Getting the Numbers to Add Up

As a consultant to start-ups and early-stage companies, I see a lot of business plans.

Often, these plans are written by entrepreneurs with great ideas and promising products but only a vague idea of the size of the market or how many middlemen they're going to have to cut in along the way. As a result, the sales projections that they come up with are often wildly optimistic -- $50 million the first year, $100 million the second year and $250 million the third -- and the profits are so enormous that an investor might wonder why the company needs to raise any capital at all.

And yet these entrepreneurs wonder why their business plans aren't getting funded.

The reality is that no matter how passionately you believe in your business, you've got to make the numbers work before you can turn your entrepreneurial dream into the reality of a profitable and scalable business. While nobody has a crystal ball that can predict the future, a good financial model will help you understand the key drivers that make your business tick and help you avoid the kind of problems that can sink your venture before it even launches.

Here are three common business mistakes that a good financial model can catch:

1. Your business must hit critical mass before it can reach profitability.

Anybusiness that relies on the power of database marketing -- a time-sharegroup, house-swapping club or online dating service, for example --requires its database to grow to a certain size before other memberswill be interested in joining. And that's the catch: Until the databaseis large enough to attract a significant number of members, few peoplewill want to join. Therefore, database marketers must spend big dollarsto acquire customers without knowing whether their investment will everpay off. The solution: Give channel partners (trade associations,clubs, affiliate web sites, etc.) a piece of the action in return forhelping lower the cost of customer acquisition.

2. The cost of customer acquisition is too high for your company to ever become profitable.

Asmany dot coms discovered 10 years ago, you can't always spend your wayto profitability. While laying out millions of dollars for advertisingmay be the quickest way to pump up revenue, it's a money-losingstrategy if your company can't turn those dollars into life-timecustomer value. Magazine publishers, e-commerce merchants and otherdirect marketers may break even or lose money when they first acquire acustomer but ultimately recoup their investment when the customer comesback to renew his subscription or place another order. By contrast, acompany that spends $300 to acquire a subscriber whospends $20 a month and cancels his subscription at the end of the yearispouring its money down the drain. The solution: Test, measure and testagain. Only when you've doneenough testing to figure out how to create a positive arbitrage betweenhowmuch you pay to acquire the customer and how much revenue the customerislikely to generate should you throw big money at a roll-out campaign.

3. Your company has no reseller channel.

Because it's difficult and time-consuming to acquire customers, most newcompanies find it easier to break into a market by tapping into a network ofmanufacturers' reps, agents, brokers and other third-party resellers. At my former company, NetCreations,our email marketing business skyrocketed once we were able to tap into the network of list brokers and ad agencies that recommended direct mail lists to leading magazinepublishers, catalog marketers and other corporate clients. By contrast,companies like public relations firms, yoga studios and pet grooming businessesthat enter a market without an existing reseller channel often struggleto survive, alternating between feast and famine. The solution: Make alist of potential channel partners before you start your business andask them if they'd be willing to send some business your way.