Feb 14

Grim Fairy Tales – Part VI

grimVIThis is the final part in a six part set of blogs about “how not to raise money for your start-up”. The grim stories you read here are based on real life events – meetings and conversations I have had over the years, and will no doubt form the basis for my next book.

So far I’ve covered:

Management

Valuation

USP/Market

Sales

Exit

 

 

This final time we’ll take a look at Scale & Scalability.

For a business to be considered investable it is pretty clear it will have to grow. The rate of growth is what is really important – slow and steady organic growth, funded through increasing sales is really not going to make a compelling investment proposition. For the most part, entrepreneurs pitching for funding understand this and present their case with rapid growth – particularly in revenues.

There are two implications to scale however – one is the rate at which you can grow the business – the opportunities to expand into new markets, develop new products or establish new sales channels. The other is the economy of scale – as you get bigger, you should get more efficient, so that the margins get bigger, delivering ever increasing profitability that out-accelerates your growth.

This is something that is much easier to write in a business plan than it is to actually deliver. This is where prior track record and experience of taking a small business through the process of becoming a much bigger business helps. And this experience will be what an investor is looking for.

It is also important to test your assumptions, identify your dependencies for growth and present a credible story about how you will scale between the point of investment and the point of exit. Remember  you should still be growing, or have the potential to grow, at the exit!

So where does this go wrong?

As you would expect, the problems are either over-ambition – claiming to rapid growth, or not establishing credibility in the claims for growth; or under-ambition, in setting a target which is too low and will not generate the returns an investor will seek.

Whilst the latter are a problem and tend to reflect inexperience or a lack of ambition, the former are more common and can lead to some fairly wild claims!

I already mentioned in Part IV the plan I saw where sales went from zero in year one to £216m in year two.

This is possibly the most extreme example of exaggerated growth, but there are plenty that fail to establish a credible plan to achieve the numbers they forecast – just because you are addressing a big market doesn’t mean you will become a big company – no matter how compelling your product.

One of the more common approaches to forecasting sales, growth and scale is to start with a set of “Year 1” numbers and then work forward applying some factor – sales double every year for 4 years, costs are indexed at 10%, directors salaries double and so on.

We all know that a business plan for a pre-revenue company is not much more than an educated guess – so at least make an effort to explain your assumptions, the critical milestones, thinking behind the projections and specifically exactly how you will sell what you forecast.

Similarly, and particularly where there is a manufactured product, establish where you can reduce costs in the production process as you scale, and identify exactly who will be making the products & where – reduced manufacturing costs are often at the expense of increased shipping costs!

Most tech companies forecast sales on a J curve (the traditional hockey stick) yet very few achieve this. Most often sales growth is flatter – steady, growing but not exponential. The fear is that the investor won’t find it very compelling if the numbers are not big enough to generate a return.

There is a well known Harvard Business Review paper by Churchill and Lewis called “The Five Stages of Small Business Growth” which in addition to identifying the stages, also identifies the issues associated with each stage. Although written 30 years ago it is as relevant today as it was then. If you look it up you will see that the first three stages have little to do with the scalable growth we desire – and if you can address the issues identified you are much more likely to get to stage 4 (take-off).

You can find the article here: Harvard Business Review

 

Permanent link to this article: http://www.concap.cc/2013/02/grim-fairy-tales-part-vi-2/

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