Avoiding Start-Up Failure Modes

 
  9th-Apr-2008

Avoiding Start-up Failure Modes

Peter H. Rose and Andrew Wittkower
Fortune Drive Associates
www.fortunedriveassociates.com

Starting a high-tech business is a major undertaking. Entrepreneurs with a clever idea for a new business usually have no previous operating experience, and consider obtaining funding to be their only major problem. It is, in fact, only one of a number of issues leading to success or failure which if addressed early on, will improve the chances of funding as well as of operational success. In this essay, we will outline some of these important factors.

Funding

Funding is usually obtained from one or more of four sources: family and friends; high net-worth individuals or small groups often referred to as “angels”; active businesses who see the strategic opportunity to expand or diversify; and venture capitalists who are the true professionals in this business.

It is sobering to consider the experience of venture capitalists, who with a 50 year funding record, have accumulated enough experience to develop a statistically valid model. Out of 2000 “opportunities”, they fund 10; and out of these ten, two are major successes, four fail within 3 years, and four continue as the “living dead”. How then does one position oneself as one of the chosen few?

The first major outside view of a start-up is its business plan, and the quality of this plan will make or break the initial barrier. Although, as we have indicated, many factors are involved, the financial plan – five-year projections of routine financial markers such as sales and cash flow - is a key element. Unfortunately, this presents the entrepreneur with a delicate and dangerous balance: a realistic plan will not be exciting enough to be funded, whereas an exciting plan will not be realistic enough to be implemented successfully without additional funds brought in at great cost to the founders. The five-year projection shows the investors what returns on an investment they might expect. The investors naturally expect to own a significant amount of the company as a reward for the risk they are taking; this is often hard for the entrepreneur to accept. They know, for instance, that a successful start-up will burn up more cash than the founders have anticipated – and they will be prepared to invest more at a higher cost to the founders. However, a good funding partner is usually well worth the fraction of the company they own, and the founders will be more successful because of the help and guidance given.

The Team

Often overlooked by the technically enthused founders, is the critically important need for a balanced team who will work together to develop the business plan. Even though the entrepreneurs, often one or two very smart technical people, believe they have the skills and sometimes the arrogance to think they can to do it all, investors have the experience to know that they can’t and they will not fund them - even if the concept itself is superb.

First and foremost is the necessity within the team for a strong credible CEO to run the day-to-day business of the enterprise. An outsider with management skills and experience must be found – often a profoundly difficult task. One of the technical gurus may indeed have the vision and leadership capability to fill this role and it is fortunate indeed when this is so but as a general rule this is unlikely. A critical initial task for the CEO is to define a clear description of the business and to have an understanding of the financial and professional objectives of the founders.

Next the group will need a CFO. Although an early-stage group may well feel that they can get along without one at the start, their lack of experience in negotiations with funding sources will harm them. And the funding sources themselves will be much more comfortable dealing with an experienced executive.

Finally, to complete the initial team, a marketing/sales individual is needed. Probably during the early days, his/her marketing skills will be at a premium, but the person should be capable of becoming the senior executive in charge of both these functions (as well as service should it be required). Clearly, this individual is needed to develop aspects of the sales strategy and competition.

Additional early-stage team members need to be considered and brought on board at appropriate intervals after funding. This might include a manufacturing manager, an administrator to take care of personnel issues including payroll and benefits, and other key functions specific to the business.

Stock Distribution

After the investor’s share of the company has been agreed upon, the founders will retain ownership and control of the remaining shares, normally a considerable amount. The founders must reach agreement on the “fairness” of the distribution of this stock amongst themselves; this has the potential of becoming a contentious issue. They also need to keep in reserve sufficient stock to attract additional key employees as the company grows.

Ownership of company stock may be viewed as deferred compensation, as is the use of stock options with delayed exercise dates which are used to motivate non-founder key employees.

The value of these shares depends upon more than the ultimate success of the business; if the promises made in the business plan are not met, the investors rule - often at great cost to the founders.

The Business Plan

After the initial team is in place, the business plan can be prepared. Within it, investors will expect many of their questions and fears to be addressed. Although some will be specific to the new business, many are common to all businesses. These may include:
advantages and disadvantages (hopefully few) of the concept; possible applications and their market size; government regulations; legal aspects including patents; capital equipment and space requirements in addition to issues addressed in the text above.

Onwards and Upwards

One would expect that a superb business plan, presented by an attractive team, would eventually be funded, but the time frame from presentation to funding is usually much longer than the team might expect – often nine to twelve months. This may cause great strain on the team since some members may still be employed, but others, totally committed to the new venture may be living on their limited savings. At this stage the critical element is trust in the team, both collectively and individually; many a team has disintegrated while the search for funding drags on endlessly.

However, when a deal is in place, the fun begins; and what fun it can be. The excitement is intense, the energy limitless. For most, the rewards are immediate and tangible: the first customer presentations, the first order, the first shipment and, at last, the first payment check. Only months or years later, when the company is meeting its business plan, do the founders have time to contemplate the possibility of their eventual financial reward.

Fortune Drive Associates was formed to help early-stage entrepreneurs with start-up issues and to provide seed money prior to the first round of funding. The background of each of the associates can be viewed on their website: www.fortunedriveassociates.com. Dr. Wittkower can be reached at awittkower@fortunedriveassociates.com and Dr. Rose at phrose@fortunedriveassociates.com.

Conclusion: When a deal is in place, the fun begins; and what fun it can be. The excitement is intense, the energy limitless. For most, the rewards are immediate and tangible: the first customer presentations, the first order, the first shipment and, at last, the first payment check. Only months or years later, when the company is meeting its business plan, do the founders have time to contemplate the possibility of their eventual financial reward.
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Domain: Electronics
Category: Business
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