New entrepreneurs are usually desperate for sales and don’t want to turn anyone down. They often don’t see how the new business could add complexity to their operations and increases their overhead and their break-even levels. They don’t understand that doing too many things may cause them to be the best at nothing.
They may have an MBA and taken finance classes where they learned that diversification is good. However, they may not have realized that diversification is good for passive portfolios where the investor has no control over the venture. It is not that great for new entrepreneurs who have limited resources.
They don’t understand that the cost of money for them could be very high and that they should not waste it on peripheral areas.
They may not have thought through their mission.
In the early days of Medtronic, Earl Bakken was repairing medical equipment and doing special projects for physicians. One of them, Dr. C. Walton Lillehei, was using medical devices for the heart, but these devices did not work during power interruptions and risked patients’ lives. So Lillehei asked Bakken to develop a device that would work through power failures. In four weeks, Bakken devised the pacemaker, which was attached to a child’s heart the next day, heralding the dawn of the modern-day electronic medical device industry. The year was 1957. There were no regulators or regulations for such devices.
Initially, as sales grew, so did losses. In 1962, sales were $518,000 and losses grew to $144,000. Bakken, whose company had gone public earlier, was forced to get turnaround capital from a local investment firm that placed two people on Medtronic’s board. These two were experienced business professionals who insisted that Medtronic decide on the kind of company it wanted to become, encapsulate this mission in a written statement, share it with all the employees, and focus the company’s scarce resources on products and markets consistent with this mission.
Medtronic decided to focus on implantable therapeutic technologies (devices) that restored people to meaningful lives. This meant that they would not spend resources in other areas such as diagnostics or laboratory products. Another key requirement of the financiers was to instill corporate discipline by keeping track of all expenses, knowing the return for each dollar spent, and hiring a comptroller who was charged with controlling Medtronic’s costs. This new mission and plan helped Medtronic to focus, bring order and control while keeping its zeal, and to grow its sales and profits. Medtronic started to thrive.
Lessons for Entrepreneurs: There comes a time in every entrepreneurial venture when it needs to focus for controlled growth, but maintain the missionary zeal of the founder. As the number of employees increases, entrepreneurs start to lose touch and the need for control grows. However, without the missionary zeal that entrepreneurial ventures usually have, the entity can become a bureaucracy. To maintain the initial zeal and to successfully transition to a major corporation, write down your mission and stick to it. Change it rarely and with the utmost care and gravity. Changing your mission too frequently can cause confusion, and waste resources and time. Make sure that the employees know the mission so that they use it consistently as a compass to guide their actions and decisions even when they are not in constant contact with you or the leadership team. Medtronic thrived in this transition because its founders understood the need for the transition and were able to maintain the mission and zeal while enhancing focus and controls.
There is a company called Segway. It was started by an inventor who is considered to be a genius because of the wide variety of successful products he has developed. The investors in Segway were considered to be the premier firms in the venture capital industry. They invested, and lost, about $160 million in the deal (MercuryNews.com, Jan 16, 2010). Why? From what I have read, the investors thought that the world would adopt the Segway as the way to travel in urban areas. Cities were even considering changing zoning laws to give greater access to all the Segway users who never materialized. The hype during the launch was tremendous. But the world did not change its habits. It did what it has always done. When the perceived benefits of a switch did not outweigh the huge costs of buying, they did not buy. There have been comments about how some of the insiders thought that the rest of us were not smart because we did not buy the Segway and change our cities. Maybe we are not. But they are the ones who lost $160 million.
Contrast this with the case of Horst Rechelbacher, the founder of Aveda, and one of the entrepreneurs profiled in my book, Bootstrap to Billions: Proven Rules from Entrepreneurs who Built Great Companies from Scratch. Horst was a champion hair designer even as a teenager in Austria. When he came to the U.S. in his early 20s, his first job was as a hair designer in Minneapolis. He quickly gained a following and one of his banker-customers offered to finance his salon. Horst started the salon, hired designers, trained and paid them while they were being trained, and expected his business to soar. Instead, after he had trained them, most of his designers left to join other salons. He tried the process again with a new batch, and the same thing happened. Horst saw reality. He decided to sell off his salons and opened a school to train hair designers. He then contacted the salon owners who had stolen his designers and asked them to send their new recruits to his new school. They did and he showed a profit from day one in his new school. He then expanded to add schools, beauty products, and opened retail stores. This simple decision to close his salons and open a school was worth over $300 million – the amount that Horst received when he sold Aveda to Estee Lauder. So have the humility to see the world as it is, not as you wish it to be.
Why is this difficult? Many entrepreneurs think that they know more than their customers. Have the humility to know that they are spending their own money, and don’t have to follow your thinking – even if you have a high IQ and have been touted as a genius in the press.
An even more dangerous time to lose your humility is when you have reached the first rung of success and own a successful business. After Earl Bakken had developed the heart pacemaker and Medtronic was on its way to glory, they still kept track of all the other developments in the field. They found others such as the Chardack-Greatbatch advanced battery that extended the life of the pacemaker and licensed the technology. This caused the next growth spurt for Medtronic. They did not have the arrogance of many large corporations that think that all the world’s great brains reside in their company and avoid acquiring or licensing technologies developed outside. An article in Fast Company (April 2007, p. 99) notes that “Merck has to go outside for help because it can no longer claim all the best scientific brains, or all the answers.” Wow, note the hubris in this sentiment. This is also known as the “Not Invented Here” syndrome. Medtronic, to this day, continues this culture of monitoring technologies developed externally and acquires or licenses them as needed, in addition to using the technologies developed at their world-class labs.
It is tough to be humble when you have a few hundred thousand, or billions, in the bank. That is precisely when you do need to be humble. Look at Toyota. According to news articles, their reputation for quality went to their heads and they were immersed in their own arrogance.
Humility is not just its own reward. It is also a tremendous business asset. So fear arrogance. For entrepreneurs, the choices are not fear or greed as they are for investors. They are fear or arrogance.
Many would-be entrepreneurs never get started because they do not find their perfect business opportunity. And many others get into a business and reach a dead-end. So where should you find your opportunity for growth?
How do early-stage venture capitalists (VCs), who invest for a profession, find hot new opportunities? VCs try to develop home-runs (spectacular successes and potential Fortune 500 companies like Google and eBay) by financing ventures with a better technology or a better business model in a high-growth, emerging industry. This means they seek opportunities with a proven (if they can get it) advantage. They seek emerging, high-growth, high-potential industries. Emerging industries usually do not have large, well-established competitors who can destroy the new venture. With high-growth, they get the wind at their back – it is easier to grow rapidly in a fast-growing industry. And high-potential means that the new industry could become large and so could their investment. Even with all these advantages and strict criteria, they succeed in getting home-runs only about 2% of the time and have a reasonable return (for the high risk they are taking) about 20% of the time.
If you are a new entrepreneur, or a potential entrepreneur, how should you find your opportunity? I would suggest that you find your opportunity in your passion or in the trends. Most of the entrepreneurs I interviewed for my book, Bootstrap to Billions: Proven Rules from Entrepreneurs who Built Great Companies from Scratch, did not seem to have an advantage at the start. Where is the competitive advantage in selling stereos (Best Buy), or wedding invitations (Taylor Corporation), or nuts and bolts (Fastenal)? Of the entrepreneurs I interviewed, 96% went with their passion and/or with the trends. Only one entrepreneur succeeded by grabbing an opportunity that came along in a company that offered him a job and in an industry without a strong growth trend. So find passion or find trends. As Gary Holmes of CSM Corporation put it, “don’t do it just for the money.” Passion helps perseverance. Perseverance helps success.
But trends can be of immense value. When Steve Shank was seeking a new opportunity, he noted that adults in America were seeking continuing educational opportunities for personal development, and that long-distance learning was becoming more popular, especially due to the prevalence of the PC. He capitalized on these trends and started Capella University. Later the Internet came along and made this business sweeter. It helps to be fortunate, but you have to be in the arena to be lucky.
What are the trends that you can capitalize on today? While there are no emerging industries today (“green” is an emerging need, but without federal or state government subsidies it is highly likely that most of the companies in the industry would never take off), there are a few trends that you can latch on to, such as the needs of aging baby boomers, the increasingly wealthy Asian markets, and social networking. There are also a lot of needs, such as energy, climate change, clean water, etc. Find solutions and you may have a winner.
You can also acquire a company if you know how to buy and to manage. Tom Auth, one of the entrepreneurs in the book who built ITI and Vomela, found his opportunity by buying the right company. Tom Auth is a CPA with strong analytical and business building skills. Since he was not a technologist, he was constantly seeking to find companies that he could grow. When he found such companies, he analyzed their strengths and weaknesses, and used his financial skills to design the best strategy to buy the business that was also fair to the seller. Once he decided on the value of the company and the price, he was not easily swayed. For one of his deals, he flew down to North Carolina to complete an agreement that he had been negotiating, only to be told by the seller that he wanted to keep the business after all. Tom’s response was that the dinner was nice, but the seller could have told him this over the phone. About a year later, the seller called him back after checking out the market and offered to sell to Auth. This time Auth confirmed that the seller was really ready to close the transaction because the deal was still attractive for Auth, and he bought the company.
So find your passion and/or trends. Or buy a business you can grow with your matching expertise and passion.
In my new book Bootstrap to Billions: Proven Rules from Entrepreneurs who Built Great Businesses from Scratch, I have profiled 28 entrepreneurs who built great companies from scratch, including the world’s largest medical device company (Earl Bakken of Medtronic), the world’s largest consumer electronics retailer (Dick Schulze of Best Buy), and the world’s largest private healthcare management company (Richard Burke of UnitedHealth Group). The 522 lessons in the book answer five key questions that each entrepreneur should consider. These include how to find the right opportunity with your unique competitive advantage, how to implement a capital-efficient sales and operations strategy in order to do more with less, how to finance to create wealth and keep it, how to build a dedicated and effective organization even without the resources, and how to be a better leader than your competitors. This column is a partial answer to the finance question.
One of the key lessons from the book is that most entrepreneurs can bootstrap to success, i.e. you don’t have to obtain venture capital (VC) to build a giant corporation if you are willing to improve your leadership skills as your company grows, and if you are willing to run your business intelligently with capital-efficient business, financial and financing strategies. Early-stage VC, money was not a key requirement for success for most of the entrepreneurs in Bootstrap to Billions. None of the 28 entrepreneurs got VC at the start of their first venture. And 22 of the 28 never got VC. Two got it later in their growth cycle and were able to maintain control even though they got VC. The entrepreneurs who bootstrapped did not obtain early-stage VC, did not share control with the investors, and kept the wealth they created. And they did not have to sell their company prematurely to satisfy the interests of professional investors.
If you have to get it, the timing of when you obtain VC is key. Get it too early, and you may have given away too much of your company and given up control, which can come back to haunt you later. Get it too late and competitors may pass you by so this is a key judgment call that each entrepreneur must make. You may want to bootstrap to build value, and get VC after proving your competitive advantage when you have more VCs interested in your business. You may then be able to negotiate a much stronger agreement and obtain a higher valuation. When Steve Shank obtained VC to build Capella, he had already built his company to the growth stage. He had added value and demonstrated his competitive advantage. He had his choice of VC firms – and he could pick the right one to satisfy his goals.
Can you always bootstrap to success? I don’t think so. VC may be essential in certain situations. If you are a potential home-run, i.e. the next Google, in a hot, emerging industry (semiconductors in the 70s, PCs and biotech in the 80s, Internet and telecom in the 90s), you may not be able to reach your potential without VC. Or others may raise more and use the additional resources to become dominant. But understand the odds and the negatives if you raise VC. Best estimates are that VCs have home-runs (like a Google) on approximately 2% of their investments. If you are not in this rarified 2% group, the odds of you as an entrepreneur profiting hugely can be low. Why? First of all, you may not be running the business because VCs like to bring an experienced management team. Secondly, they like to earn their returns before you get yours.
So should you seek VC or become capital-efficient? If your strategy is capital-intensive, or you are seeking high growth in a high-potential industry, or you don’t want to live the frugal life bootstrapping calls for, you may have to consider VC, especially if money is a key requirement for dominance. If you can beat your competitors and dominate your industry without VC, do so to maintain control and keep the wealth you create.
Due to the relentless hype of venture capital funds and the business press, many entrepreneurs believe that getting venture capital is synonymous with a successful venture and great wealth. And they also believe that you cannot build a giant business without venture capital. Both assumptions are not true.
What is true is that venture capital is very, very difficult to get. In fact, they fund so few ventures each year that the only reason why they are so important is that a few of their ventures become glorious successes. Out of an average of about 600,000 new businesses started each year, venture capitalists fund only about 300 startups and about 3,500 to 4,000 total deals. To get VC, you need to be in a hot industry and have the potential to be a dominant company in the hot industry.
Even if you are able to obtain venture capital, you cannot count your zillions yet. Estimates are that about 20% of all venture funded deals fail, and that another 60% are partial failure to minimal successes. 18% are said to be good successes and 2% are home-runs. Except for the home-runs, your returns are likely to be meager because the VC gets their money and returns first. 2% of the time you are likely to be a zillionaire, unless you have been diluted out of existence.
To add insult to injury, you also get the boot from your own company. VCs like to find “professional” management with good reason. They don’t want to have to train you to be a CEO. But not all managers live up to their own resumes.
So in summary, in 98% of the time, your financial returns are lousy and someone else is screwing up your company – perhaps your one great idea. If that’s what you want, go get venture capital.
If, however, your goal is to make money, read on. I did a study of 28 entrepreneurs who built their companies from scratch to $100 million+. One is at $84 billion in sales (UnitedHealth) and another at $44 billion (Best Buy) and a third is Medtronic. Would it surprise you to know that NOT ONE got VC at the start? One got VC 18 months after startup and an investment of $1.5 million by the entrepreneurs, in addition to getting a conditional customer. Another got it for his second venture after selling the first for a nice profit. A third got it in his sixth year when he was profitable and growing. One got it for her second venture when it had sales of around $10 million and she had just sold her first for millions. One got it in his 12th year when he stumbled due to uncontrolled spending, and he had just invented the heart pacemaker. One got corporate capital, and VCs had financed the corporation. The rest (79%) got nothing from VCs.
It can be done – you can build a $82 billion company without VC.
He’s been in the venture capital business for decades, but University of Minnesotabusiness lecturer Dileep Rao now says people don’t need venture capital to grow a business, and he’s drawn on the stories of some of the Twin Cities’ most successful entrepreneurs to prove his point.
Rao has compiled those stories into a book called Bootstraps to Billions: Proven Rules from Entrepreneurs Who Built Great Companies from Scratch. The 28 profiles in the book are a who’s who of Minnesota success stories. They include Horst Rechelbacher, who started Blaine-based Aveda Corp.; Richard Schulze, chairman and founder of Richfield-based Best Buy Co. Inc.; and Minnesota Timberwolves owner Glen Taylor, who built North Mankato-based Taylor Corp. into what is now a roughly $2 billion business.
Rao, a senior lecturer at the university’s Carlson School of Management and a columnist for Forbes.com, spent two years interviewing the subjects of the book and writing the profiles.
This article originally appeared in the Minneapolis / St. Paul Business Journal.
The banks generally still aren’t playing ball, but there are creative solutions allowing small companies to win financing.
In November 2008, Donn Flipse was forced to close one of his three flower superstores in Florida’s Broward and Palm Beach Counties. Nine months later, Flipse expanded by acquiring the business of a retiring florist in a wealthy section of South Miami. Those two events normally would have led Flipse to lean on his $500,000 line of credit. But that credit line had been personally guaranteed by a family member who, because of a decline in that person’s own finances, was unable to continue the guarantee. Flipse paid off the revolving loan with “the only thing available” — money from two of his grown children, both of whom are shareholders and sit on the company’s board. Now, for the first time in its 19-year history, Field of Flowers, which employs 46 people and expects to bring in $6 million in sales this year, doesn’t have bank financing.
Like thousands of other small business owners with good credit histories, Flipse also found his credit-card companies lowering his limits. He plans to pay back his kids in early 2010, after the Valentine’s Day and Easter rushes bail him out. “There was no choice,” he says. He recently had to lay off two of six headquarters employees, leaving the dispatcher running the computer system. “We’re not thrilled about any of it. But the company’s a part of our lives.
This article originally appeared in BusinessWeek.
Small business finance expert Dileep Rao explains why some of the greatest companies never had a dime of investors’ money to get off the ground and grow — and how hard work, integrity, creativity, and an open mind can make up the difference.
Depending on your point of view, this might be the worst time to start a small business. On the other hand, with creative business and financing strategies, it’s possible to be successful without one dime from Wall Street or Silicon Valley. At least that’s the viewpoint of Dileep Rao, a consultant and small business finance expert who teaches financing courses at the Carlson School of Management (University of Minnesota). To prove the fact that you don’t need VC funds to be successful, in his forthcoming book, Bootstrap to Billions, Rao chronicled the stories of several Minnesota entrepreneurs who started with nothing to build successful companies such as Best Buy, Aveda, Digital River, United Health Group, and Medtronics. He calls the companies in his book a “third category” of business: not small business, and not built through VC financing.
This article originally appeared at OpenForum.com.
You are starting a new company and need to find customers. An ad agency just presented you with a slick new campaign promising to do just that. Cost: $250,000. Good investment or bad?
Millions of small-business owners find themselves in similar situations every day when trying to decide how to invest (and re-invest) in their companies. There are myriad nuances to making these decisions, but there is a fundamental principle that guides all of them: getting a reasonable, risk-adjusted return on each dollar invested.
This article originally appeared on Forbes.com.
As the CEO or founder of a growing small business today, you are likely swamped meeting customer needs, dealing with inventory, shipping or customer service problems, pleasing investors, watching your budget, and looking for the next big opportunity. Wait: did you forget about your financial plan? While you might consider this a time-consuming business school exercise with little value for a hands-on small business owner like yourself, former Wall Streeter Tim Ferguson and others say that financial plans are in essence a roadmap to your future success.
As an example, a client of Ferguson’s, founder of Boston-based merchant bank Next Street, not long ago approached a bank for help financing a real estate deal. The bank declined to provide a loan, in part because it didn’t understand the company’s growth model–even though the client was a profitable business. “It makes a huge difference to have a financial plan,” says Ferguson, whose company provides advisory services and financing assistance for inner-city small businesses generating between $5 million and $100 million in revenues.
According to Ferguson, the business plan is not much different than a financial plan, but it has a much tighter focus on metrics. Ferguson says that his company spends on average three months with a client developing a financial, or “growth” plan, which includes a fact-based analysis of the business–typically covering customers, segments, profitability models and margins, number of employees, and costs. After the plan is developed, it gives the company a roadmap for a monthly budget, and also includes specific growth strategies, according to Ferguson: “You would want to develop list of possibilities such as, expanding from a local region to interstate, or beefing up your business line or making acquisitions, and then you would need to narrow all those ideas down to three or four options.”
This article originally appeared at OpenForum.com.