Street Smarts

by Norm Brodsky

  I also suggested he have the sel er’s lawyer amend the agreement so that his deposit would be completely refundable at his whim within three weeks. Why shouldn’t he be free to change his mind for any reason, as long as he acted expeditiously? The lawyer agreed and redrew the papers, but as it turned out, the change was unnecessary.

  A few days later Josh received the additional information he’d asked for. It painted quite a different picture of the company. For one thing, only 15

  percent of its customers, representing about 30 percent of its sales, were returning from year to year. In other words, Josh would have to replace 85

  percent of the customers, and 70 percent of the sales, just to stay even. What’s more, he’d have to do it with a new sales force: the company was turning over sales representatives at a rate of more than 50 percent a year.

  It was hard to see what Josh would gain by acquiring the company. The products couldn’t be al that great, or more customers would be reordering them. An established name? It couldn’t be very strong. A dedicated sales force? He was going to have to build one anyway. As for the formulas he might need to get started, he could hire a laboratory to come up with some for a lot less than $250,000. The truth was, if he real y wanted an herbal lotions company, it made more sense for him to start his own.

  In the end, Josh decided he’d had his fil of herbal lotions. He told the sel er he wasn’t interested in pursuing the deal. He wasn’t happy about letting it go, but he couldn’t argue with the numbers. The last time I saw him, he was searching for another business to buy. I don’t know whether he found one—or final y came to the realization that he’d be better off looking for a business to start.

  Ask Norm

  Dear Norm:

  About a year ago I moved to Florida from the Northeast, where I had owned a few photo-processing shops. In Florida I bought a commercial printing business. I’ve been putting in eighty-hour weeks, learning the basics. Now I’m ready to start advertising, but I’m worried about making a major mistake, especially when it comes to pricing. Should I hire a consultant to advise me?

  Sam

  Dear Sam:

  I certainly wouldn’t. You have business experience, and your instincts are better than those of any consultant you can find. Besides, you probably wouldn‘t—and shouldn’t—fol ow a consultant’s advice if you don’t agree with it. So why pay somebody to give you advice that you won’t listen to if it’s different from what you think? Instead, I’d research the industry. Find out who your competitors are, what they’re charging, what kind of quality and service they offer, and so on. Then make your own cal .

  —Norm

  The Wrong Kind of Business Plan

  Then there’s the ongoing confusion about business plans, which most people think they need in order to raise money. Granted, you do need money to get a business up and running, and you may need a business plan to raise it. But money isn’t the first thing you need, and you’re making a big mistake if you focus on raising it before you’re ready to spend it intel igently.

  Unfortunately, that’s one mistake a lot of people make, judging by the business plans I regularly receive. I’m talking about elaborate, four-color, one-hundred-page business plans, printed on high-grade paper, with photographs, tables, graphs, pie charts, flow charts, and every kind of number you could ask for. I mean, these plans are gorgeous. There’s just one problem: the numbers don’t make sense. No business operating in the real world could ever produce them.

  I remember one particularly professional-looking plan that I received from a husband and wife who were trying to raise $50,000 to start a cookie business. According to the plan, they were going to use that money to take the company’s sales from zero to $2.9 mil ion in just two years.

  Understand, it’s extremely difficult to achieve such a rate of growth in any business. It’s almost impossible to do it in something like the cookie business with only $50,000 in outside capital. You’d run out of cash long before you hit your sales target. And yet the numbers were al right there in black and white, and they added up perfectly, which immediately aroused my suspicions.

  I gathered that the plan had been written by the husband, a guy with very little business experience, using a sophisticated business plan software package. Looking closer at the numbers, I saw how he had come up with such an outlandish projection. For one thing, he’d plugged in a ridiculously short col ection period for his receivables, about twenty days, while figuring he could get away with stretching his vendor payments to sixty days.

  He’d also underestimated the amount of equipment he needed and assumed he’d be able to lease whatever he wanted on his own signature—

  without putting up any additional security. None of those assumptions were plausible. If you replaced them with more realistic ones, you’d find that the couple needed at least another $200,000 in outside capital to have a prayer of getting the company’s sales to $2.9 mil ion in the second year.

  I don’t mean to suggest that the guy was intentional y deceiving anybody. Frankly, I doubt he even realized what he’d done. My guess is that, like most people with an idea and a burning desire to be in business for themselves, he was thinking only about the amount of money he needed to drop everything else and get started.

  So how do you raise money? With a business plan, right? He’d gone out and bought the software, which had walked him step-by-step through the plan-writing process. Then he’d tweaked the numbers until he came up with a plan that showed the business achieving its goals after two years with just the amount of capital he thought he could raise.

  It was al very neat and tidy, and the final document couldn’t have looked more impressive. I’ve been in business almost thirty years, and I’ve never seen such a plan, let alone produced one. What it contained, however, was not a recipe for successful cookie making. It was a recipe for disaster.

  I believe strongly that the first business plan you write should be for nobody but yourself, and you don’t need any special software to create it. You just need to answer four questions as honestly as you can: (1) What is the concept? (2) How are you going to market it? (3) How much do you think it wil cost to produce and deliver what you’re sel ing? (4) What do you expect wil happen when you actual y go out and start making sales? The idea is to spel out as clearly as possible how you think the business is going to work—what you’re going to sel , how much you’re going to charge, who your customers wil be, how you’re going to reach them, how long it wil take to close a sale, and so on. You need to be completely candid with yourself. You mustn’t let your own economic circumstances cloud your thinking. Put aside for the moment any concerns you may have about earning a living or raising start-up capital. You can deal with those issues when the time comes. In the beginning, what’s important is to get your major assumptions down on paper.

  Why? Because you need to test those assumptions before you go out to raise money, not afterward. You need to identify as many mistakes as possible while you stil have a chance to correct them.

  And, believe me, everybody makes mistakes with their first business plan. It doesn’t matter how smart or how careful you are. There wil be major flaws. When I started my messenger business, for example, I thought I’d col ect my accounts receivable in thirty days. I found out the hard way that the actual col ection time was fifty-nine days. When I started my records storage business, I thought I could charge a monthly storage fee of 35¢ a box. In fact, we learned we weren’t able to land substantial accounts unless we charged about 22¢ a box—almost 40 percent less than the price in my plan.

  The point is that you need to give yourself time to discover those mistakes. Not that you’l catch al of them in advance, but you can reduce them to a minimum. How? By doing research. By finding out how long companies in the industry typical y take to pay their suppliers, and how long it takes them to col ect their own receivables. By trying to make a few sales. By looking for cheap office space and furnishings. By visiting a leasing c
ompany to see what terms you can get. By doing everything you can think of to get as prepared as you can be. Then, and only then, are you ready to bring out the bel s and whistles and start looking for money.

  In the long run, that research wil turn out to be the best investment you can make in your business. Having done your homework, you’l be much more likely to raise the start-up capital you’re looking for. More important, you’l be able to make better decisions about how to spend it. And you’l greatly increase the odds of making it last until you don’t need it anymore—that is, until the business can support itself on its own cash flow. Which is, after al , the goal.

  The Most Important Resource

  As important as it is to conserve start-up capital, the danger of losing it is not the biggest risk that entrepreneurs take. After al , if you work hard enough, you can eventual y earn it back. There’s another resource that, once you lose it, you’l never see it again. From that standpoint, it’s even more important—and more valuable—than money. The loss of it can cost you your chance to realize your dream. I’m talking about time.

  Ask Norm

  Dear Norm:

  I’m in the process of opening an educational facility, but I can’t get anybody to sign up. I’ve blanketed fairs and festivals with my information.

  I’ve run newspaper ads and held open houses. Our prices are lower than our competitors’ and we charge no registration fee, but we have no takers. What else can I do?

  Kathy

  Dear Kathy:

  Never assume a business can’t succeed just because you get nowhere with your initial marketing attempts. I started my messenger company with a mass mailing, offering to do the first five deliveries for free. I got zero response. I was baffled until an office manager told me, “We do dozens of deliveries every day. Five means nothing. What about the next fifty?” So the market was there. I was just trying to get customers the wrong way. In your case, price is not the main concern of parents. If they’re going to send you their children, they have to know you, trust you, think wel of you. I’d try working through community clubs, social groups, churches, and synagogues. Do a brochure with testimonials from local people saying how terrific you are with children. Later on, open houses wil be important, and price may become an issue, but first you have to establish your trustworthiness.

  —Norm

  Let me tel you about Rob Levin, who approached me for advice about starting a magazine. He planned to cal it The New York Enterprise Report and to sel it to owners and managers of smal businesses in the New York metropolitan area, offering interviews with successful entrepreneurs and how-to articles by experts. I agreed to meet with him, although I’m not sure why. I thought starting a business magazine was a real y terrible idea.

  The industry had been in the doldrums for years, with no relief in sight. As difficult as life was for established business magazines, I knew it would be even harder for a new publication, which would be competing not only against the big boys, but also against the providers of free information on the Internet. Besides, there were many easier, and more lucrative, ways to earn a living.

  But I have an ironclad rule that I wil never discourage people from pursuing their dreams. What I wil do is tel them what I think of their approach.

  Often they’re trying something that I believe, based on my business experience, is destined to fail. In that case, I’l suggest alternatives. Then again, what makes sense for one person may be a recipe for failure for someone else. So I begin by finding out as much as I can about the person I’m advising.

  As first-time entrepreneurs go, Rob Levin was a fairly sophisticated businessperson. After graduating from col ege in 1991, he had worked for Arthur Andersen as an accountant for four years, then gone back to school to earn his MBA. Subsequently, he’d been CFO or CEO of three smal companies that ranged from $1 mil ion to $25 mil ion in annual sales. He had parted company with his last employer the year before he contacted me and had been doing some consulting while he searched for a business to start. But although he had $300,000 of his own savings to invest and his wife had a good job, he could not go indefinitely without a steady income: his wife had recently given birth to their first child.

  Rob was convinced that the magazine was his ticket to success. Not only was he passionate about it, but everything else he planned to do depended on it. He had already spent $75,000 on a Web site, and—without the magazine—it would never become viable, let alone earn a profit.

  He was also planning to make money from seminars and networking groups, which would be difficult if he didn’t have the magazine to use as a platform. The question was, how likely was it that he could launch such a publication successful y?

  Not very, I concluded, as we went through the numbers. Like al entrepreneurs starting a new business, including me, Rob was overoptimistic about the sales he could generate and the time it would take to generate them, and he drastical y underestimated his expenses. One number in particular jumped out at me. He planned to sel subscriptions by direct mail and was counting on a 10 percent response rate. I don’t know a lot about direct mail, but I do know that no one gets a 10 percent response rate for a new magazine. If the mailing is successful, 1 percent to 2 percent is more like it. It would therefore take him much longer, and cost much more money, than he expected to get the number of paid subscriptions he was counting on.

  “This approach won’t work,” I told him. “You’l run out of money before you find out if your idea’s viable. You have to go about it differently. Have you thought about giving the magazine away?”

  I could see the shock and anger on his face. It was as if I’d insulted him. He later told me that the suggestion almost broke his heart. It was a huge blow to his ego.

  The logic was simple enough, however. Rob couldn’t survive without advertising revenue, and the first question of any potential advertiser would be, “How many subscribers do you have?” He wouldn’t be able to make the sale until he could give the advertiser a solid number. The fastest way to get that number, and to build a subscriber base, was to offer the magazine free of charge to the members of business organizations and trade groups. Advertisers might stil be cautious about spending their ad dol ars in an untested publication, but at least they would have an idea of the number of people they’d be reaching, and some of them might be wil ing to take a chance.

  If he insisted on going after paid subscriptions, Rob wouldn’t have a prayer of generating the revenue he needed. He’d wind up wasting a lot of precious time, which would come back to haunt him even if he quit before spending al of his money. He would probably have to take a corporate job, and he’d have a lot of ground to make up. It would take him a year or more to get back to where he’d been before he’d left his last job. Granted, he would learn some important lessons from a failure, and he might even be able to raise enough money to give the magazine another try later on.

  But, in the meantime, he would have spent three or four years and ended up back where he’d started, with nothing to show for it. By giving the magazine away, he would at least have a shot at succeeding.

  It wasn’t what he wanted to hear. He was seething when he left. I tried to offer him an olive branch by noting that he could later convert his free subscriptions to paid. That was technical y true, but I knew in my heart that—if he built a successful company around free subscriptions—he would never start charging for them. It wouldn’t be necessary from a business standpoint. I doubted he would waste his time and money on something simply to boost his ego, with no benefit to the company.

  In any case, the decision had to be his and his alone. “You have to go with your gut feeling because it’s your money and your time,” I told him as he was leaving. “I have experience, but that doesn’t mean I’m right.” A day or so later, he cal ed and told me that he’d decided to take my advice.

  He’d done some research and realized I was correct about the direct-mail response rates. He couldn’t argue with the numbers. So he was g
oing to change his plan, basing it on free subscriptions rather than paid. I wished him luck. A couple months after that, he cal ed again to ask if I’d be wil ing to let him interview me for a cover story in the magazine’s premier issue. Natural y, I agreed.

  In the end, it turned out that starting a business magazine in New York City wasn’t such a bad idea after al . The New York Enterprise Report was a big success, and it’s stil going strong. Granted, Rob could probably have made more money by having another type of business, but he’s fol owing his passion and doing what he loves, which is far more important than getting the best possible return on his investment. On the other hand, Rob agrees that he wouldn’t have gotten this far had he stuck to his original plan. “Looking back, I was overoptimistic about everything,” he says. “I would definitely have run out of money, no question. I didn’t know it then, but I do now. I was looking so far ahead that I wasn’t focusing on the next year or so.”

  Most important, by adjusting his course, Rob saved three years of his life or more. Instead of spending them spinning his wheels, he used them to lay the groundwork for a business that he can stay with as long as he likes, and that can take him wherever he wants to go.

  The Bottom Line

  Point One: It’s good to have a lot of competitors because educating a market is a very expensive proposition.

  Point Two: If you’re a first-time entrepreneur, it’s general y better to start a business than to buy one.

  Point Three: The first business plan should be simple, and you should write it for yourself, not for potential investors.

  Point Four: Your time is more valuable than money, and you should be careful not to waste it.