Monday, January 25, 2010

Entrepreneurs Love Pain

This post is going to be more personal than most…I hope you never feel this pain.

A few weeks ago I woke up not feeling well.  I could not ignore an annoying pain in the left side of my back.  I prepared for and began my day hoping it would quickly pass (no pun intended…you’ll get it a little later).  When I sat down in my second meeting at 9:30am I found I could no longer concentrate on anything except the pain.  I excused myself only to find it difficult to make it to my vehicle.  I began the most painful 30-minute drive of my life, which ended at the emergency room, knowing that something was seriously wrong and I needed help.

After a diagnosis of kidney stones and another 48 hours of pain my situation resolved itself…hopefully permanently.  Yet something troubled me throughout this experience.  You see, everyone who helped me focused on reducing my pain, not on removing the cause of the pain (the stones).  My situation only allowed for such treatment, but it sure was a helpless feeling knowing that nothing could be done to solve the real problem.

Then I realized this is why entrepreneurs like pain.  Pain is a signal that something is wrong, that something needs to be fixed, improved, tweaked, or otherwise reconfigured to solve a problem and remove the pain.  I want to be clear – entrepreneurs do not just solve or mask pain, they solve real problems in a sustainable and usually a commercialized way.

When I arrived at the hospital, I would have done anything or paid almost any amount of money to have someone solve my problem, my pain was so significant.  You see, my perception of value was directly correlated to my level of pain.  This is no different than the customers of any business – their level of pain has a lot to do with how much they are willing to pay and how quickly they are willing to make a decision to pay for the solution to their problem causing the pain.  No pain results in very few customers.  Lots of people with pain results in lots of customers so long as the cost of your solution exceeds the pain of not resolving the problem.  Marketing and sales needs to be about identifying customer pain points and helping customers understand how you will remove their pain.  Operations needs to be about actually solving customers' problems.

My pain was obvious and dominant in contrast to the pain that many entrepreneurs remove by solving a real problem.  Often customers don’t realize they feel pain and have real problems that need to be fixed.  Consider the progression of the mobile phone.  We certainly survived without cell phones, but their development has increasingly solved problems for more and more mobile users.  Many felt the pain of not having access to email and the Internet on their mobile device, and the smart phone solved that problem.  Then the I-phone revolutionized the way we think about mobile technology.  The integration of over a hundred thousand (and growing) applications that each solve a specific problem has created a very sustainable and scalable business model ripe with opportunity.  Solving problems that remove pain is the name of the game.

The conclusion is this - entrepreneurs love pain.  Well, at least the kind of pain that has a solvable root problem.  Entrepreneurs also like to help customers understand their pain and how to remove it.  Do you understand the pain that your customers experience?  Are you solving their problems in a way that removes their pain?  Perhaps most importantly, are you solving their problems better than your competitors?  The entire value proposition of your firm hinges on these points.  The better you fulfill this, the more cash flow your business will have the opportunity to create.

Monday, January 18, 2010

The Financial Swings of a Seasonal Business

Most businesses have at least some seasonality to them.  Perhaps the first quarter of every calendar year is always slow, or your business comes to a stand-still every November through December.  Here is an example of a business that slows dramatically ever summer:

2009 rev by month

Notice the valley from June to August between the peaks of April and October.  The same thing happens every year in this business - it is fairly predictable.  Even though it is predictable, this seasonality can still create financial stress every year.  Let me be even more clear - this seasonality causes gyrations in cash flow that are difficult to stomach.  Let me explain this phenomenon, then I will share a few steps every entrepreneur can take to reduce such financial stress.

Let's start by talking about July, the lowest level of revenue all year.  The company shows a significant net loss every July because its low revenues and gross profit fall way short of covering the overhead and fixed costs of the business.  Yet, counter-intuitively, this is usually when the balance of cash in the bank account is the highest.  Why?  Because in July the company is collecting all of the April and May receivables but paying out very small amounts of variable costs (because the revenue volume is so low in July).  Although this may not sound all that stressful, it is when we talk about August through the rest of the year...

You see, as the volume of the business goes back up, there are very few receivables to collect from the summer months but variable expenses sky-rocket.  This is a huge cash drain on the business, and July is stressful because the entrepreneur is wondering if they will have enough cash to handle August through the end of the year.  Ultimately, this expansion in the working capital cycle returns to more efficient levels and the cash inflows catch up with the outflows by the end of the year.  The business returns to more steady cash flows until the next summer.  Please know that when I say stress, I am referring to the worries and concerns about making payroll, servicing debt, and meeting any other financial obligations that we worry about when our cash flow is not steady.

1. Have a Budget and Review it Every Month - At the beginning of every year we implement a well-thought-out and planned budget for the entire year.  This takes into account the seasonality of the revenues and costs as well as projects the total overhead and fixed costs of the business.  This also projects the balance sheet and statement of cash flows so we can understand how all of this will impact our cash.  We review our budget after every month to make sure we are on track.  We also usually implement a "break-even" budget so we can ensure that if we are under-performing on our plan for the year we can still see that we will not lose money when the year is over.  This is especially useful to know when the slow times come - even though the business is not profitable during this time we can see whether or not we are still on track to make a profit by the end of the year when revenues come back up.

2.     Short-term Cash Flow Projections -We always keep at least 90 days of cash flow projected based on our current receivables, payroll, and other items as well as our revenue projections for that period.  This is updated weekly and reviewed by the management team.  It is amazing how few entrepreneurs fail to implement this simple yet often overlooked "stress-reduction tool."

3.     Plan Financing for Cash Shortfalls -With the business mentioned above, it is a well known fact at the beginning of every year that we will not have enough internally-generated cash to handle the upturn after the summer.  So, we determine how much cash flow we will need and make sure to have a line of credit in place to cover the shortfall.  Even though credit is tough for entrepreneurs these days, there are plenty of banks willing to loan to this company.  The company has a proven track record, it understands its seasonality and can communicate to the bank exactly what will happen with its cash flow through the year, and it has an attractive asset (the receivables) and strong personal guarantor (the entrepreneur).  This company is very "bankable."

4.    Resist the Temptation to Diversify into Non-Core Competencies - Some might look at the chart above and think it would be best to try and increase revenue during the summer months to solve the cash flow challenges of the business.  While this is great in theory, it is typically impossible in practice without compromising the core competencies of the business and, ultimately, hurting more than helping the company.  As entrepreneurs, we need to embrace the seasonality of our business as well as our core competencies and not deviate from them.  Understanding, budgeting, and planning are usually more effective than diversification.

The keys are summed up in the last sentence - understanding, budgeting, and planning.  The more you do of those three the less your financial stress will be in your seasonal business.  Reducing this stress will free you up to grow your business or spend time doing other things you love.

Tuesday, January 12, 2010

Can You Define Business Model?

I have long suspected that most business people cannot give a simple definition for the common term of "business model." It seems to be a nebulous and vague term that escapes most. Most people think they know what it means, but when you ask them to define it, they usually can't come close to verbalizing it.

So I decided to see if a group of business students, those who are in the great business textbooks every day preparing to succeed in business, know what it means.    In a classroom of a well-respected business school today I asked: "Please define business model." I received the same initial reaction I do from most--some blank stares and a few who started to raise their hands but then realized they didn't really have much to offer. Finally a brave soul took the plunge with something like this: "It's the way a company runs and operates."

That sure seems to be part of it, but aren't we missing something? A few more students offered suggestions that were similarly vague and generally lacking. My definition is simple--a business model is how your business makes money. Period. It is the accumulation of all of the sales, marketing, operations, administration, R&D, finance, and everything else that goes into a business--all the strategies and tactics--that determine if the company makes money or does not make money. Most definitions are like the ones above--mentioning different parts of running a business but failing to describe it as the company's overall plan for making a profit. Understanding this simple and quick definition, here is my two-pronged philosophy for entrepreneurs and their business models:

First, every entrepreneur can pick whatever business model they want.

Second, eventually our efficient market will determine the superior business model for each industry.  Those who innovate the best model for their industry will most likely win.  Those who quickly adopt to this model will likely survive.  And those who stay entrenched in their out-dated and archaic models will die.

In our competitive business environment, the best entrepreneurs are the ones that innovate the best business models in their respective industries.  I don't know how many of them can give a quick and precise definition of the term business model, but one thing is for sure - they get it!

Monday, January 4, 2010

4 Signs Your Business Partnership Will Fail

Business partnerships are one of the most unique and trying relationships we will ever enter. Some work, but most fail. I did a quick test. I searched Google for "business partner problems" and found about 169 million results. Compared to only 143 million results for what I assumed would be the more common term of "business partner," I think it is clear that many struggle to make these arrangements work. Here are four warning signs that our relationship with our business partner(s) may be headed for failure. Please note that this article assumes that business partnerships are in the common form of a Limited Liability Company (LLC).

1.   No Operating Agreement - many states do not require an LLC to have an operating agreement, and, therefore, many business owners and entrepreneurs do not understand the importance of this legal document.  The operating agreement is the agreement between all of the owners, or members, on how the business will run, who will be in charge, and so much more. Let me share one brief example to portray the need for an operating agreement.

While at a social event recently with my wife, we connected with one of her friends from college. He has started a business and his product is starting to sell and pick up some nice momentum. He spoke for quite some time about how excited he was, how much fun he was having, and his new-found joy in finally pursuing his passion. I asked if anyone else was involved with the business, and he said he had two partners. The entire tone of the conversation changed as he described how his "partnership" had evolved, or perhaps a better description would be disintegrated. It started with three friends getting excited about an idea. They decided to split everything three ways and they failed to put anything into writing (namely, an operating agreement).

As time passed the expectations, time commitments, investment, and basically everything else related to these "equal" partners fell completely out of balance. Arguments replaced friendship and greed supplanted a desire to share everything equally.  The problem - they never created an operating agreement that defined all of the important legal, financial, management, and time issues for their business. The lack of an operating agreement has sent this budding partnership into a death spiral that will likely end in a painful and expensive divorce.

Please know that I have many more examples like this than I do of successful partnerships. One thing all of the successful partnerships have in common - they have an operating agreement. While certain online resources can help entrepreneurs organize their entities legally, special care and consideration should be paid to the operating agreement. It is very wise to seek appropriate legal counsel as well as have healthy and lengthy discussions with your partners before you finalize this agreement.

2.  Partner Pride -This is something that usually shows up when a partnership begins to have struggles and accelerates its demise. Here is one real-world example of partner pride. Two men started a business, each owned about 45%. The remaining 10% went to other key employees. As the business grew and became quite successful,  one of the 45% owners took great pride in the success of the company. He began to tell his family and close friends that it was his company and that he was the major contributor to its success. His pride allowed him to minimize his main partner and falsely establish himself as something he was not.

When this partnership began to fall apart and his partner extended a very fair offer to buy him out, he refused. Why?  In his mind, he could not communicate to all of his family and friends that the business could exist after he left.  He was so infatuated with his fictitious position that he could not make reasonable or logical decisions. The matter was finally resolved, but not without great distractions and damage to the business. The best way I have seen to keep pride out of a partnership is to regularly review the contributions of all involved as well as discuss how each partner can improve. If done correctly, this serves to keep everyone grounded and grateful for each other.

3.  Compensation and equity are confused -Let me be as straight-forward as I can with this topic. Too often I see entrepreneurs, founders, and business owners that confuse equity and pay/compensation. These two items must be separated in order to set your partnership up for success.

A few years ago I was introduced to a business with 50/50 partners. 12 months earlier one of the partners had become permanently disabled and unable to further participate in the business. The partner remaining in the business was frustrated that the other partner put zero time into the business yet was still getting 50% of everything the remaining partner generated. This partnership was about to fall apart until we set a fair and reasonable wage for the partner still working in the business. The other partner's wage was reduced to zero since he was not working in the business, although he was still entitled to 50% of the profits based on his ownership stake in the business. Problem solved.

Ownership does not mean you should receive a wage or guaranteed payment. Ownership means you participate in profits after all expenses are paid, including the wages of those working in the business. In the spirit of understanding the difference between equity and pay, each partner's compensation should be reviewed at least annually. In this scenario, it would not be uncommon for one partner to receive a higher salary than another, especially if there is a difference in the amount of time put into the business. Please note that the legal and tax structure of the business may determine the best ways to receive both wages and profits, but that should not dictate the separation, at least mentally and emotionally, of the two.

4.   Beginning without the end in mind -perhaps all of these points lead to this one - the need to contemplate every way the partnership will need to end or be dissolved. Here is just a brief list of the different life events that could impact a partnership: death, disability, lack of interest, relocation, new opportunities, family changes, and more. How will each of these situations be handled by the partnership? An operating agreement and potentially a buy/sell agreement should contemplate these events.

In addition, beginning with the end in mind implies that a partnership will have planned exits as well. Selling a business can be very rewarding, and a partnership needs to look down the road to how each of the partners will exit. For example, one partnership for which I work consists of three partners under forty and the fourth partner is almost 65. The younger three want to stay in the business for a long time while the older partner is hoping to exit the business and retire in a few years. Orchestrating this partner's exit while not hurting the business from a cash flow and leadership perspective take thought, consideration, and planning. The point is this - if a partnership does not properly plan for expected and unexpected exits, it will likely fail.

Do any of you have good or bad partnership experiences to share?