Start-Ups, Few Survive & Attain Growth

Launching a new business—whether it’s a tech start-up, small business, or an initiative within a large organisation (newer trend of insulating and harnessing the startup mindset)—has always been a hit-or-miss proposition. According to the conventional formula, one makes a business plan, take it to investors, build a team, Launch the product in the market and start selling as hard as you can.

This sequence is as true as sun rising in West, sorry, East. One thing in this sequence of events, which everyone avoids mentioning is that you’ll probably suffer a fatal setback. The odds are not with you to succeed. Over 90% of startups fail within first 3 years. What makes the 5% survive and rest fail? Categorizing the problems and growth patterns of small businesses in a systematic way that can be useful to entrepreneurs seems at first glance a hopeless task.

As I am in mood to give my gyan free of cost , let me state that most startup businesses are 'lifestyle' businesses; the objective of the 'entrepreneur' (the term is a misnomer) is simply to produce an independent source of income for him/herself to replace wage/salary income earnt in someone else's employ.Income is likely to be very similar to the income the entrepreneur earned in his/her previous employment.  If, then, target incomes are proportional to incomes prior, and if all startup entrepreneurs start with the same business income then, to achieve the target, higher prior income entrepreneurs need to grow faster.

To survive in business it is reasonable to assume (at least as a first approximation) that this target level of income must be achieved in a set period. If entrepreneurial income is below the standard the entrepreneur has been accustomed to he will have an incentive to try harder. If income falls persistently below the target he will have an incentive to exit. Thus those businesses run by higher income-earning entrepreneurs will need to grow faster to achieve this target in the same period.

The income from self-employment may in some cases be higher than prior income but in others may be slightly lower providing the entrepreneur is willing to accept an income 'price' for the  utility of independence (Cressy, 1992)

These small, bootstrapped businesses along with well funded startups too, vary widely in size and capacity for growth. They are characterized by independence of action, differing organizational structures, and varied management styles.

Yet on closer scrutiny, it becomes apparent that they experience common problems arising at similar stages in their development. These points of similarity can be organized into a framework that increases our understanding of the nature, characteristics, and problems of businesses ranging from a neighbourhood Gym with two or three minimum-wage employees to a $2-million-a-year hardware company experiencing a 100% annual rate of growth.

For founders and owners this understanding can help them assess their own organisational trajectory & decide on the need for delegation and changes in their managerial roles when companies become larger and more complex. The framework will help Finance & Marketing consultants in diagnosing problems and matching solutions to smaller enterprises. The problems of a 20-month-old, 20-person business are rarely addressed by advice based on a 30-year-old, 200-person manufacturing company. For the former, cash-flow planning is paramount; for the latter, strategic planning and budgeting to achieve coordination and operating control are most important.

Stage I : Existence

As I have repeatedly said, Survival is the most important goal of any organisation, big or small. It's even more important for startups lest they run out of cash. In this stage the main problems of the business are gaining customers and delivering the product or service contracted for. Among the key questions are the following:

  • Can we get enough customers, deliver our products, and provide services well enough to become a viable business?
  • Can we expand from that one key customer or pilot production process to a much broader sales base?
  • Do we have enough money to cover the considerable cash demands of this start-up phase?

The organization is a simple one—the owner does everything and directly supervises subordinates, who should be of at least average competence. Systems and formal planning are minimal to nonexistent. The company’s strategy is simply to remain alive. The owner is the business, performs all the important tasks, and is the major supplier of energy, direction, and, with relatives and friends, capital.

Companies in the Existence Stage range from Gyms, restaurants and retail stores to high-technology manufacturers that have yet to stabilize either production or product quality. Many such companies never gain sufficient customer acceptance or product capability to become viable. In these cases, the owners close the business when the start-up capital runs out and, if they’re lucky, sell the business for its asset value.

More generally, initial size of the business cash-flow (a measure of business activity) will be a direct function of pre-entrepreneurial income and (in a two-period model) final size will be a function of target income, since profit is likely to be a fixed mark-up on initial cash-flow expenditures on inputs.

If we assume there are costs to growing faster, and that such costs are convex in the growth rate, it is easy to see that a positive correlation of growth and pre-entrepreneurial income will still exist. Thus it is unnecessary to assume a common initial entrepreneurial income to get the main result.

Using a Baumol-type growth model, where the costs of growth are explicitly modeled, higher pre-entrepreneurial income will imply higher initial growth objectives. Also, since marginal revenue from growth will be an increasing function of target future cash-flow but independent of the growth rate, whereas marginal costs of growth are convex in the latter, a higher MR will offer more profit from faster growth. Hence higher pre-entrepreneurial income businesses will grow faster.

In some cases, the owners cannot accept the demands the business places on their time, finances, and energy, and they quit. Those companies that remain in business become Stage II enterprises.

Stage II: Survival

"In reaching this stage, the business has demonstrated that it is a workable business entity. It has enough customers and satisfies them sufficiently with its products or services to keep them. The key problem thus shifts from mere existence to the relationship between revenues and expenses. The main issues are as follows:

  • In the short run, can we generate enough cash to break even and to cover the repair or replacement of our capital assets as they wear out?
  • Can we, at a minimum, generate enough cash flow to stay in business and to finance growth to a size that is sufficiently large, given our industry and market niche, to earn an economic return on our assets and labor?

The organization is still simple. The company may have a limited number of employees supervised by a sales manager or a Manufacturing manager. Neither of them makes major decisions independently, but instead carries out the rather well-defined orders of the owner. "

Systems development is minimal. Formal planning is, at best, cash forecasting. The major goal is still survival, and the owner is still synonymous with the business.

In the Survival Stage, the enterprise may grow in size and profitability and move on to Stage III. Or it may, as many companies do, remain at the Survival Stage for some time, earning marginal returns on invested time and capital and eventually go out of business when the owner gives up or retires. Some of these marginal businesses have developed enough economic viability to ultimately be sold, usually at a slight loss. Or they may fail completely and drop from sight.

Stage III: Success

"The decision facing owners at this stage is whether to exploit the company’s accomplishments and expand or keep the company stable and profitable, providing a base for alternative owner activities. Thus, a key issue is whether to use the company as a platform for growth—a substage III company—or as a means of support for the owners as they completely or partially disengage from the company. Behind the disengagement might be a wish to start up new enterprises or simply to pursue hobbies and other outside interests while maintaining the business more or less in the status quo."

"In the Success-Disengagement substage, the company has attained true economic health, has sufficient size and product-market penetration to ensure economic success, and earns average or above-average profits. The company can stay at this stage indefinitely, provided environmental change does not destroy its market niche or ineffective management reduce its competitive abilities. " The first professional staff members come on board, usually financial, marketing, and production managers with systems are in place. Planning in the form of operational budgets supports functional delegation.

The owner to a lesser extent, the company’s managers, should be monitoring a strategy to, essentially, maintain the status quo

Stage IV: Growth & take off

It all depends on few key decisions and their timing.

Leveraging free marketing opportunities

Marketing need not be straight jacketed like big brands, create own opportunities and use the platform effectively to create advocacy -

Solve a problem in unique manner, either cheaply over anyone else or Value for money in terms of product & brand experience.

Delegation.

Can the owner delegate responsibility to others to improve the managerial effectiveness of a fast growing and increasingly complex enterprise? Further, will the action be true delegation with controls on performance and a willingness to see mistakes made, or will it be abdication, as is so often the case?

Cash.

Will there be enough to satisfy the great demands growth brings (often requiring a willingness on the owner’s part to tolerate a high debt-equity ratio) and a cash flow that is not eroded by inadequate expense controls or ill-advised investments brought about by owner impatience?

The organization is decentralized and, at least in part, divisionalized—usually in either sales or production. The key managers must be very competent to handle a growing and complex business environment. The systems, strained by growth, are becoming more refined and extensive. Both operational and strategic planning are being done and involve specific managers. The owner and the business have become reasonably separate, yet the company is still dominated by both the owner’s presence and stock control.

This is a pivotal period in a company’s life. If the owner rises to the challenges of a growing company, both financially and managerially, it can become a big business. If not, it can usually be sold—at a profit—provided the owner recognizes his or her limitations soon enough. Too often, those who bring the business to the Success Stage are unsuccessful in Stage IV, either because they try to grow too fast and run out of cash (the owner falls victim to the omnipotence syndrome), or are unable to delegate effectively enough to make the company work (the omniscience syndrome).

It is, of course, possible for the company to traverse this high-growth stage without the original management. Often the entrepreneur who founded the company and brought it to the Success Stage is replaced either voluntarily or involuntarily by the company’s investors or creditors.


MOST IMPORTANT THING : Process & Systems at existence stage so that organisation can move to clear accountability, delegation and entrepreneur need to control only the few points.


Credits :

HBR 2013 May issue. 'Lean start up changes everything' + many other articles I have read over a period of time.

Cressy : utility of independence

Own learnings of consultancy & running 2 start ups have played a major role in these opinions.