When to Implement Budgeting

In the early stages of a new business, entrepreneurs do not pay much attention to budgets.

Financial forecasts that estimate revenues and expenses are part of the business planning process.  But these are really just estimates, since so much is unknown about what will actually happen as the business begins to grow.  Because of this, it is impossible to develop accurate budgets.  Managing cash flow is a week-to-week or even day-to-day challenge that is a reaction to what bills need to get paid first based on what revenues have come in the door. Continue reading When to Implement Budgeting

The Wild West of Crowdfunding

Looks like I have a new example to use in class for legal changes that create new business opportunities.  There are several new entities popping up due to the the growing interest in crowdfunding and the passage of the JOBS Act that will allow crowdfunding to be used for equity investments rather than just donations (the Kickstarter model).  We are also seeing growth in microfinancing, which is another segment of this industry.

One entry into the wild west of crowdfunding is a Nashville-based company InCrowd Capital, founded by Phil Shmerling.  Phil has started writing a blog on crowdfunding that should become a valuable resource for those interested in this budding new industry and those hoping to learn how to become an effective crowdfunder.  Phil is a sharp guy who will surely offer all of us useful information through his blog.

Another site was recently launched is called Seeds.  Seeds is not taking an equity approach to crowdfunding.  Instead, they have established a “game” site that links participants to real entrepreneurs seeking micro loans.  They describe Seeds as “Farmville meets Kiva.”

Here is how they describe how Seeds works:

The Seeds revenue model is three-pronged:

1) We monetize impatience. As you rebuild a citadel in the game, you can either wait hours in real time to complete a level, or use virtual currency to expedite the process. Virtual currency can be purchased with real dollars. Proceeds will be microlent to borrowers.

2) The sale of virtual goods: Within the Seeds virtual world, you can purchase limited edition virtual goods using in-game currency to decorate your world. Proceeds will be reinvested in for-profit microloans.

3) Actively asking players to make microloans to the businesses of their choice.

Thus, we’re merging two multi-billion dollar industries – social gaming and microfinance. We’re taking the profits social games make, and reinvesting it in entrepreneurs for a profit, empowering women and buoying economies (including our own!).

While some are beginning to worry that crowdfunding is just one big train wreck, I think that the evolution of the crowdfunding industry is going to be a fascinating combination of a series of little train wrecks and some amazing successful innovations.

Who is going to win?  Nobody knows, but the market will begin to give us some insights very soon.

Forecasting Revenues Key to Successful Launch

The late, legendary Silicon Valley attorney Craig Johnson used to say, “The leading cause of failure of start-ups is death, and death happens when you run out of money.”

And the leading cause of running out of money in a start-up is poor financial forecasting.

At the core of unrealistic forecasts is the undying optimism of most entrepreneurs.  Their “what could possibly go wrong?” attitude leads to many forecasting disasters.  My father used to say that when he looked at investing in an entrepreneurial venture he would always double the start-up costs and triple the time it takes to get to breakeven.

My rule of thumb is a bit different.  I believe that being overly optimistic leads to entrepreneurs making fatal mistakes in estimating revenues, which is at the heart of most forecasting errors.  So, my approach when reviewing a business is plan is to cut revenue forecasts in half.

Here are the four most common revenue foresting mistakes I see:

  • Assuming an “instant on” button for a new business.  Most business plans I read show significant revenues from the beginning of the business, sometimes even for the very first month that they open their doors.  The reality is that it takes time to build a customer base for any business.  That is why an entrepreneur should have at least six months personal living expenses available to make it through the startup in addition to the money the new business needs.
  • The magic of the hockey stick.  A common pattern in business plans is to show a relatively slow initial start to revenues, and then assume some that unexplained breakthrough will occur that leads to a sudden and dramatic increase in sales.  When you graph this type of revenue forecast it looks just like a hockey stick.  The reality is that such sudden growth is just not that common and usually results from specific actions.
  • Assuming enough sales to make the business model look successful.  In this mistake entrepreneurs forecast their expenses and then they plug in enough revenues to make the business become profitable.  When I press these entrepreneurs, their explanation of revenues is “well, these are the revenues I need to make the business work.”  The truth is that the market will not give you the sales you need, it will only give you the sales you earn through a well-executed business model.
  • The marketing plan tells a different story than revenue forecasts.  The marketing plan should specifically explain what you are going to do to achieve the revenues you forecast.  Why will customers want what you are selling?  Who are these customers?  How are you going to communicate to them about your business?  The marketing plan should explain in words the numbers shown in the revenue forecast.  Most plans just do not make this connection.

To avoid running out of cash before your business model has time to work requires an accurate assessment of how much money you will really need to get the business off the ground. While knowing your costs is important, accurately forecasting your revenues is critical.

It is so sad to see a business model that has real potential fail simply because the entrepreneur was unrealistic about how much money it would take to get to the point of success.

Minnesota Angel Tax Credits Selling Out

Lee Schafer of the Minneapolis Star Tribune called me the other day to see if I had any information on the effectiveness of angel investment tax credits for a story he was writing.

I told him that all that the tax credit programs do is speed up or slow down investments (to take advantage of their timing).  There is no evidence that they increase angel investment whatsoever. They are not the job creator politicians claim when enacting these programs.  (See my arguments in my editorial at the WSJ).

In his investigation of the program in Minnesota he found strong support among politicians for the program, but very little support from entrepreneurs.

Plymouth-based start-up MetaModix Inc. raised about $1 million earlier in 2012, and its investors got about $254,000 in credits. Co-founder and CEO Kedar Belhe said “most of my investors did not look at it as a requirement, they looked at it as a bonus.” He said any real investor commits to a deal only after first carefully considering the odds of losing everything vs. winning big.

One stated that because the Minnesota program was about to run out, he would have to wait until additional credits were approved to fund raise, since angels will sit on their hands until credits become available.  They will invest, but will wait until they can qualify for another check from the government.

Angel investment tax credit are yet another misguided program that may be based on good intentions, but that has none of the desired impact on business formation or on job creation.  We just can’t afford ineffective programs like angel tax credits during a time when we don’t have the luxury to give away tax revenues.

Schafer puts it this way:

The Minnesota program is a straightforward, get-a-check-from-the-taxpayers subsidy for purely private business activity, so it’s remarkable that the allocation has lasted this deep into the year. It’s remarkable as well that angel credits have such broad bipartisan support when the economic case remains mostly unproven.

If we are going to use the tax code to help entrepreneurs, just cut taxes and let the market do what it does best.

Putting a Crowd Around the Board Table

Crowdfunding, which uses the Internet to generate small contributions of funding from a large number of people, has been getting a lot of attention lately among entrepreneurs.

Crowdfunding primarily has been used to help raise money to support social causes and to help fund struggling artists.  The money received from crowdfunding has to be considered a contribution or a donation.  In most cases, something nominal is usually offered in return for financial support, such as a free download from a musician.

Historically, because of securities laws, small businesses have been unable to use crowdfunding. Until recently, entrepreneurs had only been able to seek funding from a limited number of people who meet specific income and wealth criteria.

A few creative entrepreneurs have used a loophole in the rules to raise money through crowdfunding.  Rather than treat money raised through a crowdfunding campaign as investments, they offer people something of value in return.  For example, a person opening a new brewpub may get people to “donate” to support the start-up by offering free admission to a special opening night event.  The contributions would be motivated by the desire of local beer enthusiasts to support a new local brewery.  The most commonly used websites that promote traditional crowdfunding are Kickstarter and IndieGoGo.

One instantly legendary crowdfunding campaign was implemented by Eric Migicovsky.  He was raising money for his new wrist watch, called Pebble, which pairs with smartphones via Bluetooth.  Contributors were promised they would get preference to buy a Pebble when the watches were introduced to the market.  Although his initial goal was to raise $100,000, Migicovsky was able to raise over $10 million to help launch Pebble.

The recently enacted Jumpstart Our Business Startups (JOBS) Act of 2012 significantly expands the use of crowdfunding for entrepreneurs.  Under the provisions of this bill, those who provide funding through crowdfunding can now become equity investors with ownership in the business.  The JOBS Act opens up the funding of start-ups to allow almost anyone to invest in entrepreneurial ventures.  Several efforts to create crowdfunding platforms under the JOBS Act are being developed, including one in Nashville called InCrowd Capital, being led by Phil Shmerling.

Attracting investors through crowdfunding requires a different approach than when pursuing funding from angels and venture capitalists, who tend to invest more in the entrepreneurs leading the team than in their ideas.

Crowdfunding investors, on the other hand, are attracted to compelling stories and business ideas they can see themselves using.  What led to the success of the Pebble crowdfunding campaign was that people were excited about a completely new technology that they wanted to be the first to own.  Not every product can create that kind of passion and excitement.

The JOBS Act certainly broadens the pool of people who can invest in small businesses and offers an exciting new avenue for raising money for start-ups.

However, using crowdfunding also may make the entrepreneur’s work more challenging.  If adding just one new partner increases the complexity of running a business, imagine what a crowd of partners can do to complicate an entrepreneur’s life!

All it Takes is Five Slides

Making a pitch for investment is one of the most important steps that many new business owners can make.  It can also be one of the most intimidating.  First impressions matter with investors, so the pressure is on to make your pitch to them a winner.

For many years the rule of thumb was to limit your initial pitch to investors to no more than ten slides in your PowerPoint deck.

But now there is a push to get entrepreneurs to consolidate their pitches even more.  The latest recommendation for pitches to initial investors is to limit the presentation to five slides.

“I am an advocate for communication in a clear, crisp way,” explains Mark Montgomery, founder of the Nashville consulting firm FLO Thinkery.  “Great ideas at the core should be simple.  If you require pages and pages to explain the concept, then perhaps the concept is not fully baked.”

Here is what I would recommend you put on five slides for an initial pitch to potential investors.

Slide One — Who are you?  When it comes down to it, investments are primarily made in people, not in business plans, concepts, or ideas.  The best idea in the world has no value to an investor if they don’t think the entrepreneur can successfully implement it.

Slide Two — What is your concept?  What problem does it solve or need does it take care of for your target customers?  This slide conveys your target market and the value proposition you offer them.

Slide Three — What is your “proof of concept”?   The more real and tangible this evidence is, the better.  Conduct market experiments and, if appropriate, develop prototypes that you can test on real customers.  A great way to get real data from customers is to give the first versions away for free.  The information you get from these first customers will be worth much more that what they might pay for the product.  And, you will have real live customers to talk about with investors.

Slide Four — What is the growth potential for this business?  Tell them what the business can become and what you will need to reach that potential.  Investors want to see growth – significant growth.  They want to opportunity to make their investment back several times over, which means you need to show how the business can grow into new markets or expand into new products.

Slide Five — What is the exit plan?   Investors want a path to get a return on their investment.  Demonstrate that there will be someone willing to buy the business to get them that return.  Find examples from your industry of other startups that have sold to larger companies as evidence.

Your presentation during these five slides should be genuine and passionate.  Show them you are committed, knowledgeable, and prepared.

If you can keep your initial pitch clear and concise, you have a much better chance of moving into more serious discussions with investors.

Finding a Small Business Friendly Bank

“There is a bank on every corner.  If you don’t like the answer you get from one, go to the one across the street.”

That is the advice my late father gave me a long time ago about finding a small business friendly bank.

Now there is a new tool to help make this process easier for small business owners.

“One of the biggest challenges that small businesses face is access to capital,” says Ami Kassar, CEO of MultiFunding, a small business financial advisory firm.  “We decided to give small businesses a gift this year and help them find local banks that are friends of small business – Banking Grades.”

Banking Grades is a proprietary online tool that grades every bank on its commitment to small business lending.  Using public data from the Federal Deposit Insurance Corporation (FDIC), Banking Grades compares the amount of a bank’s deposits to the amount of loans that bank has made to small businesses.  These loans are $1,000,000 or less.  “Based on our experience of helping small businesses find financing, we believe that a one million dollar loan is a good barometer of small business lending,” explains Kassar.

On Banking Grades, anyone can search for an FDIC-regulated bank by name, zip code, city and/or address.  Banks that make the most loans to small businesses (proportionately to their deposits) receive an A.  Conversely, the banks are not making small business loans, receive an F.  There are thousands of banks in between.  “It is our hope that small business owners will use this tool to find local banks that will lend to them.  All banks have money, but the biggest one or the closest one to your store isn’t necessarily the one focused the needs of small businesses,” says Kassar.

Banking Grades gives an A grade to 2,693 banks in America.  In order to receive an A grade, a bank needs to utilize 25 percent or more of its domestic deposits to make small business loans.

I tried it for my location.  It was easy to use and, quite frankly, eye opening.  I found out I was doing business with two banks that did not get very good grades!

Simple Act of Record Keeping Can Make All the Difference in Success

In the rush to start a new business, the simple act of keeping records often gets put on the back burner. But poor record keeping has been the demise of many otherwise successful businesses.

The entrepreneur needs clear and accurate records to help manage the challenges of the startup. These records can help manage cash flow and will provide financial statements that can help monitor the progress of the new venture.

The IRS expects even the smallest of businesses to document deductible expenses and support all items reported on tax returns.

Also, bankers monitor the progress of their business customers using financial information. If you cannot supply timely and accurate financial statements and other required information to your banker, it will hurt your ability to get loans when your business is at the stage where it could otherwise qualify.

The first step in establishing a record keeping system is setting up a separate checking account for the business. The deposits into this account should include any initial investment you make to start your business, the proceeds from any startup loans or investments, and all revenue from customers.

This checking account should be used to pay all expenses for the business, but not any personal expenses. As an owner you can draw money from this account, which can be deposited into a personal checking account to pay personal bills and living expenses.

Carefully document every expense paid from the business account. If paid by check, make careful notation of the check number, date of the check and purpose of the expense for each purchase. If paying with business debit or credit cards, keep detailed notes on each expense. Writing this on the back of each receipt is a good habit.

Set up a filing system, which can be either hard paper copies or scanned records, to track all documentation on receipts and expenses. Think ahead when setting up the filing system so it can accommodate the business as it grows. Use separate files for each vendor and customer and organize these files by type of expense or receipt.

Accounting software, such as QuickBooks, can help organize financial information. But remember that no system runs itself. Any system for record keeping relies on proper and timely input of information from you.

One lesson that many entrepreneurs learn the hard way is that you should not delegate financial record keeping to employees too quickly. Sadly, fraud is common in small startup businesses, and it often leads to the failure of an otherwise healthy business. Keep a close eye on financial records and put in systems of checks and balances. For example, never let the same person who handles revenues from customers also pay the bills, as this makes stealing money easier to cover up.

Record keeping may seem mundane compared with the other aspects of starting a business, but it is a critical step to ensure a healthy business. Record keeping systems should be simple to use. The job of the entrepreneur is to use this system to keep accurate, timely, consistent and compete records of all activity in the business.

Cyber Crooks Target Small Business

Criminals take the path of least resistance. 

If your car door is locked, they tend to go to the car that was left open.

If your house looks dark and empty, it is the one they will probably break into.

Same is true for your business.  For years cyber crooks went after large business.  After all, that is where all the cyber money is.  But over time corporate America has tightened its Internet security to the point that it is no longer easy pickings.

So now they are bypassing the corporate firewalls and coming after small businesses.

An article from USA Today on cyber criminals coming after small business has gotten a lot of attention. (Hopefully not from dumb crooks who have not figured this out yet).

There is lots of information out there that can help make your business less appealing to cyber crooks out trolling for an easy mark.  For example, NFIB has a long list of articles at their site on how to improve your IT security, Visa offers tips for small merchants on data security, and the SBA offers some tips of their own.

Enhanced by Zemanta

Not a Fan of Angel Investment Tax Credits

Milt Capps who published Venture Nashville Connections contacted me the other day to see what I thought of a bill here in Tennessee that would create tax credits for angel investors.

Here is what I told him:

Targeted tax credits for angel investments do little to spur new investments or to increase the overall activity level of angel investing over the long term. They do give angels a tax break, which is not a bad thing, but spurring entrepreneurship in our economy will come from more broad-based tax cuts that leave money in the bank accounts of customers. Recent surveys of entrepreneurs suggest that what they need most to begin growing their businesses again is improved revenues coming from consumer spending, not more access to capital. This is a well intentioned bill, but not one that will have much of an impact on economic growth in Tennessee.

Others disagree with my view.  You can see arguments for, against, and some general cautionary comments at Capps’ post on the angel tax credit bill.