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Tricky Trade-Offs That Smart People Make Before Becoming Entrepreneurs (Part 2)

21/08/2017 8:56 AM IST | Updated 21/08/2017 6:53 PM IST
Kohei Hara

Entrepreneurs often have to wear many hats and deal with a number of problems from day one of starting their business. But a key problem that entrepreneurs face even before they start a business is identifying the right business focus. Honing in on an interesting business focus which can provide long-term scalability and profitability is critical in starting a new venture in the right direction.

In my second article of the four-part series on entrepreneurship, I hope to share with budding entrepreneurs some of the key trade-offs that can help them determine their business focus and maximise their chances for success. Read part 1 of this series for more trade-offs.

Passion vs. valuation

While media attention and social conversation focus excessively on the big outliers like Facebook, WhatsApp and Instagram, which achieved success in a very short time, it's important to understand that building a real company takes time. Timeframes can differ across businesses, but it is safe to say that building a high-calibre organisation and generating sustainable value can take over 7-10 years.

Nowadays, I often find budding entrepreneurs being driven by "what's cool" in the VC world instead of what they are passionate about.

Nowadays, I often find budding entrepreneurs being driven by "what's cool" in the VC world instead of what they are passionate about. I have two major concerns with this mindset. First, the definition of "what's cool" keeps changing every 12-18 months. So, by the time these entrepreneurs are ready to launch their venture, the "cool idea" has already become passé, leaving the team disappointed for having missed the bus. Second, it is very hard to persevere through the ups and downs of business if you are not passionate about it.

Safe path vs. unexplored market

Launching a business in a market which has other players may appear to be less risky vis-à-vis unchartered territories. This logic can be fallacious as competitors with a head start in the business often pose a greater risk.

I had the opportunity of starting two companies—TransWorks (1999) and CitiusTech (2005). As co-founders of TransWorks, we envisioned the BPO market to become big although there were very few companies in that space. Entrepreneurs entering the market post 2001 found it very difficult to establish their businesses against existing players, even though the business model seemed far safer at that point! Similarly, we felt there was an unexplored opportunity in the healthcare technology market and launched CitiusTech. In both cases, launching in a new market gave us precious time to learn the business before other companies began competing with us.

Delivery focus vs. sales focus in business plan

For any business to be successful, revenues from the product must exceed costs. Having analysed business plans of new companies over the years, I find that while most teams understand cost assumptions well (e.g., raw material, manufacturing, distribution), they often get sales assumptions quite wrong (e.g., marketing, sales costs, sales conversion, pricing). For instance, a company wanted to make low-cost medical devices and export them to the US. They had a very attractive cost model (1/10th the US cost) but had assumed "standard 15% sales costs" on revenues based on cost structure of their larger competitors. When they worked out the real math—based on the cost of a US-based salesperson—$250,000 per year (salary, benefits and travel costs), and number of sales trips needed to close a deal, it became clear that the business model was unviable.

Young entrepreneurs must realise that while VC funding is a recent phenomenon, entrepreneurship has been around for centuries! They must think hard about how to start companies with minimal external funding.

To avoid such situations, entrepreneurs should take a closer look at the sales process (number of meetings, time taken for deal closure), product pricing and lifetime value of customers as these attributes have a very strong impact on the viability of any business. If these factors cannot be determined at the start, it is critical to list the assumptions and periodically validate them.

Self-funding vs. VC funding

Most entrepreneurs think that the success of a venture is synonymous with its ability to raise venture capital. Consequently, their entire focus is on developing a "capital-intensive" business model which needs significant external funding. Young entrepreneurs must realise that while VC funding is a recent phenomenon, entrepreneurship has been around for centuries! They must think hard about how to start companies with minimal external funding. This strategy may require near-term trade-offs (e.g. slow growth, smaller team), but may help the company get to breakeven and profitability quickly and retain higher equity with the team. The team can raise external funding at favourable terms once the business is more evolved.

We often hear about promising companies getting into trouble for raising more money than needed. Overcapitalisation often pushes teams to make sub-optimal decisions (e.g., drop pricing to gain market). Ironically, many VC firms are run by managers who have limited business experience, and a vested interest in pushing for higher spending to increase their stake—mostly at the entrepreneurs' expense!

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