Many clients start the entrepreneurial process asking the age-old question, “How do I raise money?” Unfortunately, beginning a business is a process that involves fulfilling a number of requirements before one can even think about raising money. The requirements for financing a business I am referring to may seem obvious, but they are critical to actually raising money:
^
How much do you need?
^
How and when will you pay it back?
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Why should someone have the faith to invest money in your venture?
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What is the expected risk and return?
^
What are the resources you have or plan to have to support the request?
Financing an Ongoing Profitable Venture
Let’s start with the easiest situation just to understand the parameters.
You have a growing and profitable business with a history of success and little personal or business debt. You have a specific plan to buy physical assets which you can then use as collateral which can be paid back from profits over a specified period. You also have an excellent relationship and history with your bank. Together, these aforementioned facts meet all the simple criteria necessary to obtain a loan for financing a business.[pullquote]Before raising money make sure you have answered these questions:
How much do you need?
How and when will you pay it back?
Why should someone have the faith to invest money in your venture?
What is the expected risk and return?
What are the resources you have or plan to have to support the request?[/pullquote]
In simple terms you have:
Credit Score of 700 or above.
Cash flow sufficient to make required interest and principal payments.
Sufficient capital and collateral to cover the entire loan.
A specific plan, history, and experience to develop confidence in the lender to make the loan.
Financing For a Startup
Now, let’s look at a more typical situation of a startup company. You have a great idea, a little experience but no history, and minimal assets. You (your venture) needs money for development and startup costs before you even really begin.
Tech companies, service companies and many retail businesses, are perfect examples. Before describing the options for financing a business open to you, let’s review some general tips you must consider in your efforts to procure financing.
It is absolutely critical you have a credible plan to convince investors you will succeed and pay the money back. The plan, when laid out properly, should build confidence and trust by the investor in you and your business.
You must know your numbers and facts cold.
Make sure to understand your assumptions, calculations, and forecasts and be able to answer all related questions. You need the energy, commitment and enthusiasm to obtain financing but it needs to be supported by real facts.
Be sure to have an accountant you are comfortable with and financial statements you understand and can explain.
Where to Look for Funding
[pullquote]Essential Considerations to Assist in the Procurement of Financing
Develop a credible plan.
Know your numbers and facts.
Have an accountant for guidance.
[/pullquote]There are several potential sources of funds for start-up businesses that should be considered when financing a business. Each potential source should be evaluated on the basis of probability, costs, long-term viability, risk, and business constraints.
Equity – Personal, Friends and Family
Equity is the amount of money you can put into the business on your own:
Money you don’t have to borrow or pay back.
Equity may also include effort (sweat equity) put into the business for it to get underway.
In general, it is difficult to start a business without any of your own, a friend’s or family’s equity to show commitment. Keep in mind it is much easier to obtain other investors if you are contributing 10% – 50% of the financing depending the project in question.
Investor Equity
Investor Equity can come in a variety of different forms. Depending on the type, they can provide significant funds especially for businesses such as services which traditionally have little assets or collateral. These investor equity sources typically expect more risk but in return correspondingly expect returns. As a general rule, they require agreements that place a number of constraints on the business, e.g. salaries to you and how expansion might be made and carried out. As part of the equity investor formula, the more you give up, the less is left for you and the less control you have, particularly, if you have to give up more than 50% of your equity.
Equity investors vary but can include:
suppliers,
partners,
venture capitalists,
private equity dealers,
private offerings,
private investors, and
Angel investors.
Traditional Banks and Loan Institutions
It is important to remember that banks need to balance their goals particularly when viewed in relation to loaning money. Banks reduce risks and make certain they get paid back. Understanding and acknowledging these factors can help reduce some of the stress one feels when dealing with bank bureaucracy, requirements, paperwork, etc. As stated earlier, the better your history, relationship, collateral, ability to repay loans, plans, etc., the higher the probability of getting a loan. Keep in mind that obtaining a traditional bank loan for financing a business startup is a more and more difficult undertaking than it was decades ago.
Additional Sources to Help Find Money and/or Guarantee Loans.
Community Based Lenders
Non-profit, independently financed, private or public organizations, which often make loans to small businesses or entrepreneurs who do not qualify for traditional commercial bank loans. These loans are often referred to as “Character Loans.” They do not require strict credit, cash flow or collateral requirements. They still require, however, character, a business plan and location in/or near the local community.
Finding a Guarantor or Co-Borrower for Obtaining a Loan.
Often time a family member or close friend is reluctant to give you cash upfront but they think you have a good idea for a business and a good chance to succeed. They may be willing to either guarantee a loan or co-sign for a loan.
Small Business Administration (SBA) Loans
The SBA does not lend money, rather it provides guarantees to a bank. The guarantee means, if a person does not repay a loan, the SBA will pay a major percentage of the loan back to the bank. All banks can make SBA guaranteed loans, but most have restrictions on what types of loans they are willing to make. Just as with most traditional banks, the SBA only wants to guarantee loans to people who are likely to repay the loan. All SBA loans are made to individuals for a business. The individual is personally liable to repay the loan.
Financing Outside the Box – Guerrilla Financing
To find money to finance your business you must consider every possible choice available. Going outside the box to find financing is often referred to as, “Guerrilla Financing.” The more you know about your business, the more options are available. Remember, both lenders and investors look for the same thing in a business – VALUE. Projected earnings and even management skills are considered part of this value proposition.
Crowdfunding
If money is the only thing stopping you from doing something good in the world, stop waiting and start doing some good! Nothing better symbolizes entrepreneurship than fundraising. Social entrepreneurs are no different. Today, there are a host of online resources for what today has become known as crowdfunding.
Crowdfunding was initially used by “social entrepreneurs” who turned to this method as a way to fund their projects, films, books, and social ventures.
Today, one of the best know crowdfunding sites is Kickstarter.com. Kickstarter is the 800 pound gorilla in crowdfunding, originally designed and built for creative arts, many technology entrepreneurs now use the site, some reporting to have raised millions of dollars. The Kickstarter funding model is an all-or-nothing model. You set a goal for your raise; if your raise exceeds the goal, you keep all the money, otherwise, your supporters don’t pay and you don’t get anything. This protects supporters from some of the risk of you running out of money before your project is completed. There are a now a number of her crowdfunding sites to consider: Indiego, Crowdfunder, Rockethub, Somolend, and more.
Free Financing Through Operational Belt Tightening
We frequently worry about financing a business but often fail to pursue strategies that might help avoid the need.
There are numerous activities that companies can do to reduce investment costs and lower overall expenses. The most common include:
rent instead of purchasing,
deferring payable terms,
shipping direct to consumers,
outsourcing etc.
Making these changes can have real impact on an organization as it relates to costs and investment. Putting these changes into place can make investors happier. These opportunities need to be considered as critical operational components. As an example, many start-ups are required to prepay expenses due to a lack of credit experience. Similarly, borrowing on credit cards is usually discouraged because of the associated high interest rates. Despite these problems, businesses can use credit cards to avoid pre-payments. All they have to do, for example, is to pay credit card charges on time which could translate to 10-30 day free money.
Financing Concerns
Finding Investors needs to be a two way street. Clearly you want to avoid loan sharks, etc. However, there are real considerations businesses need to consider when seeking investors:
Evaluate the bank by finding out what it has to offer that will fit your needs and your capability for assuming the debt.
Many entrepreneurs use smaller financial institutions which don’t provide the type of loans or products a business needs for growth:
Letters of credit,
wire transfers, and
credit cards
Above are examples of services that may be required.
Don’t be afraid to ask for references of other clients and talk to higher level executives in the organizations you are seeking funds.
Determine the process, time, and requirements from the organization where you are seeking financing. Assume there will be delays, more information requests and mistakes. For example, when you send information be sure it is received.
If possible, encourage efforts to understand your investors, site visits, introductions to you and their participants, etc… For example, in my bank, I have a customer rep who has been there for years. He warns, guides, and facilitates, and even sometimes breaks rules, to expedite my needs.
Share changes in the business that may affect your needs or the investor’s prospects. This can be accomplished formally or informally depending on the issue. For example, if you may need letters of credit, make sure to plan ahead instead of waiting for the supplier demand?
I learned a simple rule in raising money several years ago. If you are doing well and providing investors with expected returns and little risk, the relationship is great and they may even encourage you to grow faster than you should. On the other hand, if you are missing plans and affecting investors’ returns, the relationships can sour quickly. This result has some simple tips that summarize the process of finding investors:
It is a two way street that requires honesty, understanding and communication.
Don’t overestimate what is needed to meet your plans.
Understand your needs and risks to find the right kind and type of investors.
Develop plans, measure results, and satisfy investor requirements to monitor investor potential concerns.
“Money makes the world go round,” as the saying goes… And, undoubtedly, we’ve all spent time worrying about our personal finances. Yet, how much time do we actually spend trying to learn ways to improve our financial situations? Too often, we fret about things, but fail to fully understand the bigger picture or take action to better the circumstances. So, let’s discuss some ways to jumpstart financial success.
First, look at your personal finances and consider options. This can be overwhelming for some because the expansion and complexity of financial issues has made understanding them more uncertain. Additionally, many financial advisors focus on helping people do specific things (i.e. reduce risk, provide income, plan for retirement, save money, etc.). They frequently focus less on growth, reasonable risk, and family issues. Therefore, they fail to understand your entire situation.
Consider this example: low inflation and interest rates have caused bond returns to be (2-4%) dramatically less than stocks (10-20%). Similarly, small businesses are getting more access to business loans at lower rates. Yet, many advisors continue to recommended high rates of investment in bonds, which basically dilutes an investor’s potential over time. If you have 10-20% returns in stocks for a few years, you are still better off in a declining period than earning almost nothing by investing in bonds or a savings account.
Also noteworthy: having a safety net might encourage people (especially young people) to spend rather than save. This is especially true if parents can provide a backup (either monetarily or in the form of housing) when they’re getting started.
One of the first steps in financial management is to understand the parameters especially as options and opportunities become more complex. For example, research the risk of investments and understand options like buying on margin, bitcoin, shorting stocks, Game Stop stock, etc. before making any decisions.
I am always reminded of a strategy meeting held several years ago. We were discussing using a venture capital firm and the presentation included several references to EBITA. One of our design staff spoke up and asked, “What is EBITA? It sounds like an animal.” After receiving an explanation, she suggested that outsourcing and importing could lower expenses and increase EBITA. The lesson is to always ensure we understand and explore all the elements of personal finance.
So, what now?
Gather all of your information and write it down. I recommend simple rather than elaborate analysis and be sure that you are involved in the process. Elaborate analysis can have wrong assumptions, can be too complicated to understand, and is often abandoned because it is too complicated and may utilize tools that aren’t appropriate.
There are a few basic elements of your information that should be reviewed, at least, annually:
A balance sheet that includes all of your assets and liabilities. This would include securities, personal assets, debt, and long-term liabilities like mortgages. In short, how much are you worth including an estimate of things like pension and social security benefits? Keep it simple and, if needed, analyze select issues in more detail.
An income statement and plan. How much are you earning and how much of that will you keep? This mostly includes the basic information from your tax return. Where does that income go in terms of expenses, debt payments, savings, etc.?
How much debt do you have and what are the costs? Is it short or long-term and how is it changing?
Asset based loans (mortgage, car, line of credit) are much less expensive than credit card loans, payment terms, or other loans with 10-20% interest rates. For example, if you have several thousand dollars in stocks, a line of credit can be particularly attractive.
While assessing your situation, consider the values of assets like house ownership, life insurance, retirement benefits, and family assets. Consider gifts, inheritance, end of life expenses, and in-kind contributions like family vacations as part of your financial assessment. Generally, we are living longer and might want to consider giving gifts to young people before they are too old to really use it.
Identify and compare alternatives. Investing, saving, spending, types of investment, and time periods are all things that should be considered. Additionally, while evaluating your options, you need to consider the environment, personal preferences, and financial situation. I believe in, at least, reviewing alternatives even if you end up deciding against them. But, economic reforms and the decline of the pandemic should generate a strong economy in 2021.
Consider new alternatives rather than outdated standard tools. Tech platforms, Fin-tech, direct sales, the Internet etc. are driving the economy—not traditional manufacturing companies. Growth is more likely than recession and strategies like traditional companies and cash investments may be overrated.
Assess your personal situation in terms of job, monetary requirements, future expenses/needs etc. In particular, what are your passions, strengths, and constraints? I always come back to Sheryl Sandberg’s recommendation to consider, “What would you do if you weren’t afraid?”
The most important advice regarding personal finances is to just pay a little bit of attention. Consider opportunities and alternatives as well as challenges and constraints. That mindset should be supplemented by a continuous process of analyzing, measuring, and adapting to ever-changing parameters, programs, markets, and risks. Anytime we deal with money, there is potential for stress. But, we shouldn’t view personal finances as a daunting subject. Instead, look at it as an opportunity to learn, grow, improve your circumstances, and set yourself up for greater success.
Please visit our website www.startupconection.net to book a Free Session in which we can help you develop an action plan that will evaluate potential and risk. We always discuss process, expected outcomes, and cost before you make any commitment.
Dr. Bert Shlensky, president of Startup Connection\, prides himself on his ability to define what is unique about each and every business. He works closely with individuals to develop a personalized approach that targets specific areas of concern and offers solutions based on his 40+ years of experience. His expert team will address your particular needs while working to save you time and money.
Risk is a critical part of every decision. And, frankly, I think we all need more of it. We tend to think of risk as a taboo concept and it’s really not—once you understand it.
Written by
In order to benefit from risk, you need to define what risk is to you. Some people view risk as the “potential for harm or hazard” (think bungee jumping). I view risk as an “uncertain circumstance in which one manages to maximize the gains.” But, how do you maximize the probability of success?
Here are some key parameters that affect risk-based decisions:
Consider conditions. For example, you have almost certain probability that, in general, October will be cooler than September. However, forecasting a certain day adds risk and uncertainty.
Reduce risk where you can to allow even more risk in other areas. For example, more analytics in sports is creating opportunities to assess strengths/weaknesses and create new winning strategies. It has enabled athletes to take more three-point shots, hit more home runs and longer golf drives, and score more touchdowns. Similarly, surfers used to ride 29-30 waves and now they are comfortable in 50 to 80-foot waves. Jet Ski rescues, inflatable vests, and leashes are among the tools that reduce uncertainty and increase potential.
Know the value and probability of the reward. Winning the lottery has an extremely high reward, but also has low probability. Purchasing investment bonds has lower return than buying stocks, but the risk and volatility of buying stocks is higher.
Value is also affected by the law of diminishing returns, which states that: as the input or value increases, the incremental changes become less important. It is easily summarized by the old saying, “Too many cooks spoil the broth.” Other examples include adding superfluous benefits to an offer, endless presentations, annoying excessive service, or just making the reward dramatically above what is needed or desired. Let’s say you love pie, but only have it once in a while as a treat. In this instance, the value is higher. But, if you eat it every day, it becomes less special and the value decreases. The same goes for a visit with your in-laws: Once a month is good, one a week might be less good, and every day might really be pushing it…
Understand the perceived importance of the reward. People generally regret losses more than they appreciate gains—and that is a key factor to consider when making any decision. When choosing a college to attend, decisions depend on area of course study, school size, location, tuition, the school’s reputation, etc. Are some of these factors more important than others? It varies depending on the individual.
The benefits from risk are a result of integrating the above examples to maximize results. Let’s look at the game of craps as an example: When you roll two dice, there is over a 40% probability you will roll a 6, 7, or 8 and about a 6% probability you will roll a 2 or a 12. So, if you’re placing a bet, knowing the odds (i.e. the probability of the reward) will reduce the risk. Betting is based on your willingness to risk in order to earn higher or lower rewards. The most forgotten aspect of craps (and all betting, for that matter) is that, over the long run, the house wins which is why casinos are so profitable.
Risk needs to managed rather than feared. Understanding the risk, the rewards, and the importance of each can help you improve outcomes. Don’t allow fear, uncertainty, or tradition to lower your potential and prevent you from trying something new. Only those who dare to risk going too far can find out how far one can go.
Key factors to consider to increase the benefits from risk:
Understand all the information. Knowing background, probabilities, and parameters can greatly enhance outcomes. For instance, investment decisions are greatly influenced by history and trends. However, because there is so much change due to the pandemic, the risk is now more volatile and opportunistic. Knowing the circumstances around your decisions is key.
Psychology. Assessing risk has a number of psychological constraints: a) People tend to take more risks to win back losses and less risks to follow up on winnings. b) Marketers love to push fear. When you are buying a car, appliance etc., they push its safety, reliability, and excellence. After you commit, they try selling a warranty. They induce fear by citing all the things that can go wrong. c) We overestimate our skills and luck. Tons of profits are made at casinos and in sports betting based on countless people believing that they can beat the odds.
Think about your decisions and the outcomes. We often perceive decisions as win-lose situations where one-party wins and another loses, but there are different types of decisions. Changing that mentality to “win-win” can have dramatic benefits and we tend to underestimate the opportunities we have to achieve this. For example, who would have believed decades ago that the mergers of Vietnam and Germany would be so successful? So, when making a choice, brainstorm ways to maximize benefits all around.
Rethink your strategy: Zero sum game versus non zero-sum game. Which are you employing? The best negotiations result in both parties winning. This takes collaboration, assessing varying (or even opposing) goals, and increasing the metaphorical “pie.” In particular, try to understand what is important and unimportant for each party involved. For example, many traditional retailers viewed online shopping as a liability in terms of disrupting their regular business. Now, they’re viewing it as a savior, recognizing it’s a safe and effective way to meet the needs of their consumers.
Risk mitigation. The best, simplest, inexpensive, and most effective way to mitigate risk is to gather more information. The more you know about making a decision, the less risk it will involve. Other tools include: insurance, diversification, and leverage. One of the challenges of mitigation is that people often use it to take even more risk and that defeats the purpose.
Listen to your gut. Sometimes you just have to ignore some of the information and go for it. We tend to overthink things or we let fear stop us from taking risks, but there is no gain without trying and no reward without risk. If your intuition is telling you something, it’s usually worth listening.
Risk needs to managed rather than feared. Understanding the risk, the rewards, and the importance of each can help you improve outcomes. Don’t allow fear, uncertainty, or tradition to lower your potential and prevent you from trying something new. Only those who dare to risk going too far can find out how far one can go.
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Startup Connection
When you want to stand out, reach out to Bert for the tools that will build your “sticky” brand. My focus is on understanding and analyzing your dilemmas and challenges, so your company becomes profitable faster.
Call (914) 632-6977 or email me at bshlensky@startupconnection.net. Don’t leave without signing up for our useful free eBook!
Feeling stumped or overwhelmed? Contact Bert at (914) 632-6977 or Email to start the process. Thanks!
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The coronavirus crisis has caused a plethora of financial issues that businesses must now face. All of my clients are dealing with dilemmas concerning customers, credit, future sales, financing, planning cash flow, forecasting, etc. when it comes resolving financial stress.
For the most part, we still live in a world with an old system of small business financing. Most financing (including institutions like banks and the SBA) is based on antiquated businesses, such as manufacturing and retailing, where financing was handled mostly through asset loans, guaranteeing debt via family assets, and personal savings.
However, things are very different today. Most new businesses are service or technology-based, and require much less investment.
Many clients start the financing process by asking the age-old question, “How do I raise money?” That’s an outdated way to start and I believe it’s a mindset that needs to be changed in order to be more successful. For example, traditional style advisors often recommend raising as much money as possible. In contrast, I suggest minimizing to reduce costs and risk, keep equity, and avoid excessive financing charges.
Some of the biggest changes that need to take place involve utilizing alternative techniques to minimize financing needs and marketing opportunities to accelerate growth. I recommend a more comprehensive and flexible approach to the process which focuses on key issues like: How much money do you need? How and when will you pay it back? Why should someone invest or partner with you?
Additionally, we live in an environment with low interest and inflation rates, and lots of capital to invest. The rest of this article will discuss financing suggestions that take into consideration new trends and current events. For example, the government has instituted $2 trillion of relief programs for salary, unemployment, and investment that must be considered.
Operational Financial Resources
The simplest source of funds is to reduce the need for funds through regular business tactics. This can be accomplished with strategies such as outsourcing, contracting services, utilizing sharing resources, and testing. While not all of these strategies may be appropriate for every business, consider the ones that have most potential to save cash:
Plan and manage inventory to maximize return: focus on the 80-20% rule that states: 80% of your sales will come from 20% of your products. Additionally, manage inventory and services for seasonal and market changes.
Consider direct shipping from your facilities or organizations like Amazon.
Minimize investment through strategies like renting or sharing. For example, warehouses, cooking facilities, and manufacturing can all be outsourced. One caution: doing things in your home will frequently result in long-term, operational, and legal issues.
If asked, suppliers are often willing to help a business with things like financing, holding inventory, reducing production times, and direct shipping.
Use services for internet management, warehousing, and programming.
Understand and minimize complexity. For example, there’s a big difference between selling a shoe (with various sizes, colors, widths, and styles) versus selling food products (which have a few ingredients that can made into a number of items.)
Analyze why you are really spending and what you will get from it.
If the business is profitable and growing, you can frequently finance the growth with working capital from profits. This also means giving up less equity.
Expanding Marketing Efforts
Don’t wait for business to come to you, but consider the rule: you have to spend money to make money. Analytics, internet marketing, and outsourcing programs provide numerous opportunities to grow and make money faster:
A website and a simple marketing statement provide basic information for potential customers. These can be inexpensive through programming tools like WordPress.
Amazon is the fastest growing retailer in the country and controls about 30-50% of most internet sales. It is easy to set up and relatively inexpensive.
Paid search through organizations like Google and Facebook are underestimated. These options can be inexpensive and fast, and the results can be measured.
There is nothing as productive as Networking, Networking, Networking!
These tactics must be tested and measured. Kill or modify the ones that fail and expand the ones that succeed.
Non-traditional Sources of Capital
Crowdfunding was initially used by “social entrepreneurs” to fund their projects, films, books, and social ventures. It’s becoming more popular as it allows small investors to back your business through organizations like Kickstarter.
While credit card interest can accrue (at a high rate) if not paid off right away, some credit cards do offer a 30-day free program, or zero interest (for sometimes up to 18 months) with a new account.
Bartering, alliances, and exchanges are viable methods to get both excellent services and save cash.
Community based lenders (such as non-profit, independently financed, or private organizations) often make loans to small businesses or entrepreneurs who do not qualify for traditional commercial bank loans.
Traditional Sources of Capital
Equity from yourself, friends, and family. This is the amount of money you can put into the business on your own, and you don’t have to pay it back until you see profits. It may include sweat equity or contributed assets. It also provides other investors with more confidence in your commitment.
Outside equity has the same properties except it involves giving up at least some of your own equity in the company. It can come from a variety of places such as partners, venture capitalists, private equity dealers, private offerings, and private investors.
Traditional banks and loan institutions are focused on reducing risk and making certain they get paid back. These are usually asset-based loans or are combined with equity contributions.
Raising capital is a two-way street that requires honesty, understanding, and communication. Understand your needs and the risks involved in order to find the right type of investors.
Don’t overestimate your potential or what is needed to meet your goals.
Develop plans, measure results, and satisfy investor requirements.
Significant changes are occurring in financing. There will be more risk, more volatility, more uncertainty, and more focus on profit and cash flow. Thankfully, there are numerous tactics to manage these shifts. As these changes progress, consider including more alternative methods—especially cost reduction, analyzing goals and strategies, and focusing on the dynamics of the financing rather than just how much money you can raise.
Dr. Bert Shlensky has an MBA and a PhD from the Sloan School of Management at MIT. He is the President of the New York-based consulting firm The Startup Connection, where he uses his 30 years of high-level business experience to guide his clients toward maximum sales and profit. For a free consultation, please visit www.startupconnections.net.
Is risk taking scary? If you’re only thinking about the possible negative outcomes, yes. But, it can be exciting if you take more risks if you focus on the potential positives results.
Many risk takers
enjoy gambling because the the idea of
winning something is more exciting than losing… For others, the idea of
losing money is more unpleasant than the potential of gaining—and that makes
the experience unenjoyable for them.
Nonetheless, in business, it’s important (and frequently imperative) to take risks in order to expand, grow, and adapt. So, how do we take more risks responsibly?
Evaluate
The Risk
What and how much
is really at stake? If a lottery ticket costs $20 and the two potential
outcomes are to lose $20 or win $2 million, is that risk worth it? For some,
yes. But, not every risk is right for everyone.
What exactly is on
the line and how much can you afford to lose? Weigh the pros and cons. For
example, buying lottery tickets, gambling, and staying at a cheap hotel are all
things that have a low probability of “winning.” However, they are affordable and
the rewards are often high.
In
contrast, using all of your funds on risky investments, not buying insurance,
or driving somewhere without directions are all risks that have the potential
for significant loss and marginal benefits. This leads us to the next point…
Understand
The Odds
Do
you really, truly, and completely understand all the aspects of the risk? The probability
of reward, the amount of the reward, and the value of the reward? Do you know
what you’re going up against and what it would take to recover the potential
loss?
Assess The Worth
If we consider skydiving a
risk… the cost is fairly low and the probability of surviving is very high.
However, the fact that (despite good odds) there is even the slightest chance
of death makes it too much of a risk for many people. Truly understanding all the
aspects of any risk is key to deciding whether it’s worth it to you.
Know
Your Goal and Set Limits
For
me, playing cards is problematic because, if the stakes are low, I play more
daringly and end up losing quickly. If the stakes are high, I worry too much
about losing and don’t bet.
If
my goal is to have fun, I’ve learned that the best strategy is to set a
monetary limit so I can enjoy myself without worrying about excessive loss.
Different approaches will work for different goals. For example, in craps there
are some back bets that are at even odds. If my goal is to stay at the table as
long as possible to watch the action, I won’t take those bets because I’ll lose
my money faster and reach my limit sooner. For someone who is solely concerned
with winning quickly, they might take those bets.
Consider
Normal Distribution
Normal
distributions have many convenient properties, such as the concentrated curve in
the center, which decreases equally on either side. The highest probabilities
are around the mean (center or average) and the lowest at the edges of any
distribution.
Some
examples of its application are:
The
probability of heads or tails in a coin toss is 50% over the long run, but can
be very skewed one way or the other when considering just a few flips.
The
probability of rolling a 7 with two dice is about 16%. That is the same as
rolling a total of 2, 3, 11, or 12.
The
biggest issue here is that we sometimes assume a normal distribution when the
data doesn’t match. Changes in technology and/or deviant data points frequently
challenge our assumptions and estimates.
I
argue that normal distributions frequently underestimate outliers (i.e. exceptional
people like Steve Jobs, the impact of political events, technology, or just unusual
results). It’s counterproductive to always assume normal distribution is at
play when there are other important factors to consider, such as innovation,
unexpected data, and emotion. That 1% at the end of the distribution chart with
an extremely high value is what frequently accounts for exceptional behavior—
it’s where we find the individuals who ignore the odds and take a big risk.
Tips
to minimize loss:
Have a backup
plan.
Research
everything: cost, odds, competition, value, risk, and alternative strategies.
Know your
strengths and play to them.
Test and analyze
results so you can adjust accordingly.
Adapt and be flexible. Most efforts won’t succeed on the first
try, but practice integrating the positive components from each trial with some
different approaches.
Incorporate rather than ignore change, history, trends, and special
events. For example, the impact of E-commerce, analytics, and cell phones are
just starting to be understood and the potential may be much greater than
estimated.
If risk still
seems daunting to you, try to look at it this way: When playing a game like
Black Jack (or while running a business), there’s a strategy and you constantly
have to assess the cards you’ve been dealt in order to get the most out of the
money you’ve invested. Owning a business in and of itself is a risk. It’s just
a matter of deciding how much and what kinds of additional risks you want to
take to propel your business to the next level.
Sure, you can argue that riding the middle lane is safe and risk-free, but it’s naïve to think anything is “secure.” Life is more like Roulette: just when you think you see a pattern, chaos breaks loose. You could never intentionally take more risks and still suffer loss in the form of an unexpected economic slump, a natural disaster, or theft. At least with a planned risk, there are controlled aspects that take the unknown odds into consideration: a combination that weighs risk/reward and encourages growth.
Are
you a risk taker? Does risk excite or scare you? How has risk helped or
hindered your business? Share your stories in the comments!
Dr. Bert Shlensky, president of www.startupconnection.net, offers experience, skills, and a team devoted to developing and executing winning strategies for businesses of all kinds. This combination has been the key to client success. His book, “Passion and Reality for Small Business Success,” is available at www.startupconnection.net.
How
do you view the world? Have you ever stepped back and asked yourself if your
outlook is correct? You might be wondering, “How can you measure that?” Well,
you can’t because we all have a particular way of viewing the world, which is
based off of genetics, personal experience, economic status,
political/religious preference, education, and a slew of other factors. But,
you can assess whether your perspective
is effectively contributing to achieving your goals.
We’ve
all been told that when one approach is repeatedly not working, it’s time to
try something else. The same goes for perspectives. Sometimes, problem solving
is as simple as looking at things in a different way. After countless attempts,
a goal may seem unachievable—and that is when it’s time to flip your outlook.
As
business owners, it’s been ingrained in our brains that planning, budgeting,
and expertise are key to success. However, a recent shift in perspective led me
to the conclusion that they actually aren’t that important as we were once
taught to believe. Let me give you an example:
Last
month, I received and invested in four new issues and profited from all four.
One even doubled in a day. They were from different industries, but all related
to technology in some way. The most interesting aspect was that they all lost
significant money, but the losses are mostly growing. This made me take note of
the fact that many new businesses seem more focused on sales growth and
potential rather than targeting profitability. Amazon is a perfect example of
this, as it was viewed for many years as the poster child for growth and losses.
Now, companies like Uber and Wayfair are trying to emulate that model.
This
trend clearly illustrates how traditional methods of planning and forecasting
businesses are dramatically changing in nature and diversity. We’re used to the
notion that traditional small businesses need to show profitability in order to
pay bills and find investors. But, the reality for many new businesses (such as
apps, sharing sites, and innovative technologies) is the requirement to prove
their concept’s worth through larger scale, bigger investments, and exponential
growth/losses over several years. Additionally, forecasts of these larger
entities are generally meaningless and inaccurate because of the risk and
uncertainty.
With
all of that in mind, it’s easy to see how, when it comes to setting goals,
venture capitalist firms strive for potential 100 million-plus entities while
the small entrepreneur is often pleased with a million-dollar entity that makes
10% profit. Each person’s perspective is informed by their circumstances,
needs, and perceived capabilities. Some entrepreneurs are just out of college,
living at home, and may have a somewhat unrealistic view of life. Others are seasoned
venture capitalists or investors (think Shark Tank judge) looking for the next
billion-dollar deal. And then there are business owners in their 30’s or 40’s
with extensive expertise and experience who need to make a living quickly. With
very distinct backgrounds and needs, each of these individuals will come up
with a unique plan of action to achieve their goals and a strategy for
assessing risk, competition, market size and growth, resources, experience, and
expertise.
Circumstance
informs goal setting and perspective makes or breaks whether those goals are
achieved. Consider the following:
The Kaufmann Foundation, a group that promotes business growth, estimates there are about 400,000 new startups every year and that 90% of them will fail before their fifth year.
There are an estimated 131 startup companies that have achieved over $1 billion of valuation in the last few years.
Thus,
in roughly five years, the odds are about 1 in 15,000 that a company will reach
$1 billion in valuation, and 1 in 10 (mostly small companies) will survive five
years. There are, of course, significant variations in these outcomes. For
example, small companies often get bought or sold and many large companies
succeed, but have less than $1 billion valuations.
Also
noteworthy is the fact that most of the billion-dollar companies achieved
exponential growth, but also lost money over several years. For example, Uber,
though a leader in startups, lost over $5 billion in the last quarter.
Compounding the issue is that early investors were paid $4 billion in that
quarter which further complicates the situation. Similarly, nearly every new
large startup shows a dramatic increase in sales, but even more dramatic losses.
The
takeaway, perhaps, is that, with this knowledge, goal setting might benefit from
a shift in perspective. Rather than implementing a strategy that targets outcome,
an approach that focuses on immediate results may be more beneficial. The point
is: the times are changing and what once worked won’t work forever.
Things
to keep in mind:
Know your goals, resources, and risk. In particular, really understand your market analysis, competition, and how and why your company is different. Why should customers care? If you can’t answer this question, shift your perspective and look at your company through the eyes of a customer or a competitor.
For small business owners, it’s crucial to consider proper planning, adequate research, business excellence, and well-executed programs. Ensuring profit is critical to being in the 10% that succeed. It’s also important to recognize when any of these areas are failing. For instance, if you’re having problems with planning, consider a different outlook. You may be looking at the issue with blinders on. As previously stated, problems are often solved by simply stepping outside of your traditional way of thinking and assessing the situation from a different perspective.
If you require exponential growth to ultimately succeed, you still need to understand metrics. No matter the size of your business, know the risk and uncertainty, develop the resources, assess the ultimate market, and ensure there is at least a potentially profitable metric down the road. Is cash flow relevant and when?
A plan of action for an unrealistic goal will look impossible while a plan of action for an achievable goal may seem daunting, but doable. Dr. Bert Shlensky, president of www.startupconnection.net, offers experience and skills and a team devoted to developing and executing winning strategies for businesses of all kinds. This combination has been the key to client success. His book, “Passion and Reality for Small Business Success,” is available at www.startupconnection.net.
When you want to stand out, reach out to Bert for the tools that will build your “sticky” brand. My focus is on understanding and analyzing your dilemmas and challenges, so your company becomes profitable faster.
Call (914) 632-6977 or email me at bshlensky@startupconnection.net. Don’t leave without signing up for our useful free eBook!
Feeling stumped or overwhelmed? Contact Bert at (914) 632-6977 or Email to start the process. Thanks!
