousands or millions of potential new customers, or say nothing.

Most existing metrics and analytics for measuring customer satisfaction and loyalty, including the popular Net Promoter Score (NPS), don’t distinguish between recommend messages to others (word-of-mouth), detract messages or no message at all.

In his recent book, Innovating Analytics, Larry Freed, a customer experience and analytics expert, makes some convincing points on the drivers for business loyalty and success that every business owner should commit to memory. I believe his four basic rules should always come first:

  1. Customer retention is priority number one. Keeping your current customers is one of the most important keys to revenue growth. According to Inc. magazine, acquiring a new customer costs about five to nine times more than it does to sell to an existing one, and on average, current customers spend 67 percent more than new ones.

  2. Customer upsell: Sell more to existing customers. Selling more to loyal customers is a great success strategy. But to engender loyalty, you have to be delivering a good experience and keeping satisfaction high. Existing customers today are fickle and will leave you quickly if they get word-of-mouth negative messages from their connected sources.

  3. Marketing-driven customer acquisition. Traditional marketing efforts (advertising and promotions) are still important. In this context, the palette of channels for reaching customers has greatly expanded, to now include social media, digital, mobile and new online options. The challenge is to measure resources spent against return.

  4. Word-of-mouth driven customer acquisition. The new dominant method of acquisition is engaging potential customers through social media and key influencers, and converting these prospects into customers with a satisfying experience. Here the satisfaction experience does double duty, as it is messaged down-line to other prospects.

In the past, retention and loyalty were often used interchangeably. Today, true loyalty, earned by incredible experiences and satisfaction, also does that double duty of bringing in multiple additional customers through broadcast and interaction with the huge connected community.

The more traditional purchased loyalty (coupons, rebates), convenience loyalty (corner market, coffee shop) and restricted loyalty (no other game in town) only work for single customer retention. They operate like competitive retention, forcing you to win every transaction over competitors.

Another reality is that today’s consumers are multichannel, or “omnichannel.” This simply means that they may start a product search on a computer at work, continue on their home computer, visit a store for touch and feel activity, and then close the transaction on their smartphone. It really complicates the measuring process.

Others are walking the aisles in one store, while scanning for better deals on their smartphone in other stores or online. Concurrently, they are asking for the experiences of the community through FourSquare or Yelp, and broadcasting their own experiences on Facebook and Twitter.

The common thread here is quality of the customer experience, more so than the quality of customer service, and the impact of that experience on other current and potential customers. Simple customer satisfaction surveys and analytics miss several of these dimensions, and simply are no longer adequate.

You need to take advantage of innovative new tools, like the Word of Mouth Index (WoMI) from ForeSee, and the analytic power of Big Data to gain a competitive advantage today, and predict customer behavior for tomorrow. Nobody said it would be easy. How much do you really know about your company’s customer experience? Get busy and find out.

Marty Zwilling

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Saturday, February 7, 2015

7 Steps For Establishing The Right Business Model

The_Price_Is_Right Most technical entrepreneurs focus hard on building an innovative product, but forget that an elegant solution doesn’t automatically translate into a successful business. Businesses require an equally elegant business model, with the right price, messaging and delivery channel to the right target customers to keep the dream alive and growing.

Defining the right business model requires the same diligence as designing the right product, but the approach and skills required are different. That’s why investors acknowledge that two co-founders are often better than one -- with one focusing on the technical solution, and the other focusing on defining and building the business model. These two jobs need to be done in parallel.

This dual-leadership approach would have avoided the frustration I felt in a startup a few years ago where beta customers loved our software solution as a free prototype, but we couldn’t sell one in the first few months for a price that seemed reasonable for all our work and innovation. The founder had simply not done the work to validate a price and customer segment.

In the investment community, this work is called proving the business model. It starts with validating a business opportunity (a large customer segment willing to pay money to solve a real problem), in much the same way as your proof of concept or prototype validates your technical solution. Here are seven steps I recommend for establishing the right business model:

  1. Size the value of your solution in the target segment. Customers often complain that existing approaches are not intuitive or integrated, but old solutions may be familiar and locked in. Estimate your costs, including a 50 percent gross margin, as a lower bound on a price. Products too expensive for the market won’t succeed, and prices too low will leave you exposed. Match with competitor prices and market demographics.

  2. Confirm that your product or service solves the problem. Once you have a prototype or alpha version, expose it to real customers to see if you get the same excitement and delight that you feel. Look for feedback on how to make it a better fit. If it doesn’t relieve the pain, or doesn’t work, no business model will save you.

  3. Test your channel and support strategy. Now is the time to pitch the entire business model to a group of customers or a specially selected focus group. This is not just a product pitch, but must include all elements of your pricing, marketing, distribution and maintenance. Here again is your chance to make pivots for almost no cost.

  4. Talk to industry experts and investors. A small advisory board of outside people with experience in your domain can give you the unbiased feedback you need, as well as connections for setting up distribution and sales channels. It’s also valuable to talk to potential investors for their views, even if you are bootstrapping the effort.

  5. Plan and execute a pilot or local rollout. Good traction on a limited rollout is great validation of a business model. It allows you to test costs, quality and pricing in a few stores or a single city, with minimum jeopardy and maximum speed for recovery and corrections. Save your viral campaign and major inventory buildup for later.

  6. Focus on collecting customer references. Give extra attention to those first few customers, and ask for publishable testimonials and word-of-mouth support in return. If you can’t get their support, even with your personal efforts, take it as a red flag that the business will probably not scale at the rate you projected.

  7. Target national trade shows and industry association groups. You need positive visibility, credibility and feedback from these organizations as a final validation of your business model, as well as your product model, in the context of major competitors. This may also be a great source for leads as a key part of that final rollout and scale-up effort.

Your business model can be a better sustainable competitive advantage than your product features, or it can be your biggest risk exposure. Too many of the business plans I see are heavy on competitive product features, but light on business model details and innovations.

If you or someone on your team hasn’t spent at least the same effort on the business model as on the product service, you are only half prepared for the real world of business today. It’s hard to win by doing half the job, especially if that is the easier half.

Marty Zwilling

** First published on Entrepreneur.com on 1/30/2015 ***

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Sunday, February 1, 2015

Taking Your Startup Public Is Fraught With Negatives

NewYorkStockExchangeByLuigiNovi In the old days, every entrepreneur dreamed of easily taking their startup public, and making it big. Today the rate of startups going public (IPO – Initial Public Offering) is up from the dead zone, but is still less than half the rate of 15 years ago. Smart entrepreneurs now avoid this option like the plague, due to its unpredictability and the challenges of running a public company.

According to a recent Ernst & Young global report, 2014 was a strong year with IPOs actually outperforming other indices by 10 percent. Yet they see warning lights flashing, based on a still fragile global economy, and volatile markets ahead. Today 70 percent of successful startups are still acquired by bigger companies, as the safer and preferred method of growth and funding.

The reasons are a lot more complex than the meltdown of key investment banks in the US a few years ago, so don’t expect a big change in the numbers soon, even with recent stock market rallies. In my view, the key reasons that IPOs have lost their luster from an entrepreneur and investor perspective include the following:

  1. The US IPO process is still stumbling. Too many startups have experienced early financial losses and technical glitches, like King Digital Entertainment and the Facebook IPO a while back, which antagonized individual investors and startup executives as well. In addition, most ordinary investors are convinced that IPO rewards only go to insiders.

  2. Going public is an expensive process. Typical costs for startups today range from $250,000 to $1 million, even if the offering does not go through. In addition, huge amounts of executive time are required, as well as hits to key operational, accounting, and communication processes. The M&A alternative looks simple by comparison.

  3. Constant pressure to increase earnings. Because public shareholders usually take the short-term view, they want to see constant rises in the stock's price so they can sell their shares for a profit. Thus, there is tremendous pressure to increase current earnings, and little appetite for strategic investments.

  4. Startups going public are laid open to competitors and critics. Startups are typically run by a couple of executives who are reluctant to disclose via the prospectus and SEC reports all the decision-making criteria, operational financial details, and compensation formulas. With thousands of shareholders, dealing with critics is an onerous challenge.

  5. Complying with Sarbanes-Oxley requirements is a heavy burden. Public companies of any size must comply immediately with the full reporting requirements of the SEC. There is no accommodation for smaller public companies, who can’t be competitive in their space with the new accounting, documenting, and reporting processes required.

  6. Public companies are always at risk for takeovers. Friendly or hostile takeover attempts are just a couple of the many ways that company founders sense a loss of control of their own destiny. The board of directors, as well as public stockholders, are no longer part of the inside team focused on the founder’s vision to change the world.

  7. Increased liability risk exposure. Public company executives and directors are at civil and even criminal risk for false or misleading statements in the registration statement. In addition, officers may face liability for misrepresentations in public communications and SEC reports. Executives are also at risk for insider trading and employment practices.

  8. Violent market swings usually hit public companies first. Private companies in less-relevant market segments can often fly under the radar in turbulent times like the recent recession. Public stockholders are more easily swayed by emotion and the activities of the crowd, than real market conditions.

  9. Startup founders don’t fit in a public company. Most just don’t enjoy all the challenges of communicating to analysts, placating demanding stockholders, and keeping up with legal reporting requirement. They know they can be quickly tossed aside for not maintaining the right image and the right relationships with people they don’t like.

  10. The image of large public companies is negative. In the last couple of decades, the paternal image of large multi-national company leaders like Thomas Watson at IBM and Henry Ford is gone. Now the mistakes of large companies like Enron and BP have set a new image of public companies as being led by greedy and uncaring executives.

These negatives have largely overshadowed the potential IPO positives of increased capital for the startup, possible huge increase in personal net worth, broader access to investors, market for their stock, the ability to attract top-notch professionals, and the peer prestige of running a public company.

Thus most startups I know don’t even mention the IPO exit option, when applying for Angel funding, and most Angel investors will react negatively if you do mention it. As best, you should reserve this option for later stage VC discussions, once you have a well-proven business model, large market following, and substantial revenue.

More importantly, make sure first that you really want to give up the entrepreneur lifestyle for the challenges of a public company executive. I’m betting that Mark Zuckerberg of Facebook fame still has second thoughts from time to time, despite being worth $33 billion as a result.

Marty Zwilling

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