Starting an organization

2004-01-28 17:00:43
Outline  ( Startup)
I. The main question
II. The 4 most important questions when starting your own company
III. Know yourself
           1. Strengths and weaknesses
           2. Communication
IV. Failure plan choosing the product
            1. Idea and execution
            2. Competition
            3. Business plan
            4. Building a cash spreadsheet
            5. Finding seed capital

Starting Your Own Company

The core question you are facing is this: Should you "take the plunge" or just keep your job?

A full treatment of this topic would fill a book. For the sake of space constraints, I'm going to be linking to sources for additional information and limiting the discussion to the four topics that I think are most important:

• Know Thyself

• Have a Failure Plan

• Choose Your Product

• Make the Numbers Add Up

Know Thyself

Successful entrepreneurs are people who know their own strengths and weaknesses. This rule is absolute. All exceptions are flukes. You have to adopt a lifestyle of constant learning, and this means you have to understand the areas in which you most need to learn. If you truly dislike introspection, or if you are uncomfortable facing your own weaknesses, just keep your job.

How effectively do you communicate?

When you start running your own company, you will probably have good days and bad days. If your bad days are anything like mine, somebody will eventually catch you whining about "how great the company would be if we could just get rid of all the customers and the employees." :-)

Alas, there is no way around it: Becoming an entrepreneur requires you to interact with people. Any deficiencies in your communication skills are going to be exposed.

Entire books have been written on the subject of communication skills. I couldn't begin to cover the subject thoroughly here, but I do want to emphasize the importance of this issue and offer three guidelines that have served me well:

1. Shut up and listen. Good communication is not 50% listening and 50% talking. It's more like 80% listening and 20% talking.

2. When communicating by e-mail, read your message before you hit send. Look for typos and for ways that your e-mail might be misunderstood. This is a simple technique, and I am amazed how few people do it.

3. Remember that e-mail is a terrible medium for communicating emotion. The recipient can't see your facial expression or hear your vocal intonation. Any negative emotion you express is likely to be received several times stronger than you intended. Keep this in mind when you are communicating by e-mail, and never write an e-mail message when you are upset.

Have a Failure Plan

The tenor of my last article really encouraged a posture of risk-taking. I'm not backing off on that stance, but in the interest of balance, I'd like to clarify a thing or two about the other side of the coin.

Like I said in that piece, the goal is to avoid making any fatal mistakes. But I purposely left the word "fatal" undefined. The implication of this metaphor is the death of your business, but the real issue is how much impact the business failure will have on your personal life. You have to decide for yourself how much you are willing to lose. You need a failure plan.

Business failure is a real possibility. Overcoming fear of failure is not a secret trick that will magically make you succeed. In starting a new company, there are lots of things you can do to increase your odds of success, but in the end, your odds are still not very good. :-)

The important thing is to avoid any failure that is too much for you to handle. The ideal business failure is one that leaves you with the ability to learn from what went wrong and try again. Ask yourself how big of a risk is appropriate for you. Ask your significant other. The answers can vary widely based on your personal situation.

One of the most common decision points will come up if you own your own home. Every entrepreneur will eventually be presented with the opportunity to pledge his home as security for a debt or contract. Although I concede that this could be the right decision for some, I have never done it and I don't recommend it. For me, that is too much risk to accept.

Regardless of your particular posture toward risk, the important thing is to understand every risk you are taking. Ask yourself: If this risk goes badly, will I be able to handle it? If the answer is no, don't take the risk. If that means you can't start a company, then don't do it. Keep your job.

Overcoming fear of failure does not mean making a bet that could really mess up your life.

Choose Your Product

What product do you want to build and sell?

If you are contemplating the decision to start your own small ISV, then I suspect you already have your idea. But it's probably not too late to give some additional thought to this issue.

Blatant tangent: Ideas are worthless

Although you may not believe it right now, ideas are essentially worthless. You are emotionally invested in your idea. You've spent lots of time convincing yourself and others that the business will work. You are devoted to your idea and you do not want to give it up.

But like it or not, your idea alone is not valuable. In the business world, ideas are worthless. Real value comes from good execution.

The reason is that value is generated only in the presence of a risk/reward ratio. An idea by itself involves no risk, so it will lead to no reward. In contrast, execution involves risk, which is why it leads to reward.

Back to the topic: Do your marketing homework

No matter how much you like a particular product idea it would be foolhardy to launch your new company without doing some basic marketing research. At the minimum, you need to ask yourself one very important question:

What kind of competition do you want to have?

If you think the answer is none, think again. Having no competition at all can be one of the fastest ways to kill a business. You need competition, and you need it to be the right kind of competition.

When starting a new venture, every business-planning book will tell you to ask yourself if the market is big enough. True, this is an important question. You need to know if the potential customers can possibly yield enough revenue to pay the expenses you anticipate.

But as bootstrapped small ISV, you also need to ask yourself if the market is small enough. Small companies should stay out of markets that are big enough to be interesting to big competitors.

I recently heard of a serial entrepreneur who understands this concept very well. Each time he starts a company, he evaluates the market opportunity and refuses to pursue it if the market size is more than 50 million US dollars per year. This may seem counterintuitive, but the reasoning is actually quite sound. You can't beat big companies. The best way to win a fight is to not be there.

For more on this topic see my weblog article, "Choose Your Competition."

Do I need to write a business plan?

This is one of the most common questions asked by new entrepreneurs. The answer: Yes and no.

When people speak of a business plan, they are usually talking about a document that is used to convince an investor to fund the company. These documents are written for show. They're filled with fancy graphics and "wordsmithed" mission statements and highly optimistic revenue projections.

In the end, you spend hundreds of hours writing the perfect business plan, and the investor spends hundreds of milliseconds reading it. Do yourself a favor: Spend those hours working in your company instead of working on your company.

Starting a bootstrapped small ISV doesn't require you to convince anyone but yourself. This means you don't need to write a business plan, but you do need to think carefully about every issue that would normally be included in one. If writing an actual business plan document is the only way you can force yourself to go through all the necessary steps, then do it. But you can probably cover all the bases without actually writing the document.

Getting a book on how to write a business plan isn't a bad idea at all. One book I really like is called The Silicon Valley Way by Elton B. Sherwin, Jr. Note that I do not like the title of this book, since I don't like the way things are generally done in Silicon Valley, nor do I like the book's general orientation toward funded companies and IPOs and other get-rich-quick schemes (end of sermon). However, the book is still excellent. It contains 44 questions to ask yourself about any new venture. Answer them all.

Build a cash spreadsheet

At some point, the critical exercise of business planning is financial projections. This can sound tedious, boring, and difficult, but your chances of failure go way up if you skip this step.

It's not hard. Create a spreadsheet with months in the columns. The rows will be your predicted revenues and expenses. Like I said in Finance for Geeks, Cash is King. The whole reason you are doing these financial projections is to figure out if you will ever run out of cash. When you run out of cash, your business will probably fail.

Somewhere you need a cell that contains your starting cash balance. This is the amount of cash your company will have on its very first day. We call this "seed capital." Let's assume for the moment that this number is zero. At the bottom of every month's column, you need to calculate the cash balance you will have at the end of that month. Basically, take the previous cash balance, add your cash revenues, subtract your cash expenses, and that's your answer.

Your cash spreadsheet should look something like this:

Starting Cash Balance:


Jan Feb Mar Apr May Jun

Revenue 0 0 0 0 0 0

Rent 1000 1000 1000 1000 1000 1000

My salary 0 0 0 0 0 0

Phone 50 50 50 50 50 50

Coffee 300 400 500 600 700 800

Net -1350 -1450 -1550 -1650 -1750 -1850

Cash balance -1350 -2800 -4350 -6000 -7750 -9600

Seriously, be honest with yourself. I've seen people keep two separate spreadsheets while they are looking for investors. One contains "the numbers we can convince an investor to believe." The other spreadsheet contains "the numbers that we actually believe." This is one of the great advantages of bootstrapping a company: you only need one spreadsheet. Make sure it contains numbers you believe to be realistic.

Now, look at the bottom line. If any of the predicted cash balances are negative, you've got a big problem. Of course, since we left a big fat zero in the starting cash balance cell, your cash is probably negative for the very first month. Congratulations--your business died before it even got started.

Finding seed capital

Lots of stuff has been written on the subject of finding that first seed capital. I disagree with some of the conventional wisdom. Nonetheless, I'll give an overview of the usual answers:

• Borrow against your home. As mentioned above, I hate this idea. If you do it anyway and end up losing your house, I promise I won't say, "I told you so," but I'll definitely be thinking it.

• Borrow from friends and family. I'm not fond of this idea either. Eventually, we all realize that the only thing that really matters in our lives is the people. Most of us should be working harder to make our relationships healthier, not finding new ways to place them at risk.

• Have a working spouse. This is strictly a personal decision. If it works for you and your spouse, that's great. Lots of entrepreneurs use this approach to give themselves the flexibility to take bigger risks. The truth is that it's a lot easier to go from two incomes to one than it is to go from one income to none.

• Borrow from your credit cards. Of all the usual pieces of advice, this one may be the least bad. If your business fails, you could be paying off the debt for years. But this particular consequence may be more tolerable than some of the others.

Like I said, there are no easy answers. Ideally, you would start your company using cash you've already got. But that's not often possible.

My favorite solution to this problem is to start out as a consulting company and evolve into an ISV later. SourceGear was built this way. The concept is simple:

• In your first 40 hours per week, build custom software or websites for other companies. Charge them enough money to pay your expenses.

• In your other 40 hours per week, work on building your product.

After the product is released and its revenues start to grow, you can gradually stop taking contracting gigs.

If this sounds like a lot of hard work, you are absolutely right. If that sounds unappealing, keep your job.