Burn the Business Plan

by Carl J Schramm

  These examples illustrate the shakey foundation of the build-to-sell premise of much startup planning. Rather than selling stock to the public or being acquired by a big company, most startups continue to be owned by their founders long after ten years. From 2006 to 2016, an average of fewer than one hundred companies per year sold stock for the first time. Combine that number with the number of startups that were acquired by large corporations during the same ten-year period—fewer than an average of one thousand a year—and we readily see that the widely anticipated “exit strategy” that is required to be described in every business plan largely is a chimera. It happens to a mere fraction—fewer than .005 percent—of all startups.

  This reality contradicts the widely held view that entrepreneurs start and sell companies as quickly as possible, and then move on to become legendary serial entrepreneurs. Few myths about entrepreneurs are quite as false as this one. Most entrepreneurs start one company. If their startups are successful, most founders work at it for the rest of their lives, building companies that provide both income and a means to build personal wealth.

  6. Venture Capital Is Likely Irrelevant

  Perhaps the most commonly cited justification for writing a business plan is that venture capitalists will require it. The assumption is, of course, that every startup needs their money. Because the prevailing narrative tells us that an exit strategy is the focal end point of the business planning exercise, aspirants sometimes joke that venture investors are their “first customers.” This initial misperception leads to the equally mistaken view that, if an investor provides capital to a new venture, the business is more likely to succeed. This overemphasis on the importance of venture capital reflects how the experiences of high-tech firms in Silicon Valley have shaped the public vision of the entrepreneur’s story. While many of our well-known tech firms could never have reached critical mass without venture backing, only a nominal number of nontech firms ever get, or, in fact, ever need, the support of these professional investors.

  Very few nontech startups will ever appeal to venture investors. Altogether, fewer than five hundred startups are backed by major venture funds each year, and a few thousand more receive capital from individual investors, known as “angels.” But, even taken together, startups with venture and angel money constitute only a small fraction of all new companies. A 2004 survey of the five hundred fastest-growing firms in the United States revealed that only seven percent, thirty-five companies, ever had a venture investor.5

  And, also contrary to conventional wisdom, funding from professional investors is no guarantee of success. The chances of a venture-backed startup surviving five years, which is less than fifty percent, is the same as for all new companies, regardless of the source of funds. In some instances, in fact, the interference and demands of active professional stakeholders can be the reason that a startup falters or fails.6

  Happily, the majority of nontech startups need much less funding than the average $3 million seed investment made by venture funds. The federal government’s first official Census of Entrepreneurs, initially sponsored by the Kauffman Foundation, showed that the average startup needs $50,000 in capital.7 Most entrepreneurs capitalize their startups using savings, including retirement funds. Sixteen percent of all startups rely on personal credit-card debt. Bank loans, secured by the entrepreneur’s personal assets, account for another twelve percent of needed capital. Finally, seven percent of entrepreneurs turned to second mortgages on their homes. Once underway, most businesses capitalize themselves, bootstrapping growth by relying on revenues, or turn to banks for loans secured by the growing company’s assets.

  7. Every Startup Has One CEO

  When colleges began teaching entrepreneurship in the 1980s, an idea began to take hold that creative synergies would result if individuals crossfertilized their ideas, helping and inspiring one another in a common workplace. As the idea of entrepreneurial incubators developed, the process of starting a company assumed a social dimension. Nowhere is this more evident than in the ubiquitous view that startups are more likely to succeed if there are two or more founders.8 Paul Graham, an entrepreneur who founded Y Combinator, the most well-known startup accelerator, argues that for an entrepreneur not to have a cofounder is evidence that “no one has confidence in his idea.”9 Other advocates describe the ideal cofounder as a cross between an engineer and therapist, someone who brings needed technical skills and who will provide emotional support when things go badly.10

  The contemporary idea that better companies emerge when two entrepreneurs join forces reflects a cherry-picking of history, which was perhaps derived from what initially was thought to be the necessary balance and synergy that Steve Jobs and Steve Wozniak brought to starting Apple. Similarly, Gates and his partner, Paul Allen, appeared perfectly matched to start Microsoft. PayPal remarkably had six “cofounders,” including Peter Thiel, who later became famous for bankrolling Facebook.

  But, a more realistic look at the history of startups shows that every company, even those claiming multiple founders, had just one person who functioned as the “entrepreneur-in-chief.” She is the person who sparked the idea, first articulated the vision for the company and brought others together; the person who functions as the company’s driving force, without whom the startup never would have happened. Historically, most companies are the work of one person. Nearly all companies incorporated in Delaware, where the preponderance of startups anticipating growth choose to register, are established by one person. George Eastman was the sole force to bring Kodak into being. Edison was the spark for General Electric, and IBM was Thomas Watson’s creation. Fifty-six years after the founding of the Procter & Gamble partnership, when the firm became a publicly traded company, William Procter was formally recognized for what he had been all along, the company’s CEO. For good reasons, public investors generally wince at the idea of co-CEOs or shared management models; they look to a single manager–decision maker who can be held responsible for a company’s operations and results.

  Silicon Valley investors, in fact, waffle a bit on their enthusiasm for multiple founders. They know that one-founder companies have proved to be better bets; over a twenty-year longitudinal study, one-founder firms had a substantially higher rate of successful exits that resulted in returns to the venture firms.11

  Although the idea of cofounders may symbolize happy and productive synergies, the reality is that most venture firms insist on an organization chart that names a “real” chief, the person who has ultimate responsibility for the management and success of the company. General Eisenhower, charged with beating Germany in World War II, was regarded by most as anything but an egotist. In fact, many believed he got the job of Supreme Allied Commander, in charge of all the nations’ armies allied against Hitler, because of his diplomatic and modest ways. He took counsel with generals from other countries, several of whom he regarded as smarter and more astute tacticians than himself. But he also knew that winning a war, at least from his position, was not going to get done by reaching consensus at the top. Winning can’t be done without everyone working as a team, but deciding where the team is going devolves to one person. Successful companies have successful leaders, usually one each.

  Even among today’s most sophisticated technical startups, one person is the reason that the company exists. Elon Musk, who also helped to spark PayPal, became a cofounder of Tesla when he rescued a failing company and redesigned the car as well as its production methods. It was Musk who developed a new marketing strategy, and envisioned the public–private partnerships necessary to create recharging facilities all over the country. Today he is the company’s CEO and Chairman of its Board.

  Like most entrepreneurs, Musk wanted to control his company’s destiny. “Working for myself” is the most commonly stated shared motivation across all entrepreneurs in every sector of the economy. Not so incidentally, entrepreneurs appreciate that starting a company is, by its nature, a solitary experience. While startups oft
en appear to be frenzied, highly social endeavors, in the midst of it all most entrepreneurs resonate with the spirit of Alan Sillitoe’s novel, The Loneliness of the Long Distance Runner. Sillitoe tells the story of an isolated juvenile criminal who discovers himself by competing in marathons, a sport sometimes defined as “running against yourself.” Most entrepreneurs recognize the importance of going it alone.12 Paul Graham, who encourages cofounding on one hand, also suggests that cofounding is risky because the inevitable “fights among founders” can lead to failed startups.13

  8. When You Start a Company, You Are a Boss

  Every startup founder discovers that launching his company means that he has become an employer. In fact, one of his first challenges is to recruit talent. Unlike mature businesses in which managers may be able to substitute what are called capital goods (such as factories and equipment, including robots) for workers, most startups are relatively labor-intensive enterprises. In the beginning, entrepreneurs need other people to help make their ideas into concrete products. And, while established larger firms may have the luxury of making an occasional personnel mistake without hurting the organization in a noticeable way, a single hiring mistake can be fatal to a small startup. This reality requires that entrepreneurs learn to effectively manage people, and they must learn quickly.

  Most entrepreneurs intuitively understand three useful rules of hiring. As noted, the first is that it is much harder to manage a workforce with cofounders. Problems of shared decision-making usually surface first in the realm of determining what skills are needed and in evaluating employee performance. Personnel disputes often become surrogates for larger disagreements relating to the direction of the company.

  Second, entrepreneurs often are tempted to hire friends because they presume that they know them well. One of the most troubling discoveries for new CEOs is understanding that they don’t necessarily know their friends outside of the context of friendship, and that employment relationships, unlike friendships, can never be equilateral. Because the CEO has the power to fire every employee, she is not the coequal of any employee. While many startups appear to be marvelously friendly, informal, nonhierarchical organizations, the CEO, who carries more risk and worry than any other worker, knows that the company’s welfare must be her highest priority. When an employee who was first a friend is no longer of strategic value to the company, a firing almost always means the end of the friendship. Don’t hire friends—or, even worse, relatives—in the first place.

  Third, unless it is unavoidable, it is a mistake to use company ownership—such as shares, options, or other types of interests in the company—to compensate employees. Because every startup that is striving for its scale opportunity is in a continuous state of flux, the relative value of every employee, one to the other, is constantly evolving. In startup companies, if ownership interests have been permanently vested in individuals who, over time, prove to be of less value to the evolving company, the presence of previously granted shares can severely limit the company’s flexibility in negotiating with potential investors, and even complicate the hiring of new employees needed for new endeavors. Some entrepreneurs who have been ill-advisedly generous with equity awards have found themselves in messy battles for ownership control, which almost certainly is the beginning of a death spiral for a young company. If employee equity grants can’t be avoided, this is the time to spend money on an experienced lawyer who can structure awards in a manner that provides maximum flexibility for the owner.

  9. Sales Are Everything

  Jeff Sandefer, who built a successful oil and gas business, runs the Acton School of Business, the only school in the U.S. that is dedicated solely to teaching entrepreneurs, and the only school that focuses on a sales and marketing, rather than a theoretical, approach.14 Unlike accelerators owned by wealthy investors who are looking for promising new businesses, Sandefer does not invest in his students’ companies, does not profit from running his school, and refunds tuition if a student doesn’t succeed as an entrepreneur. Operating a tuition-supported school, with a customer-satisfaction ethos, is apparent in his money-back guarantee, Sandefer keeps careful track of his graduates. Follow-up statistics indicate that his approach to entrepreneurship seems to be paying off. Sixty-three percent of Acton graduates start companies. Most wait nearly two years after graduating to throw the switch, time spent in additional research and development, including extensive testing of the target markets for their innovations.

  Sandefer requires that every candidate spend three months selling door-to-door before he may matriculate. Knives, vacuum cleaners, frozen meat—it doesn’t matter. The experience makes an aspiring entrepreneur understand what salespeople know: Selling is hard work. There are very few products that sell themselves; every product needs pushing. Selling, for an entrepreneur-in-training, is also the best way to learn how to improve new products. We see that lesson in the sales model that Jobs constructed for Apple: Talking and carefully listening to customers can guide product design and improvement, and successful customer input can drive sales.

  Customers control the future of your startup. On more than one occasion, I’ve heard a failed entrepreneur say that his idea was “ahead of its time,” in other words, blaming the customers that he never had. Customers know what they want or need or like, and they will let you know what they find valuable. A corollary lesson about customer demand is to consider whether you are looking in the right place for your market. Recall the earlier story of my first business venture, where I was sure that hospitals would rush to buy my useful healthcare costs and outcomes information, but didn’t? How could they be so dumb? When I found the real customers—hospital bond underwriters—who needed the information and were ready to pay for it, I found the market that made the business a success.

  10. You Need a “Cold Circle”

  Everyone wants to cheer on an aspiring entrepreneur. Like the refrain in the old cowboy song, “Home on the Range,” “Where never is heard a discouraging word . . .” family members, friends, and kindly advisers are less likely than strangers to tell you the unvarnished truth. Your friends and family want you to succeed and will be reluctant to dampen your aspirations with tough questions. Even if they think that your idea is flat-out bad, they are unlikely to want to damage your relationship by saying so. Perhaps you’ll manage to succeed anyway, they may think, and I won’t have been the bearer of bad news.

  Billy Mann, a songwriter about whom you’ll read later, knows that asking a group of friends about your new song is a waste of time. “They will always tell you it’s the best you’ve ever written. Friends and family members are so caught up in your aspirations that they can’t really listen critically. They already think you are talented; whatever you write must be great. Their feedback is one-hundred-percent useless in judging how the market might react.”

  Making the same point, Chile’s former economic minister, Carlos Matus, referred to family, friends, and cabinet member colleagues as his “hot circle,” a very useful group for support and succor. Matus wisely took great care to test his ideas with a “cold circle” for unbiased input. It is tough to hear skeptical views of what you want to believe is a great idea, but a cold circle can save you a lot of time, pain, and money.

  11. Making Money Is What It’s About

  Richard Branson, the founder of Virgin Atlantic Airways and numerous other Virgin enterprises, once defined an entrepreneur as “Someone who jumps off a cliff and builds an airplane on the way down.” Every entrepreneur understands this metaphor in very personal terms. Starting a company involves disturbing a career path, risking savings, living with debt, and suffering the possibility that family and friends will see you fail. Attempting to wrestle an idea into a successful business requires psychological fortitude. Not everyone is suited to the uncertainty, sacrifices, and loneliness that typifies the long period from startup to knowing whether a business will succeed.

  This is why making money plays such a motivational role for entreprene
urs. If you are not starting a business to make money, go home. Making money is critical to the survival, much less growth, of your company, and pushing forward to achieve scale is the formula for financial success. Would you found a company if you didn’t see the potential to grab the golden ring?

  Of course, in addition to wanting to make money, many entrepreneurs are animated by nonmonetary or psychological rewards. Imagine the enormous satisfaction of starting a drug company that produces a medicine to cure a terrible disease. Many entrepreneurs, among them Bill Gates, report that one of the greatest rewards in starting a business has been to create jobs. All successful entrepreneurs will tell you that, had they passed by their opportunity to start a company, they would have regretted it for the rest of their lives.

  Making money is seen by many as a questionable career goal, venal and self-serving. In the 1987 film Wall Street, Michael Douglas’ deal-making character Gordon Gekko famously says, “Greed, for lack of a better word, is good.” That snatch of film footage continues to resonate as a misleading portrayal of what constitutes “business.” Partly as a reaction, interest in “social entrepreneurship” has led to the formation of tens of thousands of not-for-profit organizations, many now referred to as nongovernment organizations or NGOs.15 Most of these organizations exist to provide what in the past would have been called a charitable service to people too poor to fully participate in the marketplace. Not surprisingly, failure rates for social entrepreneurs are very high.

  Many entrepreneurs who have become part of a local ecosystem face a second distraction to their goal of making money. You are not starting a company to revive the local economy. Many colleges, especially in rust-belt cities, encourage entrepreneurship among their students as evidence of the institution’s commitment to helping its hometown. Similarly, many cities support business incubators in hopes that entrepreneurs who create businesses while working in them will add to the commercial base of the city. The job of getting a startup underway is hard enough without taking on the task of rekindling the economy around you. No entrepreneur should feel obligated to revive a local economy; her job is to get a business started that will attain scale growth and to maximize its likely success. What if achieving these milestones requires relocating to another city? Big businesses move to maximize efficiency; so should startups.