Reprinted with permission from Getting Rich Without Going Broke: How to Use Luck, Logic and Leverage to Build Your Own Successful Business by Rosalind Resnick (©2007). All rights reserved.
Rosalind Resnick, the founder and CEO of Axxess Business Consulting, a New York City consulting firm that advises startups and small businesses, is the co-founder and former CEO of NetCreations, a two-person homebased web design firm that grew to a $58 million public company and was acquired for $111 million in cash in 2001. In this excerpt from her book Getting Rich Without Going Broke: How to Use Luck, Logic and Leverage to Build Your Own Successful Business (PageFree Publishing), Resnick shares her secrets for building a multimillion-dollar business.
For most business owners, financial modeling ranks right up there on the enjoyability index with flossing, balancing the family checkbook and cleaning out the garage. Though we all know it's important, most of us would rather put it off until tomorrow.
The reality is, unless you're an MBA or numbers wonk who actually enjoys crafting complex formulas and building interlinking Excel sheets, financial modeling can be a chore that's boring, painful and hopelessly complex. That's why most business owners would rather do just about anything than sit down with a spreadsheet and try to forecast what their sales, profits and cash flow are going to look like next year, next quarter or even next month.
Back when I first started NetCreations, I was the typical small-business owner who ran her company by the seat of her pants. My idea of financial forecasting consisted of looking at last month's sales, sticking my finger in the air and taking my best guess as to what next month's sales were going to be. Because I knew my business well, I usually wasn't too far off.
But when we decided to take our company public, our investment bankers needed something a little more sophisticated than guesswork to help them justify our valua-tion and give their analysts some guidance as to what our future sales and earnings would be. So, with the help of our CFO, I built my first financial model. Basically, it showed the following: For every one new e-mail address that a partner website contributed to our database, we stood to make an additional $5 per e-mail address per year in revenue. It was this simple yet elegant model (in addition to my bright smile and engaging personality) that sold our deal to the public markets.
My point is this: No matter how passionately you believe in your business, you've got to make the numbers work before you can turn your dream into the reality of a large and profitable company. While nobody has a crystal ball that can predict the future, a good financial model will help you understand the key elements that make your business tick and help you avoid the kinds of problems that can doom your business before it even starts.
Here are five common business mistakes that a good financial model can catch--and five things you must do to ensure they don't stall your growth.
Problem: Your business is fine for now but difficult to scale as it grows. This is the bugaboo that haunts small accounting firms, PR firms, design firms and other professional services firms that are run by sole practitioners or a handful of partners. While these companies generally require little capital to start and can be profitable from Day One, they can also be difficult to scale since the owner/operator is essentially selling his time. And because businesses like these typically tap out at $200,000 to $300,000 a year, there's little margin available to hire even a single employee to handle administrative tasks or routine assignments. When the business owner does take the plunge and start to delegate, he often runs into resistance from his clients, who want him and only him to do the work. While many sole practitioners like these may soldier on for years, others burn out and call it quits, returning to lower-paying corporate jobs with steady pay, fewer hours, better benefits and less risk.
Solution: Make sure there's enough profit in your hourly rate or project fee to enable you to bring in employees or subcontractors. Generally, clients don't mind you hiring subcontractors to do the work as long as they can still get face time with you.
Problem: The size of the market you're targeting is too small. Think about all the high school basketball stars who dream about making it in the NBA. Because there are only 30 NBA teams and each team employs a handful of players, the chances of your son becoming the next Michael Jordan are very slim. It's the same Darwinian economics that makes it difficult for an aspiring talent scout or literary agent to make money. Unless you can sign up a hot college draft pick or persuade John Grisham to switch agents, it may be years before your literary agency or sports management firm can generate enough revenue to cover the cost of recruiting and servicing your clients--much less make a profit.
Solution: Pick a bigger market with less competition. A business that makes a nice profit is a lot sexier than having a company that makes you pay for the privilege of hanging out with athletes and celebrities.
Problem: Your business must hit critical mass before it can achieve profitability. Any business that relies on the power of database marketing--a time share group, a house-swapping club--requires the database to grow to a certain size before others will be interested in joining. And that's the catch: Until the database is large enough to attract a significant number of members, few people will want to join. But until more people join, nobody will want to sign up to be a member. Therefore, database marketers must spend big dollars to acquire customers without knowing whether their investment will ever pay off.
Solution: Give channel partners (organizations, clubs, affiliate websites, etc.) a share of your subscription revenue in return for helping you lower the cost of recruiting members for your database. Add B2B revenue streams to your model so you can start generating e-commerce and affiliate marketing revenue even when your database is small.
Problem: The cost of customer acquisition is too high for your company to ever become profitable. As many dotcom companies discovered six years ago (and satellite radio networks are discovering now), you can't always spend your way to profitability. While laying out millions of dollars for advertising may pump up revenue, it's a money-losing strategy if your company can't turn those dollars into lifetime customer value. Magazine publishers, catalog merchants and other direct marketers may break even or lose money when they first acquire a customer but recoup their investment when the subscriber renews for another year. By contrast, a company that spends $300 to acquire a subscriber who spends $20 a month and cancels his subscription at the end of the year is pouring its money down the drain.
Solution: Test, measure, then test again. Only when you've done enough testing to figure out how to create a positive arbitrage between how much you pay to acquire the customer and how much revenue the customer is likely to generate should you throw big money at a roll-out. If you can't figure out how to create a positive arbitrage, cut your losses and move on.
Problem: Your company has no preexisting reseller channel. Because it is difficult and time-consuming to acquire customers, most new companies find it easier to break into a market by tapping into a network of manufacturers' reps, agents, brokers and other third-party resellers. At NetCreations, our e-mail marketing business skyrocketed once we were able to partner with list brokers and ad agencies that recommended direct-mail lists to leading magazine publishers, catalog marketers and other corporate clients. By contrast, companies like PR firms, yoga studios and pet-grooming businesses that enter a market without an existing reseller channel often struggle to survive, alternating between feast and famine.
Solution: Make a list of potential channel partners before you start your business and ask them if they're willing or able to send business your way. If they're not, come up with another product or service that your channel likes better.
Getting Rich Without Going Broke is available at online bookstores, including Amazon.com and BN.com, and atPageFree Publishing. Rosalind Resnick is Entrepreneur's "Advisor" and "Money Matters" columnist.