Starting a Business From Scratch … Without Investors (Article #2 - Show Me the Money!)
(This is the story of Embrazio, a leather accessories company in Boulder, Colorado, complete with lessons learned and a few tools and exercises all brought together for your entertainment and hopefully a bit of learning to boot. The story is told in the form of a series of articles by Embrazio founders Scott Schaefer and Stephanie Boyles … who also happen to be married.)
Article #2 – Show Me the Money! … let’s do some financial planning
In article #1 we described how we took an idea for a new leather belt and cell phone holster from Stephanie’s head to a working prototype we could test with potential buyers. Getting early feedback from real potential customers (i.e., not just friends and family) should be among the first things you do. We listened carefully for where we were wrong, for ways to make it better, and for things others didn’t like about our design … not for validation we were right. We incorporated the feedback into a new design and repeated the testing process. This can go on for several cycles before you arrive at a design that is ready for production. At this point, costing, sourcing, and real financial analysis is needed to decide if you have a product or a business opportunity on your hands and to understand what it will take to get across the finish line to your definition of success.
A Product, Or A Business?
Did we want to prove our initial product and then sell it to someone else like Brighton or the Frye Company or were we up for investing and growing a complete line of leather accessories? Uh, to be honest, we hadn’t thought much about it so far. Thinking back on it now, we should have at least done a back of the envelope business case in parallel to our prototyping so that we clearly understood the magnitude of time, cash, and mindshare/focus required to start making money instead of serially investing as needed.
This is a consequence of our own hubris and of not using the same discipline that would have been required if we were seeking outside money. An external investor would have required at least a basic set of financials. Plus, we were so lathered up by the positive market feedback we were getting from a small set of initial customers that we just couldn’t slow down.
Fortunately, early cost estimates from the factory we were negotiating with to make our product forced the issue. Neither of us were comfortable writing a check for $10,000+ without some sense of where we were going and when we might get paid back from the business. Step one was deciding if we wanted to create an entire business around leather accessories or if we wanted to simply prove demand for our initial product and sell or license the rights to someone already in the market. We had access to enough capital (i.e., money) on our own to go either way so we asked ourselves the following questions:
- Can we envision additional products and markets that would build upon and extend our initial offering?
- Do we personally have the energy, drive, desire to build a brand?
- Do we have the skills, or can we acquire the skills, necessary to build a brand either by learning ourselves or partnering with others?
- Do we understand and want to commit to the amount of time it takes to grow a brand especially without bringing in outside investors (something we just didn’t want to deal with)?
Without taking you through all the sausage making, wine drinking, and hair pulling associated with getting to an answer, we both decided yes, let’s build a brand. With that “north star” in mind, we set ourselves to the work of forming a business model and creating a financial business case that would serve as our roadmap to getting to a profitable and growing new brand called Embrazio!
Lesson #2 – Have a destination in mind and a plan to get there!
The “business model” describes how you plan to structure and operate your business to make money. The “business case” is a financial description of the business over time. It is usually done via a spreadsheet and includes projections on sales, revenue, expenses, and capital investment. It produces estimates of profit and loss and, most importantly, cash flow surpluses and deficits. Together, the business model and business case answer questions like the following:
- What is the value created by this product or service?
- Who will recognize and pay for that value (i.e., the Target Market)?
- How and how much will they pay?
- How and at what cost will you create the product or service?
- How will you create market awareness?
- How will you sell?
- How will you provide post-sale service and support?
- How will you grow beyond your initial offering and expand your market?
- What are the threats, risks, and competitive pressures this business will face and how do you intend to avoid, overcome, or mitigate them?
The good news is that if you avoid or forget to ask and answer these questions up front, God/Mother Nature/Karma will surely force you to answer them in real time as you continue on. The bad news is that it can be much more painful and expensive to go through this exercise later rather than sooner (i.e., Karma can be a bitch!). In our case, the pain was somewhat mitigated because we were placing small bets with our own money and our own blood, sweat, and tears. Until now, we’d put off doing a formal business case under the excuse that we didn’t really have the knowledge to make assumptions about costs, prices, and customer demand, etc.. In reality, having gone through the prototyping process, we knew enough at this point to make educated guesses in each of these areas.
With the need to start writing large checks for leather and hardware and to engage a cut and sew factory to start manufacturing, we knew we could wait no longer. We dusted off some business cases we’d done for others and began inputting the assumptions under which we’d move forward with Embrazio. We had the benefit of lots of experience and had existing templates for doing our own business case. If you happen to be starting a business without this knowledge and experience, it’s really not a showstopper. There are plenty of “how to” videos on this subject on YouTube and there are lots of freelance accountants and business consultants that can help you through this phase. It is, however, critical that you understand and agree with the assumptions forming the basis for the case. It’s your business and no one should understand it better than you.
Once these foundational elements were in place describing “what we are going to do,” we were able to turn our full attention back to “how we get it done.” That’s where we’ll pick up with Article #3 - Moving From Prototypes To Production!
Summary of Article #2
- GET EARLY VALID FEEDBACK. Prototype your product or service to a point where you have refined and tested the idea with real world potential customers, not just friends and family.
- DECIDE, IF IT IS A PRODUCT OR A BUSINESS. Think hard about whether you really have the basis for building an entire business/brand or if you simply have a product/service that can be proven and then sold to someone with an existing market position.
- DEFINE YOUR BUSINESS MODEL. Think creatively about the many different ways you could structure your business for success. For example, how will you price, sell, and deliver your product/service?
Financial Planning Checklist:
- Based on real potential customer feedback, do I understand my initial offering, the value it creates, and the price I can charge?
- As we said in article #1, keeping your initial offer as simple, low cost, and narrowly focused as possible will make it faster, easier, and require less cash to get started in the market. Once you’re in the market, you’ll learn at a much faster rate and can make adjustments accordingly based on real world data.
- Is this a product/service or a business?
- This is largely a subjective question for you to answer in your heart. For example, we have a friend who is a professional photographer and also loves biking. He created a special tool for fixing a common problem on high end Tour de France type bikes. Should he give up his successful photography business to build a new business around specialty tools or just prove the need for the tool/solution and sell it to an existing specialty tool business? Either is an option but the ramifications and requirements to be successful on the path chosen should be well understood with clear sober thinking before the decision is made.
- Have I thought through and created the best business model possible?
- Business models are a key source of differentiation. Taken in the extreme, they can disrupt entire longstanding industries. Consider for example the way Amazon structured its business model when they first started. Until they came on the scene, books were sold via brick and mortar stores like Barnes & Noble. Amazon built a business model for easy, predictable, and convenient shopping online starting with books and then expanding to damn near everything. How you sell (direct in person, online, via distributors, via sales reps., etc.), how you build (in-house team, single source provider, combination of contractors, etc.), and how you price (on time, license, usage, etc.) are but a few of the key business model decisions you will make. They will be important to your competitive differentiation and profitability so give them lots of thoughtful consideration.
- Do I have a financial business plan in place for the next 18 to 36 months?
- Take some quiet time to really understand what you want from this business and then do the basic financial analysis to quantify the time, effort, and mindshare it’s likely to take to get there. There are many basic financial tools you can access via Google and YouTube searches. You don’t need to be an MBA or accountant to think through the input assumptions like what prices you’ll charge, how and at what cost will you sell and support, and so forth. Keep the analysis up to date as you learn more and change course and you’ll be clear eyed and sleep better knowing you have this roadmap in place.