Of course the answer isn’t no for everyone. But both of these options only make sense for very, very, very, few people.

The idea that VC money isn’t automatically the way for a startup to succeed is starting to get some traction. Sarah Guo just wrote about it, and Gary Vaynerchuk followed up.

This isn’t a new idea. The first of this by a VC that I read was back in 2012 byChris Dixon. The New York Times wrote an article illustrating this point in 2013. But neither really took hold in the zeitgeist. Maybe Guo and Vaynerchuk will get the message out to more people.

And what most people understand about the NBA but not about VC is that the choice it not entirely up to you. I’ve never been taller than 5’6″ and not terribly athletic. Did I ever have a chance at the NBA? NO. And it had nothing to do with my passion or my drive. It had more do with my genesthan my dreams.

Despite the fact that many people love basketball and quite a lot are good at it, most of the press covers only the very top levels of play — except for the occasional article about North Korea. And yet, you don’t see everyone who can make a jump shot reading coverage of the NBA finals and saying “Yup that’s going to be me next year.” But for some reason they read about Zuckerberg and say “Yup, I can do that — just look at this app I made!”

Maybe because we’ve bought into this thing we tell our kids that you can be anything you want to be. You know, “In America anybody can grow up to be president”. I guess George W. Bush proved that was true. But still.

Here’s Why

Investor money (I’ll include professional angels as well as VC but not your rich uncle who loves you and doesn’t care about the money) needs to make a huge return because that’s the way equity investing works. Making a huge return requires a good exit. “Good exit” includes timing as well as size. And this is often where investor’s goals and those of the entrepreneur diverge. Mark Suster has a great article showing how you could have a $30M exit and the founders end up making $20K per year for their efforts. But when you take investor’s money you’re subject to the golden rule. “He who has the gold, makes the rules.”

Having any exit at all, never mind a good one, has very little to do with making a great company. Of course, a great company is required, but it’s hardly sufficient.

From my decades of work as an entrepreneur, a few less decades of consulting with scale-up companies, and almost a decade of angel investing here’s what I’ve come to believe.

1. The ability to make a good company is almost entirely under your control. You have to do things right, and avoid doing anything stupid. But if you’re willing to follow your customer’s passion above your own and work at it, you can do probably pull it off. By “good company”, I mean one that meets the needs of customers, produces wealth, produces jobs and lasts a long time.
2. The ability to make a GREAT company is all that plus some good luck and timing. Warren Buffett and Ross Perot have been quoted as saying as much, but you can see luck and timing in the history of many other great entrepreneurs. Bill Gates comes to mind. And, by the way, if you’ve done the learning of #1 properly, you’ll probably be able to see if you’ve got that luck and timing or not.
3. The ability to have a good EXIT is something else entirely. The things that you can’t control (as entrepreneur or investor) that affect your ability to have an exit include the size of the market, the competitive space, changes in technology, changes in regulation, and entrepreneurial fashion. By that last one, I mean some sectors get hot for a while and then get cold or vice versa. Often faster than you can build a company. The multiple you’ll get when things are hot is considerably more than when they’re not.

Here are two ideas to give you hope if you feel your chances of being a unicorn have been dashed. There are billion dollar companies which have been privately funded. And according to one researcher I talked to, 50% of the IPOs in the last half-century did not take VC money. Better practice that jump shot.

[This article was orginally published on Medium.com]

Like most people, you turn around. You don’t say “Well I’ve invested an hour in this road, I’m going to make it work. Commitment to my goal will get me there.”

Let’s say you paid for tickets to the theater and the afternoon of the show an old friend from out of town shows up and wants to buy you dinner. You’d rather spend the time with your friend than at the theater. What will be the financial difference to spending time with your friend vs going to the show?

It makes no financial difference at all.

Yet, most people find it emotionally easier to give up the wrong road than to give up the money spent on tickets. Why? because emotionally we don’t understand sunk costs. It gets worse.

Let’s say you invested $20,000 in a machine to make widgets because you want to add a line of widgets to the framuses you already sell. Then you find out that people who buy framuses don’t want widgets. And you realize you might have to spend another $50,000 to find widget customers – and maybe more. Besides that, even if you find them, widgets aren’t as profitable as framuses. What should you do?

Don’t Succumb to the Sunk Cost Fallacy

That’s the voice in your head that says “I can’t stop now or everything I’ve invested so far will be lost.” The truth is it’s already lost. Losing more won’t bring it back. You spent an hour going down the wrong road. Going further won’t get it back. You spent the money on the theater tickets. Depriving yourself of time with your friend won’t put the money in your pocket. Same way with the widget machine.

It’s hard to do emotionally but consider this. Only future costs are relevant to an investment decision. This includes investment in time as well as money. Only future costs. Past costs are sunk. Don’t let them become an anchor.

The Original Question

How do bootstrapping start-ups in New York handle accounting?
Do they have an in-house bookkeeper or a consultant? What would be a normal monthly expense for a small company with no employees (just founders)? Where could one find a reliable accountant? There are thousands on craigslist but no way do differentiate.

My Answer

It really depends on the size and scope of your operation – and especially how many transactions you need to keep track of.  Consider the difference between functions and jobs. There are a number of finance related FUNCTIONS that every business needs to perform. In large companies some of these may involve a full time department let alone position. But in super small companies they can all be done part time by one person. The functions are needed in all companies – if there’s enough work, it becomes a job.
Here’s a short (incomplete) list of financial functions.

Bookkeeping – this function records all the transactions in a timely and appropriate way. Appropriate means not only in regards to laws and such but in a way that yields the kind of reports that the company cares about. Some companies, for example, need profitability reports by customer and job so the transactions need to be entered with that level of detail by whoever does the bookkeeping.

Collections – this function needs to know who owes you money, how much and since when (thus bookkeeping has to put that info in) and works to get the money in the door. If you have a retail operation where no one owes you money, then you don’t need anyone to perform this function.

Accountant – I’m generalizing here, but this function in a small company is usually outsourced to someone who can file taxes. They may also oversee the bookkeeping to make sure it’s done appropriately. They usually run “standard” financial reports: Profit/Loss, balance sheet, cash flow. Good ones help you understand what those reports mean.

CFO and Financial analysis – This function understands how management decisions affect the cash situation of the business. They are usually responsible for raising cash (through loans or investment) to cover the cash needs of what management decides to do. Also they should be able to run reports that tie financial data to the real world: which products are generating the most and the least profit / what does it cost to acquire a customer / what is the lifetime value of that customer.

So, back to your original question. Define your needs and work load in these various categories. Decide which ones you want to handle yourself and which ones you want someone else to do. Then depending on the scope of the work either hire someone or outsource it. To determine the qualities of that someone you want to use, ask around. Ask your lawyer or even other business owners you know who are successful. Then talk with the people and see how good they are at explaining what they do to someone who doesn’t speak accounting.

Two warnings: 1)  You should always, always, always pay enough attention to your finances to understand what is going on and find mistakes (or malfeasance) as soon as possible. You can’t outsource the responsibility. So you should not have the same person responsible to record income, make bank deposits and reconcile the bank account.

2) If yours is a start-up that is likely to grow and need to raise outside funds in the future – even if you’re bootstrapping now – then you need to have the systems set up by someone who’s familiar with what the future needs will be. Otherwise you’re asking for a large problem down the line.

We’re using principles laid out in the book The 1% Windfall by Rafi Mohammed. The title comes from the idea that if a company can increase prices by 1% and keep costs the same they will reap a windfall. BUT what’s counter-intuitive is that you don’t just jack prices up across the board. Mohammed provides over four dozen pricing tactics, some of which involve actually lowering prices.

The goal is to use pricing to capture as much revenue across all spectrums of customers by appealing to what they are willing to pay – and by doing so raise your prices by 1% while keeping  costs the same. For example, did you know Starbucks (the company famous for calling their small size tall) actually has a 4th size? In addition to Tall, Venti and Grande (that’s small medium and large to you and me) they have a size called SHORT? It’s not on the menu, but if you ask for it, you’ll get it in every Starbucks. That way they can capture extra revenue from some folks without broadcasting to everyone that they have an “extra small”  size.

I don’t have room to go over every aspect of my session here but I will give you three points. These are inspired by the book, but I’ve added a twist or two.

#1 – Customers pay for value as they perceive it.

Before you can start any pricing strategy, you must understand value from your customer’s point of view. And not all customers value the same things. By appealing to different aspects of value, you can set different prices for different customers and capture more sales and more profit.

You are somewhat familiar with how airlines do this. Every time they make a sale they sell the same product (a seat in a metal tube that goes from point A to point B). But prices change based on other things that customers value. Things such as how far in advance to buy the ticket, if it’s refundable or not, if it requires a round trip or a Saturday night say etc.

#2 – All Sales are emotional.

Even the most sharp penciled CFO who eats and sweats spreadsheets is emotionally involved in getting value for their money. And you can benefit from appealing to that emotion as well as to logic.

#3 – The point of pricing is profit not revenue.

Your pricing structure as well as related policies (like your sales commission structure, when to give discounts and what to get in exchange for them) must be developed to maximize profit. Your bottom line is more important than your top line.

Takeaways:

1. Read the book.

2. Institute a pricing strategy based on the customer’s calculation of value and your calculation of profit.

3. Call me if you need help with #2

I hesitate to say that money is what’s most important in your business, but it’s what’s most critical. Financial repercussions connect everything that happens in your business to every other thing that happens. The weird thing about money is it’s fungible – unlike almost anything else we value. Since every dollar is like every other dollar, we often don’t realize how big an impact managinge each one can have.

But when cash is tight, your company is like a person in precarious health. Normal things that most people do without thinking must be planned and monitored so they don’t have devastating consequences.

Do it when you need to squeeze every penny. Often for these reasons:

• You’ve got a lot of debt you need to pay off
• You’re growing really fast and need every penny
• You’re in start-up mode or launching a new product and don’t know when the market will respond

Companies should also do it, when they want to maximize profit. Otherwise, you can spend 20 years of your life working at something, make a living (not much more) and have a gnawing sensation that the business should have done better financially but they don’t know where the money went.

Why don’t small companies do it more better?

• They don’t know how
• It can be tedious and not as much fun as other parts of the business (thought it’s not rocket surgery).
• They think that it won’t really affect their decisions because cash is so tight. If that’s true you aren’t doing it right.

I’m working with a client who’s paid off a lot of debt and needs to start maximizing his profit. He’s just beginning to realize how critical every cash decision is. I’ll be posting how we develop the system for him to manage it.

Takeaways:

• Stay tuned for future posts on HOW to manage cash.
• In the meantime, you can see an overview of the concept here.

[tags] cashflow, business tool, manage cash, cash, profit, accounting [/tags]

Over 100 companies asking for money. 25 in “late state” meaning they had revenue of over $1million and the rest “early state.” The industries ranged all over the map. A medical device to cool spinal fluid and reduce paralysis to a replacement for terazzo tile made with recycled glass. There was a portable solar hot water heater and an online video game for women.

All of what I saw was well thought out and most was well presented. All were past the “just an idea” stage – at least a prototype and some had been in business for 10 years and were raising money for the next stage of growth.

It’s the 13th annual one that this group put on. The concensus was there were not enough investors there – perhaps it’s gotten so popular nobody goes there anymore. It also seems that Connecticut is behind the curve in organizing investors at the angel level (where I play). That may have something to do with it. I heard that nation wide in 2005 angel investors put up the same amount of money as VCs but they put it into 49,000 deals where as VCs funded 3,000 (not sure those numbers are exact, but the scale is).

I found 3 companies that look interesting. Not sure I’ll put money into any of them but I’ll continue my research. Mostly I made some good connections for a company I’m working with and with some other investors to learm more about how this game is played.

I’ll keep you posted.

Profit – Return to Owners or Invest for Growth?
The fourth reason money goes out of a business is the best of all. Profit. When COGS is covered, the bills are paid, and the lenders/investors are getting their fair share, what’s left is profit. Probably why you started the company in the first place. Before I tell you how to spend profits (really, it’s not obvious – at least not completely) let me draw a distinction for you.

Owning a Business vs Owning a Job
When you own a company but don’t work there (say you buy shares of a public company) you only get money if the company shows a profit, and the board decides to give that profit to investors as a dividend. However if you work there you get money for the work you do. Most small business owners don’t really make a distinction about how they earn the money they get from their companies. But I suggest you do.

Here’s how:
Step 1. Write down how much you take out of the company on an annual basis.

Step 2. Figure out what you do for the company and what it would cost (at fair market rates) to replace what you do. You may not be able to replace yourself all in one shot. Perhaps you’d have to hire 1/2 a salesperson, 1/3 of a CEO and the rest little bit of everything. Total that all up, and assign it to the right section as if it were an actual cost. If all the money you take out comes from COGS and OVERHEAD or if it would cost you more to replace yourself in those areas than you take, then you effectively own a job.

Step 3. If you could pay to replace yourself and still there’s more money that you take out, figure out how much you’ve invested in the company and what a reasonable payback would be if you were an outside investor. That’s what you’re earning from your investment in the business.

How to spend profits
If, after step 3, you still take more money out of the company, then the company is truly showing a profit. Now you have a choice. You can take that profit out of the company and split it among the owners. This is what a public company does when it declares a dividend. Or you can reinvest that profit in the company in some way that adds capcaicty: new locations, new equipment, moving into a new market etc. If you have to put that “profit” back in the company to buy inventory (COGS) or keep the lights on (Operations) then it’s not really profit.

If you do decide to reinvest your profit, you should do an analysis like an outside investor would. Figure out how much additional capacity (sales) your new investment should bring in. What extra costs will you incur before sales reach that point? When they do, how much of the new sales will go toward new COGS, how much toward the increase in operational expenses and how much should be left to pay back your investment. After payback, how much profit will there be?

That will help you decide if it’s a wise way to spend your money.

[Disclaimer: I’m speaking here in conceptual terms. The mechanics of how you pay yourself and how you reinvest have various tax and legal ramifications. These differ with your situation and the legal entity of your company. You should consult a qualified tax and legal advisor before you take action. I am neither. Use this information just for making conceptual decisions.]

Says Seth Godin. I think he gives a pretty good alternative.

Takeaways:

• Not all VC funding is bad for every company.
• Thinking that funding is always the solution is bad for every company.

In case you missed it: Part 1 – Part 2 – Part 3 – Part 4

Payback

Payback is the third reason for a company to spend money after COGS and Operations. I don’t mean payback as in sending some goon out to break a bunch of kneecaps. Payback is what I’m calling the money you use to pay back lenders and investors who gave you cash to get the business going. If it’s a loan, the payments are usually figured as overhead, because you have to pay them every month. If investors contributed the funds, payback is usually figured as a dividend, or share of profits or maybe return on investment. It’s not usually figured all in one place, after COGS and Operations. And that accounting methodology has made it harder than it should be for entrepreneurs to raise financing. Let me explain.

Entrepreneurs tend to focus on potential (size of the market) and cash flow (making it through the month paying all the bills). Investors and lenders know that after paying all the bills there has to be something left over to pay back their investment and make a profit on it. Sure they want to see potential, but they also want to know how long it will take before there’s enought money to pay them back without hurting the operations. And they want to see that the risks of them never getting paid back have been minimized. So if you want to raise funds, be prepared to show how you’ll pay back your investors from cash flow, and when. Thinking about it as a separate category makes this easier to show.

Tech bubbles happen when investors too, forget about this and figure they’ll get paid back by selling the company to GOOGLE for $25million. But I digress.

I suggest that when you do cash flow projections you separate all the people you’ll pay into groups. Put the payments for COGs in one group, the payments for operations in the second group and the payements to payback in the third. This should show you and investors how much cash will be available to return their contribution, and when.

Takeaways:

• Use a separate category to show how you’ll have money to pay back your loans and investors without hurting the cash you need for COGS or Operations.

What do you call a person who speaks two languages? Bi-lingual. What do you call a person who speaks three languages? Tri-lingual. What do you call a person who speaks only one language? An American. – Old Joke

Numbers are the language of business, yet many business owners don’t really know that language. They survive, but not as well as they could. My learning of this language has been completely self-taught, as a result, my understanding is less than orthodox. In some ways that’s better.

• I’ve tried to learn to use the language, not to produce reports that I’m “supposed” to have but to actually accomplish what I need. Usually what I need is some basis for making a decision. The language isn’t designed for that, but the process of learning it myself has been very helpful.
• Because I don’t know the language very well, I don’t trust my understanding of it, I usually come at a problem from several different angles. If they all point in the same direction, I’m reasonably confident that I’m on the right track. But I don’t stop looking for a new angle. This has given me confidence in my decisions through tough times.

You’ll see the ideas above in the numbers below. Advice for MBA’s and accountants: You are schooled in numbers: the language of business. But knowing the language doesn’t mean you have anything to say. If you want to help entrepreneurs, you have to learn to use that language in the context of what a small company needs.

Here are 5 numbers every business owner should know.

#1. Your COGS – Cost of Goods Sold. As a percent, this is how much of every sales dollar goes to buy the material and make it into a form that it will generate that sales dollar. If you sell only a few things, you should know your COGS for every product. If you sell a lot of items, perhaps you can group them and figure your COGS by product line or market. If you do a lot of custom work, you may need to figure out your COGS for each sale.

#2 Your Gross Profit in dollars per month. This is what’s left after you subtract COGS from your sales. This dollar amount has to cover overhead, payback and profits. It’s also the lowest price you can sell your next widget for without actually paying the customer to take it. Obviously you can’t sell them all at this price or you’d never cover overhead. But if you hit a dry spell and want to keep your crew busy, or if you want to entice a new customer with a loss leader, this is as low as you can go without really taking a loss. Gross Profit as a percentage of sales is called Gross Margin. You’ll need the margin for the next one.

#3 Value of your next customer. Here’s how it works. You take the dollar amount of your average sale TIMES the number of sales the average customer makes over their lifetime as a customer TIMES the Gross Margin. This is how much money your next customer will put in your pocket.

EXAMPLE: Let’s say you run a country club. Your average member stays a member for 5 years (60 months) and spends $1,000 a month in dues, green fees and restaurant meals. Your COGS for all that is $600 a month. So your gross margin is 40%. Your next average customer is worth $24,000: $1,000 per month sale TIMES 60 months TIMES 40%

CAVEAT: This is only true for your NEXT customer. Or the next number of customers you can serve without adding to your overhead, or making some capital expense. But in that context it can be useful to determine ways to increase the value of each customer (“You want fries with that?”) and you use it to compare to #4

#4 Cost of acquiring the next customer. This is money spent on marketing, advertising and sales DIVIDED BY the number of new customers that effort brings. Effort that brings in more value than it costs is worth it.

#5 The Magic number. Every business has one number that summarizes the health of the whole business – usually on a daily basis. Sometimes it’s obvious: a hotel uses % occupancy, a restaurant, the # of meals sold per night. But sometimes it helps to get creative. One manufacturer used the weight of all the items they shipped out in a day. It turns out for them, pounds on the shipping dock did a good aggregation of profit margins in different product lines. One restaurant owner used the number of people in line at 8:30 PM. If there were a lot of people waiting, his staff turned tables quicker to sell more meals. If not, they encouraged dessert and after dinner drinks to sell more that way.

The Magic number for a start-up is always your break even point. You must know that. When you hit it consistently you’re not a start-up anymore.

Takeaways:

• Know your numbers.
• Make them easy to use and train your staff to use them.
• Be sure you know what assumptions your numbers are based on. The Apartment industry has been using Occupancy Rates as a magic number. But recently as their market went south, staff would give away concessions (free rent) to entice people to sign leases. This kept their occupancy (and presumably bonuses), high while profits tanked. It took some companies a surprisingly long time to figure out this disconnect.