The Real Start-Up Secret? Keep Your Costs Low!

Over my career, I have been fortunate to be part of a number of start-up companies. From one of the first 100 employees at americangreetings.com during the dot-com heyday to Fire Rover, COhatch and Re-Grip today, I have experienced first hand both the successes and failures that start-up companies try to achieve. Some have been successful, some failures, but from what I have experienced the companies with the best chance of success are able to keep their burn rate low.

I spent a ton of time over the years working with VC and PE groups that look to invest in the next big thing. They throw money at businesses, inflate their multiples, all with the goal of hitting the ball out of the park. While I have seen this approach work and these types of investment can produce winners, there are typically a number of losers on the back end, whether the public or large investment funds that get into too late as the increased multiples have been passed down the investment stream? The truth is anyone can throw money at a business, but throwing money at growth does not guarantee profitability.

Just look at WeWork. No one can argue that they did not have a great idea. The "shared economy" makes so much sense, but it needs to be executed in an effective business model. Most businesses spend between 2% and 20% of their costs on rent. Utilizing a shared space for companies has so many benefits, especially companies that are in a strong state of flux like start-ups. Not to mention the benefits of being a part of a business environment that is made up of a bunch of unique business models, cultures, industries, and sizes of companies that can benefit from each other's learnings.

The real issue is that the business model doesn't work. No matter what they say in their advertising, WeWork is just a real-estate broker. They purchase a pie and sell off pieces for 2X+ what real estate is worth wrapped in a shiny package. When their members pay retail prices for their spaces, (those members of WeWork know what I mean) the costs benefit starts to make less sense.

I worked with a Client for 6+ years called One World Direct. They were a venture-backed direct-to-consumer fulfillment company that was funded by a PE group in the '90s for an investment of a million bucks. The operators of the business lived in Pasadena, one of the most expensive zip codes in the US. They realized early on that the cost structure needed to be their differentiator so they open their fulfillment center in a small town in South Dakota to keep the costs low. Fast forward over twenty years and they are still going strong. The ride has not been easy and they definitely have battle scars, but the low-cost structure has allowed them to continue to fight the good fight as the D2C trend is currently cycling hardcore in their favor.

Unlike WeWork, at COhatch our goal is to reactivate and repurpose underutilized assets in local neighborhoods. Our goal was for our memberships to be affordable to small businesses, start-ups, non-profits, and businesses alike. We knew that if we catered to the "real community" as opposed to the "glitz and glamour" of a pristine downtown office address, that we might not generate the excitement that the WeWork's of the world generated and we were ok with not having the unlimited advertising and promotional budgets that their investors like Softbank had bestowed upon them.

We built our company from the ground up with a grassroots approach to marketing. In the beginning, we stood outside our first location in Downtown Worthington during their amazing farmer's market and explained to each passerby who and what we were. Some members of the community ignored us, some are still are members, but most understood and appreciated the value we provided to a former space that was at one time the community's theater and hadn't seen the light of day for almost 100 years until we reopened. Did we want to make a splash and advertise our community to the world, of course, but we did what our budget could afford and kept our burn rate low.

I am saying not to advertise? Absolutely the contrary. The dollars you spend on sales and marketing are critical to the success of a business. What I am saying is to keep your costs low. When we started Fire Rover, in lieu of investing in the expense of renting a space and heavy equipment we needed to build and test our fire elimination units, we utilized a partnership with a local scrap metal company in order to keep the burn rate low. Was it painful for the team, sure, but the company was burning so much cash prior to our first sale that the only thing having that space would have done is dilute the existing shareholders or burden the company with future payments on loans.

Another key to keep your burn rate low is your employees. It is a delicate balancing act bringing on the right amount of staff/labor at just the right time. From my experience, the "build it and they will come" approach has not gone well. Not only does it hurt the business but the employee can become bored or undervalued unless they truly feel utilized. Having to let go of some employees when things do not pan out is far worse than having to hire and train employees when things begin to go well.

When I came on board one of my Client's WMG, they had about $10million in sales and had been in business for twenty plus years. I proceeded to grow a new line of business that made up an additional $5million in revenue in less than 24 months. I warned the owner, whom I considered a good friend, not to expand too fast as we were in an extremely mature market and were consolidating a larger piece of a shrinking pie. We needed to walk away from some of the revenue in an effort to keep the business profitable. Yes, this would have negatively affected my compensation for the sales, but it was the right thing to do. He made large investments in new space, new equipment, and new technology. Fast forward to year 5 and the company couldn't pay its bills and had to shut down laying off 300 people.

No one ever says that start-up businesses are easy. What I have learned in my twenty+ years doing this across many industries and companies is that if you are stretched for capital, you are forced to take unnecessary risks. Obviously, there are times when you have to take this approach, but being a little frugal upfront can keep your business long enough to take a few more swings at the plate. I do not believe in the old adage that "real entrepreneurs" will have lost a fortune and made a fortune a number of times in a lifetime. Maybe for a career gambler, but for most of us that want to start and grow businesses...a sensible, lowest operating business model is the way to go until you have the profits to reinvest in growth!

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Ryan Fogelman, J.D., MBA is a serial entrepreneur that has helped start and grow brands in numerous business models and industries. Ryan's companies have recently won two Edison Innovation Awards, two Retailers Choice Awards, and two Fast50 Awards. Ryan can be reached at [email protected].