If you are thinking of buying or starting a business then this is a must read article. Most people get fired up with a business idea and jump into it only to realize at a later date full implications of the business they have entered.
Before starting a business it is important to understand what constitutes a great business. There is no point in putting your hard earned money and effort at risk without fully understanding implications of the business you are starting.
You must consider following important issues before deciding on the business idea you wish to pursue.
Competition or Monopoly
Competition indicates that there is demand for the product or service. However, competition also means reduced market share and profits. In a fair capitalistic system, competition reduces profits to zero or it will force non competing firms to go bust thereby increasing chances of business failure.
Entering a monopoly business is good because profit margins are assured. However, you will need to do market research to ensure that there is demand for the product or why no one else has entered the market space. Creating monopoly may also need deeper pockets in order to create demand for a new product.
You can also create monopoly by providing great value to the customers that other businesses are not doing. Another method to create monopoly is by creating differentiation with other product and services to stand out in the market space.
Starting a business in an area where demand exceeds supply is a great idea. This will reduce your marketing costs and ensure profit margins. Entering a low competitive market and creating monopoly by value addition is a great strategy for new business start-ups.
If possible start a business that is hard to copy and protect your intellectual property right. This can also be achieved by entering the market aggressively and creating brand recognition.
Understanding the Business Cycle
Every business has a lifespan – some have longer lifespans whilst others have relatively shorter lives. Eventually every business will die. Businesses like education, health, hospitality, energy have longer lifespan when compared to technology companies. In the past 70 years, we have witnessed transition of the music industry from records, LPs, tape recorders, CDs to downloadable music on your iPhone and iPad. Even iPods, after their short glory, have become extinct.
Remember Kodak. They had the highest market share selling film rolls. Advent of digital cameras and smart phones made them go bankrupt.
High-tech companies have shorter lifespans but have higher profitability margins. Are you looking for short term profits or sustainable wealth over generations? Do you want to start a high profit company and sell for windfall cashflow or are you looking to build a business for long term? Do you enjoy the challenge of starting new companies every few years or will like to run with a sustainable business idea for longer duration?
Both business models have their plus points. You have to decide what is right for you.
Timing in the Industry
Timing in the industry is the key to your success. As explained earlier each industry has a business cycle. Always enter a business during the growth phase of the industry. There will be lesser competition and higher profit margin. Your business will have a longer life span. Entering a business that has peaked or is in declining phase will only bring grief.
For example oil industry is in declining phase as against solar energy which is the new hope of renewal energy. Will you buy service station that are likely to go extinct in the next decade because most countries are phasing out fossil fuel cars. Remember the demise of video libraries that were doing thriving business only a decade back.
Filling Need Gap
The business you enter must fill a need gap in the market. It should solve problem in an intuitive way that no one else is solving. Your profits will be proportional to level of problem you are solving. Greater the pain point and the solutions you provide higher will be viability and profits of your business.
Before starting a business look for problems facing other businesses and people and build your business around solving that problem.
Always start small focussed on a small niche and scale upwards. Facebook started as social website for a college and grew from there. Amazon started their business selling eBook’s and today they are the world’s largest online retailer.
You may be starting out small but have a vision for the future growth of your business. Look at the scalability of the business model at the time of evaluating ideas for the business you wish to start.
It can be argued that it is possible to scale up any business. However, certain types of business are much simpler to scale up than others. For instance it will be relatively hard to scale up a dairy shop or a farming business. It is easier to scale up internet based businesses like Uber and Airbnb when compared to a physical goods company.
Franchising is another method of scalability. It is also a great source of generating passive income. Here again it is not easy to franchise every business. Look at future possibility of franchising the business when evaluating business opportunities.
Business with a Real Estate Backbone
Real Estate has created more millionaires than any business or investment. Therefore a business that has a real estate backbone to it gives it strength and sustainability. Industries like hospitality, education or heath generally have some element of real estate investment in the background that ensures long term wealth as long as the business can sustain operating profits.
A word of caution. Starting or buying a business as a freehold going concern reduces cashflow as part of the money generated from business goes into servicing the loan for the property you own. This should be taken into account when drawing up the business plan and making cashflow projections.
There are creative ways to overcome the problem of cashflow as was done by McDonald to fund their growth.
Ray Croc founder of McDonalds found that banks won’t fund his expansion plans because he did not own any assets. He started buying land in key locations and built McDonalds. After running the business for few months he put a lease on the property and sold the business franchise. In doing so he created two sources of passive income from the rent of the property and franchise of the business. New long term lease to the tenant greatly increased valuation of his property. In doing so he created cashflow and equity. Banks were happy and leant him even more money to expand his business. He continued repeating the process and rest is history..
The business you buy should be financeable. Most people think that once they have business idea venture capitalists and banks will be waiting in the wings to the fund the business. The reality kicks in when they start making rounds of financial institutions. They find that funders are super conservative in what they finance. They either want some kind of security as collateral which in most cases is real estate or ask for very high percentage of equity that you may or may not be willing to give.
This is why starting small within your resources and scaling up is a better option. Start a business that has very low start-up cost. Asking for additional funding for a profitable running business is much easier as lenders have more faith in your capability and your business idea.
There are some creative ways to generate cashflow to fund your business or buy businesses with no money down but these are beyond the scope of this blog post.
In certain types of businesses like real estate it is easier to apply financial leverage because banks are eager to fund the business as property is considered low risk.
Other businesses are more suited to human or technology leverage. There is a saying that humans create more problems than machines. Labour laws in respect to wages, hiring and firing, health and safety are complex in most countries. It requires great effort and human skills to manage labour intensive businesses when compared to tech companies. Technology leverage requires higher knowledge skill set but is cheaper and easier to manage.
The most important leverage you have is your knowledge. Most businesses fail not because the business opportunity or timing is wrong but because of lack of knowledge, time management and personal discipline of the entrepreneur behind the business.
When you are starting a business you have to be aware of your capabilities and opportunities your environment offers. These include not only knowledge about the product and services you are marketing but also your management, marketing, business development and financial skills. No person has all the knowledge or skills needed to be successful in business. The gaps have to be filled by taking advice from professionals in various fields or partnering with people who have the skills that you lack.
Before starting or buying a business you have to be clear in your mind the type of leverage suited to your business. What type of business systems you can apply to run the business more efficiently.
Start Up and Maintenance Costs
Businesses have a start-up and maintenance cost to run a business in terms of finance and effort. It may not always be possible to have a low start-up and maintenance cost business. If there is choice go for low maintenance business. Your time is the most precious commodity. Look for lifestyle business opportunities that free up your time and effort. You will be rewarded in terms of better family life and health.
Start a business that has low fixed costs that include interest on loans, rents, salaries and utility bills. By using existing resources and hiring part time or virtual assistants you can keep your bills down. Some of the biggest companies like Microsoft, Apple and Amazon started in garages with no rents and virtually no employees.
Risk Management and Exit Strategy
Every business opportunity comes with some element of risk. This should not deter you from starting a business. Excitement and passion are important when starting a business but one should not be carried away by emotions.
Businesses offering high rewards generally carry higher risk. The risks can be from outsiders like creditors or within the business enterprise due to injury and health issues. It is important to analyse elements of risk in every business opportunity and study ways and means to mitigate that risk. These include setting correct business structures and insuring damage to business, property and income.
It is also important to have an exit strategy in place in case things go wrong and not according to plan. Even the best executed plans can go awry. Avoid businesses wherein exiting the business can be a problem.
Deposit Recycle Time
Deposit recycle time is the period within which you take out your initial investment from the business. Once your initial investment is out then the business becomes risk free to you. It is important to remember that you still carry responsibility towards your investors, creditors and employees.
In a good business opportunity you should be able to recover your initial investment within 12 to 24 months. There are smart business people who start a business with no money of their own or recover their initial investment with 3 to 6 months.
There are conflicting requirements when starting a business. For instance buying underlying freehold property is a great strategy for wealth creation but can reduce profits and put pressure on cashflow to run a business successfully. Similarly trying to make business risk free by insuring everything will cut into profitability of your business.
Prudence and balance is the key to running a successful business. No two situations are alike. However understanding the principles and applying them to the maximum possible effect will translate your business idea into successful reality.