By Ed McLaughlin and Wyn Lydecker
This text is excerpted from Chapter 10 of our book, The Purpose Is Profit. Here, I’m going to talk about Profit Principle #3: Don’t Start Up Until…
It is only natural that you struggle with the desire to start up knowing you do not have all the answers. At the same time, you realize that you will never start up if you attempt to answer every question. Recognizing this challenge, I have developed a short list of questions entitled, Don’t Start Up Until…
These questions center around your business model but only require ‘the back of an envelope” to figure out how you are going to make money, how much it is going to cost to run your business, and how soon you will generate a profit and reach breakeven.
Your ability to secure pre-orders will not only validate your business model, but have a direct impact on your funding requirements, which will influence ownership and control.
Remember, you only need rough estimates to validate your business model, but you will need firm pre-orders to launch. Answering the following six questions will give you confidence that you are ready to start up.
1. Don’t start up until you know how you’re going to generate revenue (simple estimates will suffice)
- How many customers are there?
- How much product will each customer buy?
- How will you price your product (share of value, cost-plus, market pricing)?
- Calculate revenue by estimating monthly sales (customers x units x price)
- Calculate revenue per quarter and revenue per year
2. Don’t start up until you understand how much it will cost to run your business (do your homework on expenses)
- How much will it cost to produce your product (manufacturing & distribution)?
- Who will be on your management team, and how much will it cost to compensate them (equity and/or salary)?
- How many employees will you need to start up, and what will it cost to compensate them (salary & medical)?
- Where will you work and how much will it cost (rent per month/year, furniture costs, utilities, & supplies)?
- How will you communicate with your customers and how much will it cost (computers, printers, mobile phones, internet access, website, & hosting)?
- How will you brand the business (business cards, brochures, letterhead, & signage)?
- How much will it cost to sell your product (marketing, travel, & entertainment)?
- How much will it cost for risk management and compliance (legal, accounting, & insurance)?
3. Don’t start up until you know how you’re going to make a profit (back of the envelope)
- Revenue minus Cost to Run Your Business equals Profit or (Loss)
4. Don’t start up until you have pre-orders to validate your business model and liftoff plans
5. Don’t start up until you have lined up the funding you need to reach break even (typically 18 months of operating capital)
- Estimate how long it will take you to reach breakeven
- Determine your startup and operating capital needs
- Generate a list of funding sources and alternatives
6. Don’t start up until you have a crystal-clear understanding of the impact of your choice of startup funding on your costs and control.
- Self-funding or bootstrapping will maximize control and avoid outside partners and interest payments
- Selling equity will avoid interest payments but reduce control by introducing outside partners
- Raising debt financing will let you maintain control by avoiding outside partners but will require interest payments
I completed the financial modeling portion of this exercise in my kitchen with my two founding partners. We hashed things out with a flip chart and markers to get comfortable that we had a financial model that would work. It took about two months to figure things out and be confident that we were on the right track. I completed the pre-order portion of this exercise by meeting in the field with my first two customers: Patterson Dental and IDS Financial Services (now known as Ameriprise). Once we had these orders in hand, combined with our financial model, we were able to make the decision to bootstrap and launch.
Ed McLaughlin is currently co-writing the book “The Purpose Is Profit: Secrets of a Successful Entrepreneur from Startup to Exit” with Wyn Lydecker and Paul McLaughlin.
Copyright © 2014 by Ed McLaughlin All rights reserved.