4 Things You Must Do When Starting a Company

The lean startup movement (of which I am a big proponent) has thankfully eliminated the “build it and they will come” attitude among aspiring entrepreneurs.

In its place, most new entrepreneurs build minimally viable products (MVP), test them with real customers, receive feedback, adapt and refine, and continually repeat until they find a product that customers like (at a minimum) or ideally, crave.

This new process reduces risk, minimizes cash burn, allows companies to fail early, and allows investors to put their larger investments into only those companies that look like potentially big winners.

However, it also puts a very heavy emphasis on the product – an emphasis that can result in distracting startups away from other essential activities that when initiated at the start of a business can help to identify and reduce other risks just as enormous.

The Biggest Risks

Those risks will vary from company to company and industry to industry, but some risks are common to all startups:

1. Will customers crave your product?
2. What will customers pay for your product?
3. Are their sufficient numbers of customers?
4. How will you make customers aware of your product?
5. What will it cost to produce your product?
6. What will it cost to run your company?
7. How much cash do you need?

So how does a startup manage these risks from their inception and consistently?

Reducing Those Risks

The popular iterative process described in the second paragraph of this article addresses risk #1 very well. If pricing experiments are included, it can also address risk #2.

Addressing risk #3 requires some level of market and industry research. I’m not suggesting a major effort here, but I am suggesting that you spend at least some time understanding market segmentation, the competition and which segments each competitor aims for. Make sure you include substitute (indirect) competitors.

Failure to address risk #4 early is perhaps the most common mistake of newbie tech entrepreneurs. Often, they’ll think “once we figure out what the product is, then we’ll figure out how to sell it.” This is just a few steps away from “make it and they will come.”

Another common attitude among newbie tech entrepreneurs is “oh, the internet will take care of sales.” The fact is making sales takes work for 99% of companies. Internet sales are not easy! And margins when selling through Amazon are close to nil.

Iterate on your sales model just like you iterate on product features. Start with an initial proposal (based on serious thought!). Then iterate as you learn more. Some of your basic options include inside sales force, outside direct sales force, sales channels/distributors (e.g., Amazon), and internet sales from your own website along with a major SEO effort. Each choice has major impact on your costs and thus your viability as a company.

The easiest way to address risks #5-#7 is to create a quick financial model.

1. First, make a list of all your business assumptions; this is a good idea to keep you organized in your experiments anyway; after all, it is these very assumptions that serve as the hypotheses that you are testing in your lean startup experiments.
2. Use a tool to automatically transform the assumptions into pro forma financial statements. These financial statements will then tell you (a) when you will be profitable, (b) when you will break even, (c) how much cash you will need, and (d) what your company’s valuation will be based on industry averages, and (e) what kind of return your investors are likely to receive.

The actual process of entering data for business assumptions should take you no more than 30 minutes. But the real value of using a tool that requires you to write down your business assumptions is the thinking that it inspires you to do. For example, for manufactured products, it asks you questions about what you assume the cost of raw materials will be; for software products, it asks you questions about how many customer support people you plan to hire, and so on.

Remember, these are just assumptions, so you can launch your company with your eyes wide open. You don’t want to start a company that you know will be unprofitable from the start.

I am not advocating for a full business plan. On the other hand, I do not believe that just having the right product is a sufficient first step. Instead you need (from the start!) to be engaged in at least four simultaneous risk-reduction activities:

1. Building an MVP and then iterating it until customers crave it
2. Studying the market, segmentation, and competition
3. Assuming a sales model and iterating as more is learned
4. Building a financial model based on assumptions and iterating as more is learned

Here are some examples of why just getting the right product is not good enough:

Why the “Right Product” is Not Sufficient: Example 1

Let’s start with a hypothetical case. You have created a product that provides a special nutritional source for pregnant women in Niger, to help reduce the country’s 14% rate of maternal death during childbirth.

You can run a series of experiments to determine if the product is palatable and refine it if necessary. You can also run a series of experiments to determine its efficacy on reducing deaths.

However, the biggest hurdles are not the product’s features. The biggest hurdles are logistics, costs, prices, and everything else that makes up the business.

Why the “Right Product” is Not Sufficient: Example 2

Turning to a simpler example, suppose you are building an app. You can tweak it based on myriad experiments until you have the product that customers love. But if customers expect to download the app for free, you have no business.

Why the “Right Product” is Not Sufficient: Example 3

Let’s look at another example, this time from a real company: This company planned to manufacture industrial lubricants with very unique properties and capture a large percentage of the market by (a) marketing unique differentiators that were the result of unique raw materials that were “green,” and (b) price the products well below competition.

That sounded like a great value proposition for all stakeholders. However, a careful early financial analysis revealed that the green raw materials drove the cost of goods sold up to around 85% of the planned price. This left just a 15% gross margin, far too low to support infrastructure costs. A financial analysis at the beginning revealed that this company was a non-starter.

Why the “Right Product” is Not Sufficient: Example 4

Let’s look at one final example, another real company: Adapta Medical. Founded by Dr. Glen House, and based on his numerous patents, Adapta iterated on and perfected an intermittent urinary catheter that an individual with limited dexterity (e.g., a C6-C7 quadriplegic) could use to self-catheterize.

From the beginning, Dr. House experimented with product designs, customer satisfaction experiments, multiple manufacturing sources, and financial models, simultaneously. The tasks that took the longest time and consumed the most energy were working out the manufacturing and cost models. Fortunately for him, he started on these from the beginning, so after about a year product iteration (to arrive at the first commercially viable product), he only had another two or so years to work out the manufacturing and cost model glitches.

Now that he is in production, he continues to perfect the product, iterate on the financials, hone the costs, and adapt the manufacturing processes. Learn more about Adapta at www.adaptamedical.com.

Summary

These days, everybody thinks they can launch a new company. The popular process of “iterate the product until customers like it” provides necessary but not sufficient assistance to the na?ve first-time entrepreneur. At a minimum, an entrepreneur must start with these four activities to mitigate the risks of starting a business:

1. Building an MVP and then iterating it until customers crave it
2. Studying the market, segmentation, and competition
3. Assuming a sales model and iterating as more is learned
4. Building a financial model based on assumptions and iterating as more is learned

Start doing all of them at the beginning; don’t do them sequentially.

About the Author

Dr. Al Davis has published 100+ articles in journals, conferences and trade press, and lectured 2,000+ times in 28 countries. He is the author of 6 books. He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting their business strategies to optimize financial return for themselves and their investors. Formerly, he was founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003.

If you'd like to learn if your great business idea will make money, take a look at Will Your New Start Up Make Money? If you'd like a tool that transforms business assumptions directly into pro forma financial statements, check out www.offtoa.com.

Risk Photo Credit: “Los Angeles Graffiti Art” by A Syn (Creative Commons)

Niger Flag Photo Credit: "Niger Flag" by Philippe Verdy (Wikimedia Commons)

Not for Sale Photo Credit: "Onis Not for Sale Sign" by Noblestrawberry (Creative Commons)