It seems all of us dream about starting a business, being the master of our own fate, answering to no one but ourselves, and maybe even generating wealth in the process. Typically, we have a service skill or a product idea we think would make a good business, but then embracing the business and personal risks we suspect are involved are just too frightening (a healthy “reality check”). So, only a hearty few of us actually pursue our dream. But is what we think we want to offer the marketplace really a business, or is it in truth a pastime that would at best lead to eking a living doing something we like to do, working endless hours, sacrificing money, family time, and sanity?
All too frequently aspiring entrepreneurs launch their business-to-be by offering what they want to promote to the marketplace, rather than the other way around – finding out what the marketplace responds to and offering what it wants. Management visionary Peter Drucker wrote in a Forbes, “…marketing…has become a tool to support selling. It does not start out with “who is the customer?” but “what do we want to sell”. It is aimed at getting people to buy things that you want to make [offer]. That’s getting things backward. American industry lost the fax machine business that way. The question should be “how can I make things the customers want to buy?”. Unfortunately, too many start-up businesses are initiated just that way.
Through work experience or as a pastime the entrepreneur has developed a skill or product he or she thinks could be developed into a full-fledged business and away he/she goes, risking fortune, family, demoralizing disappointment, and expending enormous energy on that great idea or gadget, only to learn what every prospective business owner must know: the marketplace is a tough taskmaster! It doesn’t care what we want to sell, it only cares about what it wants to buy.
One young woman I know borrowed from family and friends (the usual sources for start-up money) and embarked on creating a special interest magazine for community drum and bugle corps organizations (remember the Casper Troopers?). Alas, the venture failed even though such groups were on the rise at the time. Was it a good idea that failed only because the magazine wasn’t funded or promoted well enough? Doubtful. It was likely because there just wasn’t a market for such a magazine. Another struggling entrepreneur has been working for several years on a business idea to install a turn-key investment department in small financial institutions that lack such services. The concept seems to be a good one, and the need is obvious. Unfortunately, however, there just aren’t any buyers. Again, is it because of failed execution, or are there some subtle issues not understood about prospective buyers? Most likely it’s the latter.
So, what does this tell us about attempting to “go into business for ourselves”? Don’t go into business for ourselves, go into business for our customers, but first find out if there are any! Contrary to common belief, new businesses don’t create markets (a popular misconception inspired by selling gorilla Proctor and Gamble). For a start-up enterprise, markets either exist or they don’t, and no amount of selling effort will make it otherwise. Before setting out, conduct research to estimate the size of your potential market and estimate realistically how much of that market, if it exists, you can sell to in your first few years. If you need to, spend money in this endeavor, hire a researcher or research firm, and invest as much of your free time as necessary trying to come up with a reasonable estimate, but don’t give up your day job just yet!
Then using the market numbers, you have generated, discipline yourself to make a realistic projection of your annual sales and costs to operate. This dose of realism about the fickle marketplace will tell you if you have a true business idea or not. If everyone did this the failure rate of start-up businesses would plummet because so many “good ideas” wouldn’t be pursued as businesses (it is estimated that 80% of new businesses fail in the first 5 years). In this writer’s opinion, most new business failures occur because of a lack of market, and an unwillingness to subordinate our desires to push what we want to sell, to determine what the marketplace wants to buy. Sure, there may be enough market to turn our pastime into a “business”, but is there really? Or is the market for our product or service only large enough relative to our selling “reach” to squeeze out a meager living? And what’s the difference between working for ourselves, merely making a living, and creating a real business?
So now your research is completed and you conclude that there is a real market for your prospective new “business”, but is it really a true business, or is it just a way to make a living doing something you like to do? What exactly is a true business anyhow? Probably the best way to evaluate if your small business is a true business is to determine if it can be sold. Sounds crazy, doesn’t it? You haven’t even started out creating your new venture and we’re already talking about selling it. Well, perhaps surprisingly that’s exactly what venture capitalists do – those individuals or small groups of private investors who back other people’s new business ideas in return for a share of ownership. Before they will even consider financing a proposed new business venture, however, they want the proposer to show them how they can “harvest” their investment. That almost always means selling their ownership interest in the business either privately or to the public through an IPO, an Initial Public Offering (a public stock sale, stock which is usually listed on one of the major stock exchanges).
Why is the ability to sell your business a good “acid test”? It’s because a true business is an entity all to its own. If set up properly as a separate legal entity from its creator (a proprietorship, a partnership, a limited liability company, an S or C corporation) it will also “make its own money”. That is, make a profit. Most prospective business purchasers don’t want to buy a business that’s not profitable or that has only marginal prospects for profitability. They want to buy an entity that will pay them a return on their investment as distinct from the salary they would earn as an employee of the business they bought, presuming they wish to work for the company.
Look at it this way: when you go to work for someone else you receive pay in compensation for the work you do. You typically have nothing invested in the company that hired you. Your savings are invested in something else (e.g., CDs, money market funds, bonds) that earns you some sort of return. But when you create a business, you intend to work for, the business should pay you reasonable compensation for your work plus make a profit, your return for your invested savings. The declared profit is something someone else would scrutinize very carefully to determine if they wanted to buy your business – it would represent what return they would get on their investment. Their return would be represented by cash (profits) taken out of the company each year, or, if profits are left in the company for growth or capital purchases to maintain the firm, increased value of the company if they sold it.
To create a true business, then, your efforts must be focused on managing the company for profitability, which is money the firm earns above and beyond a reasonable salary you would pay yourself as its employee-owner. A reasonable salary, by the way, is no more than that which you would have to pay someone else to do your job. Anything beyond that is company profit. Incidentally, most new businesses take at least 2 years to “turn a profit”, so if you have done so earlier than that, you’re probably on to something!
An article in Forbes magazine about Harry Jamieson, a Scottish fly-rod maker, illustrates the point. As it turns out, Prince Charles is an avid fly fisherman and a devotee of Mr. Jamieson’s split bamboo handcrafted fly rods, branded Clan Rods. So much so that the Queen Mother proffered the Royal Warrant to Jamieson, the “…much sought-after official stamp of approval issued by the House of Windsor to the best tradesmen.”. That brought a lot of interest to Harry’s highly prized Clan Rods, including Daiwa, Range Rover (yep, the car maker), and a prospective purchaser, Original Tackle Co., a small manufacturer of high-quality fishing equipment who wishes to produce a limited edition of the handmade rods. Jamieson says he earns in income about half the $100,000 in annual revenues for Clan Rods, but, as Forbes observes, “…is it a business? Subtract the value of his highly skilled labor, however, and you have a business that is scarcely breaking even. If Jamieson retired or died, would there be anything left to sell? Is there, that is, a way to capitalize the talents of an artisan (turn it into a real business)?”. Turns out someone thinks so. Original Tackle has been negotiating to buy Clan Fishing Rods for a reported $500,000, but to make the investment work they would have to hire a staff of six to eight apprentices to increase production and keep Mr. Jamieson on as a consultant for at least several years (the Royal Warrant stays with the individual who earned it).
As you can see, Harry Jamieson doesn’t yet have a real business. He’s making a living, but that’s it. To turn his pastime/living into a business Mr. Jamieson will have to expand on his own, thereby taking on the necessary debt and risk, or become a partner of sorts with the Original Tackle Co.
Which would you do?
Tuck Aikin was a former SCORE colleague of mine for many years until his retirement. Tuck is a prolific writer and wrote small business-themed articles for the Colorado Springs Gazette for many years. As a co-mentor, Tuck was my inspiration for me starting this blog. The preceding post is reproduced with permission from the author.
