The Harvard Business Review Entrepreneur's Handbook 2018 PDF
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A.K. Ghosh Memorial School
2018
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This handbook provides a comprehensive guide for entrepreneurs, covering essential aspects of starting and growing a business, including business planning, financing, and leadership. It leverages research and insights from Harvard Business Review, providing practical advice and examples of successful ventures.
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US$29.99 MANAGEMENT The one primer you need to develop your entrepreneurial W skills. hether you’re imagining your new business to be the next big thing in Silicon...
US$29.99 MANAGEMENT The one primer you need to develop your entrepreneurial W skills. hether you’re imagining your new business to be the next big thing in Silicon Entrepreneur’s Handbook Valley, a pivotal B2B provider, or an anchor in your local community, the HBR Entrepreneur’s Handbook is your essential resource for getting your company off the ground. Starting an independent new business is rife with both opportunity and risk. And as an entrepreneur, you’re the one in charge: your actions can make or break your business. You need to know the tried-and-true fundamentals—from writing a business plan to getting your first loan. You also need to know the latest thinking on how to create an irresistible pitch deck, mitigate risk through experimentation, and develop unique opportunities through business model innovation. Entrepreneur’s The HBR Entrepreneur’s Handbook addresses these challenges and more with practical advice and wisdom from Harvard Business Review’s archive. Keep this comprehensive guide with you throughout your startup’s life—and increase your business’s odds for success. In the HBR Entrepreneur’s Handbook you’ll find: ▪ Step-by-step guidance through the entrepreneurial process ▪ Concise explanations of the latest research and thinking on entrepreneurship from Handbook Harvard Business Review contributors such as Marc Andreessen and Reid Hoffman ▪ Time-honed best practices ▪ Stories of real companies, from Airbnb to eBay Everything You Need to Launch and Grow ISBN-13: 978-1-63369-368-5 Your New Business 90000 STAY INFORMED. JOIN THE DISCUSSION. VISIT HBR.ORG 9 781633 693685 Harvard Business Review Entrepreneur’s Handbook H7303-Entrepreneur.indb i 11/2/17 1:14 PM H7303-Entrepreneur.indb ii 11/2/17 1:14 PM Harvard Business Review Entrepreneur’s Handbook Everything You Need to Launch and Grow Your New Business Harvard Business Review Press Boston, Massachusetts H7303-Entrepreneur.indb iii 11/2/17 1:14 PM HBR Press Quantity Sales Discounts Harvard Business Review Press titles are available at significant quantity dis- counts when purchased in bulk for client gifts, sales promotions, and premiums. Special editions, including books with corporate logos, customized covers, and letters from the company or CEO printed in the front matter, as well as excerpts of existing books, can also be created in large quantities for special needs. For details and discount information for both print and ebook formats, contact [email protected], tel. 800-988-0886, or www.hbr.org/bulksales. Copyright 2018 Harvard Business School Publishing Corporation All rights reserved The material in this book has been adapted and revised from works listed in the Sources section and from Harvard Business Essentials Entrepreneur’s Toolkit: Tools and Techniques to Launch and Grow Your New Business (Harvard Business School Press, 2005), subject adviser Alfred E. Osborne. No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise), without the prior permission of the publisher. Requests for permission should be directed to permissions@ hbsp.harvard.edu, or mailed to Permissions, Harvard Business School Publishing, 60 Harvard Way, Boston, Massachusetts 02163. The web addresses referenced in this book were live and correct at the time of the book’s publication but may be subject to change. Library of Congress cataloging information is forthcoming. eBook ISBN: 9781633693715 H7303-Entrepreneur.indb iv 11/2/17 1:14 PM Contents Introduction 1 PART ONE Preparing for the Journey 1. Is Starting a Business Right for You? 11 PART TWO Defining Your Enterprise 2. Shaping an Opportunity 23 3. Building Your Business Model and Strategy 41 4. Organizing Your Company 63 5. Writing Your Business Plan 77 PART THREE Financing Your Business 6. Startup-Stage Financing 103 7. Growth-Stage Financing 115 8. Angel Investment and Venture Capital 131 9. Going Public 149 H7303-Entrepreneur.indb v 11/2/17 1:14 PM viContents PART FOUR Scaling Up 10. Sustaining Entrepreneurial Growth 171 11. Leadership for a Growing Business 181 12. Keeping the Entrepreneurial Spirit Alive 195 PART FIVE Looking to the Future 13. Harvest Time 213 Appendix A: Understanding Financial Statements 225 Appendix B: Breakeven Analysis 241 Appendix C: Valuation: What Is Your Business Really Worth? 245 Appendix D: Selling Restricted and Control Securities: SEC Rule 144 257 Glossary 263 Further Reading 273 Sources 277 Index 285 H7303-Entrepreneur.indb vi 11/2/17 1:14 PM Introduction William Bygrave, a scholar and practitioner of entrepreneurship, describes an entrepreneur as someone who not only perceives an opportunity but also “creates an organization to pursue it.” That last part of Bygrave’s definition is essential. Ideas are one thing, but opportunities as we generally understand them are best addressed through business organizations formed by entrepreneurs. Thomas Edison, for example, recognized the business opportunity in urban electric illu- mination, which he pursued through tireless laboratory experiments that eventually produced a workable incandescent light bulb. But invention was only part of Edison’s genius. He also formed a company that brought to- gether the human and financial resources needed to implement his vision of commercial and residential lighting. That company was the forerunner of the General Electric Company, one of today’s largest and most powerful enterprises. The same formula has been repeated through history: recognizing op- portunity and addressing it through an organization. Some opportunities are evident and just need to be harnessed; others are created by the en- trepreneur. For example, in 2007, when roommates Brian Chesky and Joe Gebbia could no longer afford the rent on their San Francisco loft, they decided to rent out space to guests. They set up a website with some photos of their apartment, quickly gaining three guests for their first weekend, at $80 each. Soon they began hearing from others who had found their site and wanted a similar offering for informal lodging in cities around the world. H7303-Entrepreneur.indb 1 11/2/17 1:14 PM 2HBR’s Entrepreneur’s Handbook The next spring, Chesky and Gebbia enlisted former roommate Nathan Blecharczyk to help them establish Airbed & Breakfast. To raise early fund- ing, they bought cartons of breakfast cereal, repackaged it in the theme of the 2008 election, and resold it to conventioneers, raising about $30,000. Nevertheless, their site’s growth stalled. While living off the extra cereal, though, they were accepted into Y Combinator’s accelerator program. In the summer of 2009, they began testing their own services to better un- derstand their users’ needs. Realizing how poorly the properties were rep- resented online, the entrepreneurs began a photography program in which hosts could have professional shots of their properties taken. Learning and course-correcting as they went, Chesky and Gebbia saw their customer base rocket from one thousand in 2009 to over a mil- lion in 2011. Airbnb’s financials are not formally disclosed, but in 2015, market reports placed its value at $25.5 billion with projected revenue of $900 million for the year, based on the company’s reported three-million- plus listed properties worldwide. Not all startup stories are so bright, of course. A complete definition of the entrepreneur must also recognize another factor: risk. In the financial world, risk contains the possibility of both gain and loss. The entrepreneur puts skin in the game—usually in the form of time and personal savings. If the venture goes badly, his or her time and hard-earned savings are lost. And indeed, 75 percent of startup ventures fail to return investors’ capital, according to research by Harvard Business School’s Shikhar Ghosh. But if things go well, the entrepreneur can reap a sizable profit. So if you have a business idea or an idea about how to fill a market need—or even if you just think you’re interested in starting a business—how do you make sure that your venture is successful? The same basic process applies whether your idea is the next high- growth wunderkind, a robust B2B player in a critical industry niche, or a local retail shop close to home. You recognize a potential commercial opportunity and pursue it through an organization, your own managerial or technical talents, and some combination of human and financial capital. Of course it’s never quite this simple; in fact, the entrepreneurial journey H7303-Entrepreneur.indb 2 11/2/17 1:14 PM Introduction3 often takes many twists and turns. This book will walk you through this process in more detail. The role of entrepreneurs Entrepreneurs play an important role in society. As described by econo- mist Joseph Schumpeter in the 1930s, entrepreneurs act as a force for cre- ative destruction, sweeping away established technologies, products, and ways of doing things and replacing them with others that the marketplace as a whole sees as representing greater value. In this sense, entrepreneurs are agents of change and, hopefully, progress. Thus, it was entrepreneurs who displaced home kerosene lamps with brighter and cleaner-burning gas in the middle to late 1800s. Those gas lamps, in turn, were displaced by Edison’s incandescent electric light system, which provided better per- formance and greater safety. Fluorescent lighting came along years later, displacing many incandescent applications. We see this pattern repeated in virtually every industry. Entrepreneurs invent or commercialize new technologies that displace the old. Photo- copying, the personal computer, the World Wide Web, the spreadsheet, and new and improved drug therapies and medical devices are all prod- ucts of enterprising entrepreneurs. Entrepreneurs also introduce products, services, and platforms that deliver something entirely new: the electronic calculator, next-day package delivery, crowd fund-raising, aircraft simu- lation software, oral contraceptives, angioplasty to open narrow heart ar- teries, and online marketplaces for everything from apartment rentals and ride-sharing to homemade crafts and financial payments. Entrepreneurs have given us even mundanely useful things that our parents or grand- parents would not have imagined: computers we take everywhere (like our iPhones), contact lenses, milk in aseptic packaging that requires no refrig- eration, online auctions that bring together buyers and sellers from every part of the world, and on and on. These products and services improve customers’ lives. Many are also beneficial to society and to the planet, be they improved drug therapies, microloan systems that alleviate poverty H7303-Entrepreneur.indb 3 11/2/17 1:14 PM 4HBR’s Entrepreneur’s Handbook around the globe, or drones that target pesticides to the crops that need them most, eliminating waste and pollution. In conceiving of these new products and services and forming and running enterprises to bring them to customers and users, entrepreneurs often sweep away stagnant industries and replace them with growing ones that generate new jobs, often at higher wages. Thus they have a central role in building wealth and dynamism in the societies in which their enter- prises operate. What’s ahead This book takes a linear approach to entrepreneurship, from initial ques- tions that you should ask yourself before you begin (“Am I the type of person who should start a business?”) to the last issue that you’ll need to consider as a successful business owner (“How can I cash out of the business I’ve built?”). Though your own experience is likely to differ from this simplified framework—the entrepreneurial process is nothing if not iterative—this book should give you a good overview of the issues you’ll probably face and how to approach them. Part 1 prepares you for your journey. In chapter 1, we describe the self-diagnosis that every prospective entrepreneur should undertake. Are you the right type of person to start up and operate a business? This chap- ter will help you answer that important question. Part 2 helps you define your enterprise. The first steps in the entrepre- neurial process are to identify and evaluate potential business opportuni- ties. Chapter 2 offers five characteristics you should look for in a business opportunity, particularly focusing on the problem your business is trying to solve. It also introduces the lean-startup methodology as a way to eval- uate market interest and to experiment with other hypotheses about the opportunity you’ve identified. If your initial evaluation of the opportunity pans out, you’ll further refine your business model and strategy. These two critical concepts are the focus of chapter 3. It describes how the business model explains the way key components of the enterprise work together to make money—and H7303-Entrepreneur.indb 4 11/2/17 1:14 PM Introduction5 how to begin to test your business model with real customers. It also shows how strategy must be designed to differentiate the entity and confer it with a competitive advantage. Finally, the chapter offers a five-step process for formulating strategy and aligning business activities with it. Assuming that your evaluations and experiments have given you con- tinued confidence in your business idea, you’ll need to structure your busi- ness from a legal perspective. In chapter 4, you’ll learn about the various legal forms of business organization used in the United States. You’ll see their pros and cons and decide which organizational structure is best for your venture: a limited-liability corporation, a sole proprietorship, a part- nership, a corporation, or something else. Chapter 5 gets you started on writing a plan for your business, incorpo- rating many of the elements discussed previously. A business plan explains the opportunity, identifies the market to be served, and provides details about how your organization expects to pursue the opportunity. The plan also describes the unique qualifications that the management team brings to the effort, lists the resources required for success, and predicts the re- sults over a reasonable time horizon. This chapter tells you why a business plan is necessary, gives you a format for organizing one, and offers tips for developing each section in the format. It also describes other documents similar to a business plan, such as a pitch deck. Part 3 focuses on how to get the funding you need to finance the vari- ous stages of your enterprise. The global recession of 2008 took a big toll on entrepreneurship, a sector that has not yet recovered. In the United States, new business starts went from 525,000 in 2007 to just over 400,000 in 2014. There are many reasons for this drop-off, but small businesses tend to fare the worst in a recession because they depend heavily on bank debt, which becomes harder to obtain during economic downturns. Since the re- cession, some new forms of financing, such as crowdfunding, angel invest- ing, and online banking, have appeared. This part of the book describes those new forms along with more traditional methods of raising capital. Chapter 6 concentrates on the financing requirements that businesses typically encounter in the first phase of their life cycles. It also provides an overview of life cycles for different types of businesses. H7303-Entrepreneur.indb 5 11/2/17 1:14 PM 6HBR’s Entrepreneur’s Handbook In chapter 7, the discussion of financing continues. It addresses the next stages of a business’s life cycle: that of growth and maturity. Chapter 8 focuses on rapidly growing firms and their need for external capital specifically. Entrepreneurs can bootstrap early development from personal sources, friends, and relatives, but these enterprises usually need external infusions of capital to move to a higher level. This chapter intro- duces two external sources of capital—angel investors and venture capi- talists or venture-capital firms (VCs)—and explains how best to approach them and win their support. At some point, many growing firms with exceptional revenue potential seek and obtain financing through an initial public offering (IPO) of their shares to individual and institutional investors such as pension funds and mutual funds. That rare event results in a significant exchange of paper ownership shares for the hard cash the firm needs for stability and expan- sion. Chapter 9 describes what it takes to be an IPO candidate, the pros and cons of going public, the role of investment bankers, and eight steps for doing a deal. Because very few businesses will obtain external capi- tal from an IPO, we also present an alternative arrangement: the private placement. In part 4, we discuss the effects of growth on your organization. Par- adoxically, success is sometimes the entrepreneurial company’s greatest enemy; hierarchy, bureaucracy, and complacency frequently follow. Chap- ter 10 walks you through the organizational and strategic aspects of deal- ing with growth, while chapter 11 emphasizes that you as a leader may need to reexamine your way of working and even your own role as your business becomes larger. As organizations grow, they tend to become more complacent about how to best serve their customers. Chapter 12 addresses how you can sus- tain entrepreneurial innovation and energy in your growing company even as it naturally becomes more process-driven and operations-focused. You can keep new ideas flourishing through efforts to manage your organiza- tion’s culture, strategic considerations around innovation, and your own leadership involvement. H7303-Entrepreneur.indb 6 11/2/17 1:14 PM Introduction7 Finally, in part 5, we look to the future. In chapter 13, you learn about harvesting your investment in a private business. Founders—and the busi- ness angels and venture capitalists who support them—look forward to the day when they can turn their paper ownership into real money. This chapter describes the motivations that lead to harvesting, the primary mechanisms for doing so, and the methods you can use to answer the all-important question, “What is this business worth?” Additional resources The back of this book contains material you may find useful. Appendix A is a primer on financial statements. If you haven’t studied accounting or haven’t thought about it for a long time, this material will bring you up to speed. Go to appendix B for details of breakeven analysis not covered elsewhere in the book. Appendix C provides an overview of the methods used to determine the value of business enterprises. The appendix won’t make you a master of this very technical and specialized subject, but it will teach you enough that you can deal intelligently with valuation experts. Finally, appendix D is taken directly from the US Securities and Exchange Commission site. It explains Rule 144 on the sale of restricted and control stock. Few readers will ever need to understand Rule 144, but those who do may find this useful reading. The appendixes are followed by a glossary that provides definitions of key terms. Finally, the book includes a “Further Reading” section. There you’ll find suggestions of books and articles—both recent and classics—that provide more detailed information or unique insights into the topics cov- ered in these chapters. H7303-Entrepreneur.indb 7 11/2/17 1:14 PM H7303-Entrepreneur.indb 8 11/2/17 1:14 PM PART ONE Preparing for the Journey H7303-Entrepreneur.indb 9 11/2/17 1:14 PM H7303-Entrepreneur.indb 10 11/2/17 1:14 PM 1. Is Starting a Business Right for You? What makes entrepreneurs tick? More specifically, what are the personal traits and backgrounds of people who become successful entrepreneurs? This chapter considers those questions and helps you decide whether you have the right stuff to be a business entrepreneur. Many books and websites include self-scoring tests that you can use to assess your fitness for entrepreneurial life. (The US Small Business Administration [SBA] provides one such test on its site at https://www.sba.gov/starting-business/how-start-business/entrepreneurship-you.) These assessments can be a good place to start as you think through what entrepreneurial work would mean for you and whether it’s a good fit for your personality and goals. This self-evaluation is especially useful if you’re starting with an idea for a business. Having ideas is important, but it’s only one step in a process that also requires other skills and per- sonality traits. H7303-Entrepreneur.indb 11 11/2/17 1:14 PM 12Preparing for the Journey This and other tests typically integrate some combination or subset of the traits shown in table 1-1. Let’s look at these traits in more detail. Ideas and drive Christopher Gergen and Gregg Vanourek, founding partners of New Mountain Ventures, an entrepreneurial leadership development company, describe the basic process of entrepreneurship as follows: “Understand a problem, grasp its full context, connect previously unconnected dots, and have the vision, courage, resourcefulness, and persistence to see the solu- tion through to fruition.” Without those first elements—a full understanding of a problem, new connections, and a vision or direction for a solution—there is no entrepre- neurial venture. Whether the problem you’ve identified is global or local, broad or niche, your ability to spot it and conceive new solutions is a core element of entrepreneurship. And passion about the problem you are solv- ing might not be as important as you think—see the box “A passion for the work.” People skills Having identified a problem or even a potential solution is one thing. But to launch a successful venture, you must also make other people see the merits of your idea and invest in it—whether they are employees, custom- ers, or funders. Your ability to lead, persuade, take feedback, and build a network will determine whether you’ll actually be able to bring your idea to fruition. In the HBR Guide to Buying a Small Business, Harvard Business School professors Richard S. Ruback and Royce Yudkoff describe the people skills that entrepreneurs need first: “You need to feel comfort- able reaching out to people you don’t know—sellers,... investors, your employees—and when you do reach out, you need to project an air of con- fident optimism.” H7303-Entrepreneur.indb 12 11/2/17 1:14 PM H7303-Entrepreneur.indb 13 TABLE 1-1 Common entrepreneurial traits Entrepreneurial Ideas and drive People skills Work style Financial savvy background Creativity Leadership Goal oriented Experimental mindset; OK Comfortable with Family members have with starting small and finance started businesses Vision Persuasion Comfortable with recognizing and moving uncertainty Comfortable Friends have started Ability to identify Influence past failures with financial businesses opportunities Self-challenging Network building Perseverance in the face of governance You have worked at a small Passion Solitary: don’t like adversity Ability to excite people business or startup working for others; by vision Tendency to continuously prefer being own boss look for a better or differ- Rarely satisfied or com- ent way to do things placent; can’t sit still Ability to close a deal Driven to plan and be Ability to listen, trust, take prepared advice Sources: Bill J. Bonnstetter, “New Research: The Skills That Make an Entrepreneur,” HBR.org, December 7, 2012; Daniel Isenberg, “Should You Be an Entrepreneur? Take This Test,” HBR.org, February 12, 2010; Harvard Business Review, “For Founders, Preparation Trumps Passion,” Harvard Business Review, July–August 2015; HBS Working Knowledge, “Skills and Behaviors That Make Entrepreneurs Successful,” June 6, 2016; Veroniek Collewaert and Frederik Anseel, “How Entrepreneurs Can Keep Their Passion from Fading,” HBR.org, June 16, 2016. 11/2/17 1:14 PM 14Preparing for the Journey A passion for the work Passion, long considered an important part of entrepreneurial work, keeps entrepreneurs going when the going gets tough. It’s the spark that inspires an investor to sign on; it’s the vision for the change you’re going to usher into the world through your new product or service. In- deed, “Follow your passion” is increasingly becoming a catchphrase as the generation that was raised with it comes of age in the professional world. But experts caution against thinking of passion as a primary require- ment for your success as an entrepreneur. Here’s why: Research shows that passion simply doesn’t correlate with success years out from the founding of a new business. Research also shows that passion in entrepreneurs tends to fade over time, even during the first few months of the enterprise’s founding. When it comes to funders particularly, serial entrepreneurs Evan Baehr and Evan Loomis write that “potential investors will ask themselves three simple questions during a meeting: 1) Do I like you?, 2) Do I trust you?, and 3) Do I want to do business with you?” To earn an investor’s trust, you must first be appealing and interesting enough for them to get to know you well enough to trust you. To succeed in the high-pressure, fast- paced world of venture funding, you must know how to connect with peo- ple—and know when your tactics for connecting with them aren’t working, and switch to a tactic that will. But successful entrepreneurship isn’t just about convincing others about the brilliance of your idea, just as networking isn’t only about get- ting funding, and just as selling to customers isn’t only about selling. These activities will also yield feedback about your business idea or how your company is operating. That information is worthless if you don’t know how H7303-Entrepreneur.indb 14 11/2/17 1:14 PM Is Starting a Business Right for You?15 While expressing passion for your business or idea can help if you are trying to secure funding from a less experienced source— relatives or semiprofessional angel investors, for example— professional funders prefer strong preparation and a calm demeanor, which they associate with good leadership, over passion. As former venture capitalist and entrepreneur Dan Isenberg writes, “Passion is an emotion that blinds you.” If you are too emotionally attached to your venture, you won’t see its problems objectively or be able to correct course when you need to. Sources: Cal Newport, “Solving Gen Y’s Passion Problem,” HBR.org, September 18, 2012; Harvard Business Review, “For Founders, Preparation Trumps Passion,” Harvard Business Review, July–August 2015; Harvard Business Review, “How Venture Capitalists Really Assess a Pitch,” Harvard Business Review, June 2017; Daniel Isenberg, “The Danger of Entrepre- neurial Passion,” HBR.org, January 6, 2010. to listen or accept feedback. In their research of entrepreneurs around the globe, marketing professors Vincent Onyemah, Martha Rivera Pesquera, and Abdul Ali found that one of the most common mistakes in selling a new offering was entrepreneurs’ failure to listen to their customers’ com- plaints about the product: “Some realized that their passion and ego made them respond negatively to criticism and discount ideas for changes that they later saw would have increased the marketability of their offerings.” Successful entrepreneurs know when to stick to their guns—and when to take the advice of others and shift course. They also know how to recognize when they’ve reached the end of the road. When a project isn’t working, they accept that they have to shift to something else—failing fast is better than failing long and slow. On the subject, Isenberg quotes Joseph Conrad: “Any fool can carry on, but only the wise man knows how to shorten sail.” H7303-Entrepreneur.indb 15 11/2/17 1:14 PM 16Preparing for the Journey Work style Being your own boss may sound appealing—no one to tell you what to do!—but it also means that to succeed, you need to challenge and motivate yourself. There won’t be anyone else to do it for you. Successful entrepre- neurs are intrinsically motivated by the problems they see around them and the solutions that they envision; they can’t sit still while there’s work to be done (and there’s always more work to be done). They are also often goal oriented: they fix their eyes on a prize and im- patiently and relentlessly try different ways to get there, shifting strategies quickly when necessary (see the box “Stretching the rules”). Stretching the rules In a comprehensive study of entrepreneurial characteristics conducted between 1987 and 2002, Walter Kuemmerle, an associate professor at Harvard Business School, identified comfort with stretching the rules as a common characteristic of successful entrepreneurs. Certainly, entrepre- neurs need to be creative, seeing opportunities where others don’t and challenging assumptions about every part of the business. For example, LinkedIn founder Reid Hoffman maintains that “freedom from normal rules is what gives you competitive advantage,” describing, for example, how Uber’s use of employee referrals for hiring decisions—rather than formal screenings—helped the company scale up more quickly. But when this outside-the-box thinking turns into disregard for legal regulations or an excuse for personal misbehavior, the consequences are more troubling. For example, Uber and Airbnb are frequently faced with scrutiny about their skirting of regulations for taxis and hotels. Har- vard Business School professor Benjamin Edelman reflects on this issue: “Uber counters that [the] rules primarily benefit taxi drivers and keep prices needlessly high. That may be. But the law’s unambiguous require- H7303-Entrepreneur.indb 16 11/2/17 1:14 PM Is Starting a Business Right for You?17 Indeed, most new ventures, no matter how well planned, are experi- mental, and as an entrepreneur, you will benefit from an experimental mind-set. A willingness to start small gives company founders an opportu- nity to test and fine-tune a product or another offering before locking into a business model that will allow them to scale. They have the patience to see how customers respond to a product, its price, and the way it is served. In this way, they can course-correct before expending large amounts of capital. The classic counterexample of this patient, experimental approach comes from Webvan, a dot-com-era company whose leaders were unwill- ing to take such an approach. The company’s founders—including Louis ments were duly enacted by the responsible authority. In Uber’s world, a general contractor might decide building codes are too strict, then skimp on foundation or bracing. Who’s to say which rules are to be fol- lowed and which to be broken?” Meanwhile public scandals around employee mistreatment and sexual misconduct have suggested other ways that a disregard for the rules can go too far. Beyond the personal damage caused, research has shown that corporate punishment for CEO misbehavior (not necessarily outright illegal acts) can be inconsistent, but the effects on the com- pany’s reputation if such misbehavior is made public can be significant and long-lasting, and negative effects reverberate within the company as well. Entrepreneurs, then, have a harder charge than simply “breaking the rules”: they must find a way to deliver iconoclastic creativity without disregarding civil society. Sources: Walter Kuemmerle, “A Test for the Fainthearted,” Harvard Business Review, May 2012, 122–127; Reid Hoffman and Tim Sullivan, “Blitzscaling,” Harvard Business Review, April 2016; Benjamin Edelman, “Digital Business Models Should Have to Follow the Law, Too,” HBR.org, January 6, 2015; David Larcker and Brian Tayan, “We Studied 38 Incidents of CEO Bad Behavior and Measured Their Consequences,” HBR.org, June 9, 2016. H7303-Entrepreneur.indb 17 11/2/17 1:14 PM 18Preparing for the Journey Borders, founder of the Borders bookstore chain—envisioned a nationwide home-delivery system for groceries. Webvan began by building a monster 330,000-square-foot automated warehouse in Oakland, California. It quickly raised more than $850 million in equity capital and began work on twenty-six similar facilities in metropolitan areas across the United States. But the company never came close to breaking even. Within two years, it had burned through its cash and was forced into bankruptcy. By most estimates, Webvan had tried to do too much too fast. Instead, successful entrepreneurs are willing to shift strategies quickly. But a good experimentation process can’t eliminate all risk in an en- trepreneurial venture. Unlike the more established corporate managers, you as an entrepreneur need to be comfortable with risk and must not be intimidated by a shortage of information. Compared with your corporate counterparts, you are much more likely to find yourself in a situation in which making a sale, landing a contract, or reaching an agreement with a lender means the difference between survival and bankruptcy. En- trepreneurs are so close to the edge of failure that every deal has major consequences. Whereas a corporate manager might say, “I’d like more in- formation before I can make this decision,” an entrepreneur must make the best of uncertainty and move forward. Standing still and waiting for more information isn’t an option. This kind of pressure builds particularly around deal making. Success- ful entrepreneurs, according to Kuemmerle, understand how to seal a deal. “However tough the market or small the transaction, they know exactly what they must give up—and what they can get away with—while finaliz- ing deals under pressure.” Financial savvy In ongoing research at Harvard Business School, Lynda M. Applegate, Timothy Butler, and Janet Kraus have found that HBS graduates who have gone on to start businesses tend to rate themselves as more confident with financial concepts and financial governance than do other graduates. If you’re less confident with the numbers, this book includes appendixes with H7303-Entrepreneur.indb 18 11/2/17 1:14 PM Is Starting a Business Right for You?19 an overview of common financial statements and concepts like breakeven analysis. These sections can introduce you to (or refamiliarize you with) these concepts. Entrepreneurial background Entrepreneurship runs in families to a surprising degree. Children of business owners are more likely than others to start or purchase their own enterprises. Similarly, anecdotal data indicates that children of busi- ness owners are more likely than others to enroll in the entrepreneurship courses offered by undergraduate and MBA programs. This connection should not be surprising. The challenges, joys, dif- ficult choices, and rewards of business ownership are frequent topics of discussion around the dinner tables of business-owning families. The chil- dren often learn the what and how of enterprise ownership from these dis- cussions and from many weekends and summers working in the family store or factory. Indeed, Paul Newman, whom most people think of sim- ply as an accomplished actor, grew up in a business-owning family and has recounted in interviews the many childhood weekends he spent in his father’s store. Those experiences surely had something to do with his founding of Newman’s Own, a packaged-foods company whose profits are donated to charity. Jim Koch, founder and chairman of Boston Beer Company, repre- sents the sixth generation of brewing in his family. Similarly, Dan Brick- lin, co-inventor of the first spreadsheet software VisiCalc, came from a family that owned and ran its own business. Bricklin’s background surely influenced the future course of his life: “My father headed up the family printing business, Bricklin Press, which had been founded by his father in the 1930s. Afternoons spent at the printing plant and dinners devoted to the day’s business problems prepared me... for the trials I would face in my own business ventures... Growing up, I never ex- pected that some big company would eventually take care of me; instead, I was always looking for opportunities to turn some nifty ideas into a business.” H7303-Entrepreneur.indb 19 11/2/17 1:14 PM 20Preparing for the Journey No matter what your background is, an entrepreneurial venture may be right for you. Successful enterprise is a combination of personal qualities and quality planning. You don’t have to be a genius with a killer idea: most successful startups begin with incremental innovations. You don’t have to be totally fearless, either: entrepreneurs who prosper have a healthy aver- sion to risk. Nor is technical business know-how essential: you can learn as you go along, or you can enlist an experienced businessperson as a co- owner. An individual who has all the right qualities for entrepreneurial work but a poor plan will not succeed. Nor will a person with a great plan but weak motivation and a fear of uncertainty. What you must have is a solid plan, the ability to execute it, and a high degree of motivation—motivation that makes business success an impor- tant personal goal. Do you have these qualities? Summing up Ideas are an important element of success for entrepreneurs, but they’re not sufficient—you also must consider your personal background, inclina- tions, motivation, and skills. Tests are available to measure a person’s suitability for an entrepreneurial life, but these tests should be used only as a rough gauge. Entrepreneurship runs in families. Children of business owners are more likely than others to start or purchase their own enterprises. H7303-Entrepreneur.indb 20 11/2/17 1:14 PM PART TWO Defining Your Enterprise H7303-Entrepreneur.indb 21 11/2/17 1:14 PM H7303-Entrepreneur.indb 22 11/2/17 1:14 PM 2. Shaping an Opportunity Cesar managed the service department of a large car dealership. With five years on the job as manager and many more as a mechanic, Cesar under- stood the economics of the auto service business, and he saw what might be an opportunity. “We’re starting to sell more electric cars,” he told his sister at a family gathering. “The national organization estimates that electrics will account for 10 percent of our unit sales five years from now. And two other auto- makers are moving into electrics. I think that these plug-in vehicles will define the automobile market in the coming years.” “How’s that going to affect your service department?” his sister asked. “Quite a bit,” Cesar responded. “We’ve already brought in new diag- nostic machines and trained people on the electric vehicles’ electronic sys- tems—which are substantially different from those of traditional cars and even hybrids. And we’ll be very busy in the years ahead, since we’ll get all the repair and maintenance business on these cars for the foreseeable H7303-Entrepreneur.indb 23 11/2/17 1:14 PM 24Defining Your Enterprise future, even after warranties have expired. Traditional mechanics don’t know how to work on electrics, and many will never learn.” Later that day, Cesar reflected on this conversation. “There may be an opportunity here,” he told himself. After new electric vehicle warranties expired, he reasoned, owners would have no options for repair and main- tenance except high-priced dealer service departments like his. Neighbor- hood mechanics wouldn’t be equipped or trained to deal with these cars for many years. Many owners would welcome a lower-priced alternative—one that specialized in the repair and maintenance of electric engine vehicles. Cesar began envisioning a service center called the Electric Car Care Cen- ter. And if that proved successful, he could foresee a chain of cloned out- lets—perhaps a national franchise. Cesar had recognized a business opportunity, a great way to begin. But before he begins to pursue it, he needs to further evaluate what he knows about the opportunity—and what he doesn’t. Identifying a problem to solve In 2004, leading expert on entrepreneurship Jeffry Timmons described a business opportunity primarily as a product or service that creates sig- nificant value for customers and offers significant profit potential to the entrepreneur. Increasingly, entrepreneurs and those who study entrepre- neurship are focusing on what creates that value to begin with, on defining and refining the problem that needs to be solved for customers and users. You need to be sure that the problem exists and be able to describe it in some detail before you begin to invest heavily in building your solution. In other words, Cesar will need to make certain that drivers of electric cars will need his specialized service. He’ll also need to know the number of these drivers and understand their behavior to ensure that his solution meets an actual need that customers have. This problem focus has come to the fore because the entrepreneurial journey is rarely a straight line between seeing a need, identifying a solu- tion for that need, and then simply executing on that solution. In the H7303-Entrepreneur.indb 24 11/2/17 1:14 PM Shaping an Opportunity25 long-accepted standard process for entrepreneurship, would-be business owners would identify an opportunity in the marketplace and, using what- ever data at their disposal, create a business plan and financial forecast that would be pitched to investors. If they got the funding, then they would follow through on the long process outlined in the document to build a team, create the product, market it, and hope the plan panned out. But more often than not, it didn’t. No matter how well conceived the original product or offering, there are always major unknowns at the out- set of a business venture: What is the right business model? Will it scale? What will competitors do? What will be the unexpected glitches in the supply chain? And there’s the biggest questions: Is there really a market for the product or service as conceived, and if so, how big is it? Many entre- preneurs are so excited about what their new gizmo or service can do that they forget to assess its value to customers. But in the end, the business can succeed only if enough people recognize this value and are willing to pay for it. For example, perhaps there is a market for service for electric cars in Cesar’s town, but it’s not the lower-price market he imagined. It turns out that the people who buy electric cars are wealthy and are more interested in convenience than cost savings. If Cesar can discover this marketing information before he begins building his company around the idea of a lower-cost shop, he’ll have a chance to reassess how he’ll differentiate his business from the existing dealers. Whether your business idea is a local service operation or the next big thing in the tech sector, begin by asking the following customer and mar- ket questions. As you go, evaluate your confidence in your answers, and begin thinking about how you will test them. Note that the questions don’t assume that the person using your offering is necessarily the customer pay- ing for it—many businesses create a product for a user but are paid by a downstream customer like an advertiser. What is the problem you are trying to solve for your customers or users? H7303-Entrepreneur.indb 25 11/2/17 1:14 PM 26Defining Your Enterprise How many people have this problem? In other words, what is the size of the market? Are your potential customers or users aware of this problem, or is the need latent, that is, undiscovered? Is the market stable or growing? If it’s growing, at what annual rate? How will your solution benefit customers or users? What percentage of the total market could the product or service reasonably hope to capture over the next few years? Is another product or service from competitors available to fill part of this demand? Who exactly are the potential customers? Can you name them? Can you describe them? How can you reach the potential customers and make a trans- action—directly, on your own website or bricks-and-mortar loca- tion; through distributors like the Apple or Google app stores; or through already-existing retail channels? How does the utility of the product or service compare with substi- tutes? For example, a tablet device is easier for a customer to carry around than a laptop. But it may not have all the functionality of the full computer. With his experience and knowledge of service department costs to guide him, Cesar begins to answer these questions and measure the breadth of his newfound business opportunity. He has industry estimates of electric vehicle sales; he knows which diagnostic and other equipment is needed—and what it costs; and he is intimately familiar with the cost of running a fully staffed service facility. When he begins putting these num- bers together, his optimism grows. But running through this exercise also helped him realize where he needs more information. Table 2-1 shows how Cesar has sized up what he knows about the problem he’s trying to solve. H7303-Entrepreneur.indb 26 11/2/17 1:14 PM TABLE 2-1 Market evaluation for the Electric Car Care Center Aspect of the market Cesar’s evaluation Cesar’s confidence and unknowns Problem you Help customers take care of their Confident that this will be a need—but are trying electric vehicles. will customers see it, and what will to solve make them choose my shop rather than their dealer? Customer Lower price than equivalent service Dealers tend to be expensive, so lower benefit from at the dealer. price seems likely to be a good bene- your solution Greater expertise. We service only fit—but will it be good enough to attract electric vehicles and have all the customers away from their dealers? right equipment. It would be great to test some pricing with existing electric car owners. Market size Currently over two million electric We’ve been seeing more and more vehicles on the road worldwide. electric cars on the road, but it’s not clear what the trajectory of growth will be. We’ll want to understand this more before investing heavily. Market A 32 percent compound annual rate Will this growth be sustained? And is growth occurred in the United States over the growth of electric car ownership rate past four years. the same in our town as nationally? Industry projections differ substan- tially on growth projections. Market share Share of service business within a This is a guess; we’ll need to test it. twenty-mile radius estimated at 18 percent during the first five years. Competitors Primary competition is dealers who These observations seem accurate get most of the business during war- or likely. ranty periods. Other new electric specialty shops are likely to open to service the ris- ing demand. Few neighborhood garages would have the training or equipment to provide service. Customer Will become obvious as warranty We will definitely want to test this awareness periods expire and the high cost of projection. of need dealer service becomes clear. Customers All owners of electric vehicles of all We need to learn more about the makes and models. demographics of people who buy electric cars. Most who come into the shop tend to be wealthy—early adopt- ers. But will that change if the price of fuel rises? Reaching Buy list of electric car owners for We have lots to test here—maybe customers direct email. start a Twitter account or Facebook Use social media. page with electric car care tips and see how many people follow us? Then Advertise on hyper-local sites. we’ll be able to market to those cus- Offer free informational clinics tomers as well. (“Understanding Your Electric Vehicle”). Partner with local environmental groups to get the word out. H7303-Entrepreneur.indb 27 11/2/17 1:14 PM 28Defining Your Enterprise Experimenting to test your hypotheses Chances are that you, like Cesar, may have some good, informed thoughts about these questions, but your guesses are no more than that. Approaches to entrepreneurship coming from Silicon Valley take into consider- ation these unknowns at the outset of a venture and deliberately expect twists and turns—or pivots—in the entrepreneurial path. In a design- thinking approach to creating a new product or offering, innovators ac- tively experiment with their idea to better understand the market and its needs before proposing a solution. One common formulation of this ap- proach is the lean-startup methodology, which focuses on finding a repeat- able and scalable business model for a new offering (see the box “The lean startup”). The lean startup and other similar models of entrepreneurship are iter- ative and nonlinear—not a step-by-step path—but they realistically reflect how companies change as they grow and learn. Taking an experimental approach from the earliest stages of your evaluation of an opportunity can reduce risk by helping you to home in on the right problem to solve, rather than jumping straight to the opportunity. And while these techniques were originally developed to help rapidly growing tech companies, the practi- tioners who created them see them as equally applicable to other small businesses as well. In particular, the lean-startup approach emphasizes customer devel- opment, or working with and learning about customers from the early stages of building a solution. See the box “Agile, customer-based develop- ment” for an example of how this approach can build your understand- ing of the problem you are solving for customers—and how to build your solution. Evaluating the opportunity Especially in an experimental approach, evaluation of a business opportu- nity is less of a onetime event and rather a set of questions that you need to ask over and over as you experiment and learn more about your business. H7303-Entrepreneur.indb 28 11/2/17 1:14 PM Shaping an Opportunity29 The lean startup This methodology, named by entrepreneur Eric Ries in his book The Lean Startup, has grown in popularity from its Silicon Valley roots to MBA classrooms. As described by serial entrepreneur and academic Steve Blank for HBR, the lean startup incorporates three elements: A business-model canvas: A business-model canvas is a one- page document that captures your hypotheses about your busi- nesses—your guesses about what you do not and cannot know about your business plan in advance. Seeing these unknowns all on one page allows you to imagine how the different parts of your business might fit together. The standard framework for a busi- ness-model canvas was developed by Alexander Osterwalder and Yves Pigneur in their book Business Model Generation (figure 2-1). Blank business-model canvases are available for free in exchange for registration at Osterwalder’s website, strategyzer.com. (We’ll talk more about business models in the next chapter.) Customer development: To test your hypotheses, you need to interact with your customers. Gone are the days when you’d keep a product in development a secret from the world, afraid that your competitors would steal it before a big splashy launch. Instead, as Blank explains, most industries recognize that “cus- tomer feedback matters more than secrecy and... constant feedback yields better results than cadenced unveilings.” Go out to your potential customers, vendors, and partners for feedback on the hypotheses in each part of your canvas. Agile development: To generate useful feedback from your customers, create prototypes to share with them—and do so quickly. What is the minimum viable product that you can create to test your idea? And once you get feedback, how quickly and (continued) H7303-Entrepreneur.indb 29 11/2/17 1:14 PM 30Defining Your Enterprise incrementally can you iterate on your product design to get more feedback without wasting time on the development of unneces- sary elements? (See an example in the box “Agile, customer-based development.”) Source: Steve Blank, “Why the Lean Start-Up Changes Everything,” Harvard Business Review, May 2013. FIGURE 2-1 The business-model canvas Customer Customer Key partners Key activities Value propositions relationships segments Who are our key What key activities What value do we How do we get, keep, For whom are we partners? do our value propo- deliver to the and grow customers? creating value? Who are our key sitions require? customer? Which customer Who are our most suppliers? Our distribution Which one of our relationships have important Which key resources channels? customers’ problems we established? customers? are we acquiring Customer are we helping to How are they What are the from our partners? relationships? solve? integrated with the customer Which key activities Revenue streams? What bundles of rest of our business archetypes? do partners perform? products and model? services are we How costly are they? offering to each segment? Which customer Key resources Channels needs are we What key resources satisfying? Through which do our value propo- What is the minium channels do our sitions require? viable product? customer segments Our distribution wants to be reached? channels? How do other Customer companies reach relationships? them now? Revenue streams? Which ones work best? Which ones are most cost-efficient? How are we integrating them with customer routines? Cost structure Revenue streams What are the most important costs inherent to our For what value are our customers willing to pay? business model? For what do they currently pay? Which key resources are most expensive? What is the revenue model? Which key activities are most expensive? What are the pricing tactics? Source: Strategyzer, “Canvases, Tools and More,” accessed July 12, 2017, www.businessmodelgeneration.com/ canvas. Canvas developed by Alexander Osterwalder and Yves Pigneur. H7303-Entrepreneur.indb 30 11/2/17 1:14 PM Shaping an Opportunity31 Agile, customer-based development When Jorge Heraud and Lee Redden started Blue River Technology, they were students in my class at Stanford. They had a vision of building ro- botic lawn mowers for commercial spaces. After talking to over a hun- dred customers in ten weeks, they learned that their initial customer target—golf courses—didn’t value their solution. But then they began to talk to farmers and found a huge demand for an automated way to kill weeds without chemicals. Filling this need became their new product focus, and within ten weeks, Blue River had built and tested a prototype. Nine months later, the startup had obtained more than $3 million in ven- ture funding. The team expected to have a commercial product ready just nine months after that. By 2017, the company had successfully launched a robotic lettuce thinner and was working on using drone-based tech- nology to add accuracy to its sensing-and-spraying products, as de- scribed on their website at http://about.bluerivert.com. Source: Adapted and updated from Steve Blank, “Why the Lean Start-Up Changes Everything,” Harvard Business Review, May 2013. As you try different elements of your business model in the market, you’ll learn more about the problem you’re trying to solve—and your solution’s viability in the marketplace. What you learn about customers will help you continually evaluate your idea. Timmons offers the following criteria for an opportunity worth pur- suing: 1. It creates significant value for customers, who are willing to pay a premium to solve a significant problem or fill an important unmet need. 2. It offers significant profit potential to the entrepreneur and inves- tors—enough to meet their risk-versus-reward expectations. H7303-Entrepreneur.indb 31 11/2/17 1:14 PM 32Defining Your Enterprise 3. It represents a good fit with the capabilities of the founder and the management team—that is, the idea is something they have the experience and skills to pursue. 4. It is durable: the opportunity for profits will persist—and, indeed, will probably grow—over a reasonable time and is not based on a momentary fad or a quickly disappearing need. We add a fifth characteristic to this commendable list, this one sug- gested by Alfred E. Osborne Jr., director of UCLA’s Price Center for Entre- preneurial Studies: 5. The opportunity is amenable to financing. One would think that a promising commercial idea would always find financial backing, but experience teaches us otherwise. We explored the first criterion in the first half of this chapter; now let’s examine the other segments of this definition in more detail. Will it deliver a significant profit? To qualify as a good opportunity, a business must offer the potential for significant profit. But what amount constitutes significant? Each person will have a different view. Some entrepreneurs and investors will look for something capable of providing a comfortable livelihood—perhaps one that can be passed on to children as they mature. Others will seek much more in terms of financial gains for themselves and their financial backers—but potentially over different periods. For example, venture capitalists typi- cally anticipate a long time horizon before they see a return, but they have higher profit expectations than do other business investors. Risk must play a part in every consideration of profit opportunity be- cause the risk and return tend to go hand in hand. Corporate employees often fret about workplace insecurity: “I could lose my job if the economy doesn’t improve.” For the people who start new businesses, however, the risks are far higher. If things don’t work out, they lose both their employ- ment and the personal savings they’ve invested. Investors are similarly at risk; in the worst case, they can lose all their invested capital. Given the H7303-Entrepreneur.indb 32 11/2/17 1:14 PM Shaping an Opportunity33 high risks of entrepreneurship, there should be correspondingly high po- tential rewards associated with an opportunity. There is a very real trade-off between risk and return, as shown in figure 2-2. Point A in the figure has zero risk and a very low return. Points B, C, and D provide the investor or entrepreneur with rewards com- mensurate with the risk. But you should avoid opportunities at point E—in fact, any point below the diagonal line—because they do not fully reward the investor or entrepreneur for the risks taken. As a more concrete exam- ple, why invest in a business that promises no more than a 5 percent return when you could do almost as well by investing in ten-year US Treasury bonds, which have no default risk? Every business rests on an economic structure that influences the enterprise’s ability to compete and succeed. Some businesses—such as supermarkets—have a very low profit margin on sales, but the successful ones have very large sales volumes. (Expressed as a percentage, profit mar- gin is profit divided by sales revenue.) On the other end of the spectrum, we have, for example, custom furniture makers who don’t sell many items but who generally make a large profit on each sale. What is the profit structure of your business opportunity? Think, too, about the cost structure of the proposed business. Some businesses operate FIGURE 2-2 The risk-versus-return trade-off Return D C B E A 0 Risk H7303-Entrepreneur.indb 33 11/2/17 1:14 PM 34Defining Your Enterprise with high fixed costs and low variable costs. Fixed costs stay about the same no matter how many goods or services are produced. For example, an automobile engine plant has high fixed costs—for debt payments, insur- ance, specialized equipment, and salaried supervisors. These costs remain roughly the same whether the plant produces one hundred engines per year or ten thousand. Variable costs, in contrast, rise or fall with the level of out- put. These include the cost of materials, energy, and, often, labor. Under- standing these costs will help you understand the basis of profit. And if you know the revenues you’ll receive from each unit sale, you can determine the breakeven point of your operations—that is, the number of units you’ll have to sell before you earn a profit. (See appendix B for an explanation of the breakeven point and how to calculate it.) Enterprises with high fixed costs and low variable costs (e.g., high-volume manufacturers) generally have high breakeven points but enjoy high profitability on sales after they get past that point. Those with low fixed costs and high variable costs (e.g., a technical service firm) have low breakeven points but relatively low prof- itability on sales thereafter. A successful entrepreneur must understand the economics of a busi- ness opportunity. The next set of questions will help you think through and evaluate the economics of your opportunity. Try to provide a complete answer to each. Will the business be a price setter or a price taker? What are the constraints on pricing what the business sells? What is the supply-and-demand situation for your product or service? Is demand elastic or inelastic—that is, would a price increase dra- matically reduce buyer demand (elastic), or would demand be only slightly affected (inelastic) in the short run? What substitutes do prospective customers have for your product or service? Will the business be dominated by fixed or variable costs? H7303-Entrepreneur.indb 34 11/2/17 1:14 PM Shaping an Opportunity35 To what extent can suppliers and employees enforce cost increases on the proposed business? You can begin to measure profit opportunity by means of a pro forma income statement. (If you are unfamiliar with the income statement or other financial statements used in business, see appendix A.) This kind of income statement provides a best estimate of future revenues, expenses, and taxes for one or more years. The net result shown on the statement is the anticipated profit from the entrepreneur’s measure of opportunity for those years. Because lenders and investors will want to see a set of these statements, let’s create a pro forma income statement using Cesar’s Elec- tric Car Care Center as an example (see table 2-2). Here, Cesar has forecast results during the first three years of operation. In Cesar’s case, the first year of operation shows a net loss of $21,000, even though he has earmarked a very small salary for himself. The magni- tude of the opportunity grows substantially in succeeding years, however, as the volume of business (i.e., revenues) increases. If volume continues to build in subsequent years, a second facility—if not a regional chain—might be feasible. Naturally, the opportunity reflected in a pro forma income statement is only as valid as the numbers it contains. A person such as Cesar, who conceives of a business that is closely or directly related to his current expe- rience, can usually develop reliable expense numbers. Labor and benefits costs, interest expenses, rent costs per square foot, and so forth are within the scope of his experience. Revenue projections are another matter. In the absence of existing customers, Cesar has to assume revenue figures and revenue growth. And therein lies the most dangerous trap for the entre- preneur. Anything you can do to experiment to get a more realistic view of these numbers will give you a better sense of whether the opportunity is worth pursuing. Is it a good fit for you and your team? A good fit is a situation in which the entrepreneur and management team have the managerial, financial, and technical capabilities, along with the H7303-Entrepreneur.indb 35 11/2/17 1:14 PM 36Defining Your Enterprise TABLE 2-2 The Electric Car Care Center, pro forma income statement for years ending December 31, 2018, 2019, and 2020 2018 2019 2020 Revenues $450,000 $700,000 $1,000,000 Expenses: Owner’s salary 40,000 70,000 90,000 Employee salaries 140,000 160,000 200,000 Benefits 70,000 85,000 100,000 Workers’ insurance 14,000 15,000 20,000 Equipment loan 1a 42,000 42,000 42,000 Equipment loan 2b 14,000 Insurance 4,000 4,200 45,000 Shop rent 40,000 40,000 40,000 Utilities 6,000 6,200 6,400 Other 10,000 10,000 10,000 Parts & materials 100,000 185,000 250,000 Advertising 5,000 6,000 7,000 Total expenses 471,000 623,400 824,400 Profits before tax (21,000) 76,600 175,600 Tax 0 22,980 35,400 Profits after tax (21,000) 53,620 140,200 a. $300,000 loan at 9 percent for twelve years. b. $100,000 loan at 9 percent for twelve years. personal commitment, that are needed to address a business opportunity. Cesar, the fictional character in our electric car service example, appears to have a good fit with the opportunity he has identified. He already un- derstands the technology and knows how to deal with it. He is also experi- enced in the management of an auto service business. As you consider an opportunity, think about the expertise and skills it will take to run that business. Do you have those competencies? At what point will you be able to hire for them—and are they in high demand and hence very likely to require a high salary? What kind of work can you con- tract out versus bringing in house? H7303-Entrepreneur.indb 36 11/2/17 1:14 PM Shaping an Opportunity37 Will it last? Some opportunities are durable—that is, they are opportunities that busi- nesspeople can exploit over long periods. They are long-lasting and des- tined to grow over time. The software industry has demonstrated this durability. Other industries are too fleeting to sustain profitability over the long term. From the 1970s pet rock fad to the virtual world Second Life, most opportunities associated with fads and fashion are equally short- lived. By the time customer requirements are defined and addressed, the market has lost interest and moved on to the next new thing. Some opportunities lack durability even though demand remains high for a long time. Low barriers to entry create these situations. A visible op- portunity with low entry barriers to new competition is a deadly combi- nation. The supply of the product or service can quickly exceed demand, resulting in price reductions and business distress all around. As you evaluate your business idea, consider first whether the need you’ve identified is likely to be sustained. Sometimes, you just need to take the time to see if a new fad has staying power. It can be worth the invest- ment of time to wait before making an investment, according to London Business School entrepreneurship professor Freek Vermeulen, even in dig- ital industries. But speed is often what is called for to achieve one much-lauded source of durability in many industries: network effects. Where the value of a business’s offering depends on the number of users it attracts, being the first to achieve scale in a particular market can create high defensibil- ity; users are less likely to defect to a competitor with fewer users, because it’s less valuable to them. This means that eBay and Etsy become more valuable for sellers as they attract more buyers, and more valuable to buy- ers as they attract a wider variety of sellers. In these kinds of businesses, defensibility comes from growing very, very quickly, becoming the first mover at scale in your target market so that you can be the first to capture those users or customers. But effectively capitalizing on network effects isn’t just about scaling your user base as quickly as you can—you also need H7303-Entrepreneur.indb 37 11/2/17 1:14 PM 38Defining Your Enterprise to be aware of issues like building trust among the participants on your platform, focusing on the right kinds of users, and avoiding disintermedi- ation. (With disintermediation, participants’ trust in one another and the ease of the transactions grow so great that the participants can sidestep you as an intermediary.) Can you defend the solution you are offering? Can you take advantage of network effects? Do other aspects of your offering make it difficult for competitors to emulate or replace? What’s the competition? Now try to answer the next set of questions, which address your compet- itive landscape. If you’re entering an existing market, you’ll be up against competitors. Some may be entrenched and capable. If your market is new and attractive, you can be sure that it will attract other pro