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Tuesday, April 24, 2012

The Art of Growing a Company


EMOTIONAL PURSUIT

While starting up, the initial emotion many entrepreneurs face is fear. For many a hopeful entrepreneur, the initial reactions are mixed, ranging from “probably it is not the right time to start-up” to “may be it is impossible for me to start-up,” primarily due to the opinions you hear from the investing community. Phrases like “we invest in only 50 million dollar companies” or “we look for a management team with track record” or “we are not funding now” send a shiver down every potential entrepreneur’s spine.
This is a reality today. The market situation is such that you may not get funding. But I want to pose the question “is there life without funding? Can you start a business without funding?” I say that it is possible and one need not lose heart. Garage start-ups were always the time-honoured method of starting up. I am not making a case for bravado. It is quite likely that most of you may not start up immediately. It might not even be the most ideal decision. But the option to start-up immediately exists, is possible, and can be done. What you have to be aware of are the logical issues arising from a decision to start-up immediately, its implications, and how you can manage them.
At the end of the day, entrepreneurship is not a cerebral kind of pursuit you can put inside management matrices and analyse—it is an intensely emotional  pursuit. You can read up on management literature, you can get the theory but it is really a gut-wrenching kind of an experience. It will take everything out of you and very rarely will you be prepared on the emotional front—which is really the most important aspect.
A typical management framework will highlight the following likely steps: you analyse the opportunity, you find out the idea, start the company, go through a ramp-up process and finally do an IPO. That is true. But what does it feel to actually go through the steps? From my experience and those of people I know, most entrepreneurs tend to go through certain stereotyped phases. I have found this out from personal experience, from other people who have started out, and from those people who wanted to start out but could not.

CONFUSION

The first stage which I call as the stage of confusion is one where you have the intense desire to start-up. You might not be very sure how you will start-up and  thus have a very high likelihood of going through this phase of confusion. Betraying my MBA background, I have tried to divide this into the three “F”s — Fright, Flight, Fantasy.

Fright

The first phase is fright. If you have always been a performer from an academic background where failure is not tolerated and you have never failed in your life, the first question always is—will I fail? The second question is: “my colleagues are getting into a corporate job. From the first month onwards, they are going to get paid an amazing amount of money. I do not know what my future is. Will I lose out?” In our parent’s generation, all of us have heard horror stories of “uncle x” or “cousin y” who miserably failed in business. Your nightmare will be whether you will be this generation’s
example. Your fright will lead you to rationalize thus: “maybe I will start in a corporate job first and then I will actually start out.”

Flight

The second phase is what I call flight. Your idea may be good but there is no guarantee of success. Your inability to find a “guaranteed success plan” leads you to flight from idea to idea. You suddenly get a brainwave and you become extremely excited. You think that this idea seems to be good but the next day you wake up and talk to some people and suddenly realize that it may not be so great. You get depressed. You jump to a second idea and repeat the entire cycle. You keep on hunting for that perfect idea. Stories like “this friend of my friend started a business and it is doing 100 million dollars now” or a cover page on the “youngest billionaire” frustrates you no end since these people have somehow crossed the threshold and are on the fabulous shores of success. You keep on thinking, “why am I not getting the idea? Why can’t I focus on something?”

Fantasy

The third stage is fantasy. If you are one of those people who are not starting with a clear idea, you might start fantasizing and rationalizing that whatever idea you have is actually the killer idea. This is a dangerous stage. When people tell you that your idea will not fly, you disregard it since it is your baby and it is really the only idea you have. You mould your perception to suit the situation.

CROSSING THE THRESHOLD

Probably 80 per cent of would-be entrepreneurs would not cross the three stages discussed above. People who manage to cross this threshold have made the first serious step. What happens after you cross the three stages? Again I use MBA speak—the three “Ps”.

Peer Pressure

The first is peer pressure. You decide to break the news to your family and loved ones. They are not likely to be thrilled. You start facing resistance and start thinking, “should I really start out?”

Procrastination

The second phase is procrastination. The impact of your decision slowly starts sinking in and you suddenly become aware of industry pundits who claim “entrepreneurship is at an all time low” or “corporate jobs are the best bet now.” There would be this study from a leading international management school which claims that there is a close correlation between the timing of start-ups and IPO performance which ends by saying “you should not start now, start three years later.” So lots of people postpone the decision and think about going for a second MBA in the US.

Poverty

The third stage is poverty. You start planning out your financial requirements and you suddenly realize that you may not have enough money saved up. So how do you survive? You start thinking: “may be I should work for eight months and save up.”
But, when it comes to-crunch, only you can find the answer. The question is a Hamletian “to be or not to be.” Really, there is only one way to do it. Starting up is like jumping off a cliff—you close your eyes and do it. There is no other answer. If you want to start, just do it. But it does not mean that you just blindly jump. Before jumping off, we have to pack some practical baggage and what are those?
First, definitely a parachute! Carry at least six months of financial expenses. This is important when you are starting out since you will be generating clarity for yourself. When you are looking at opportunities, the last thing you want to worry about is survival money. Questions like “how do I get my food? Can I pay my rent?” should not be a drag on you.
Second, develop an activity plan for the first month. The first 30 days would be full of confusion and there will be a million things happening. So, before you actually are in that stage, try to chalk out a 30-day activity plan which will make your transition into entrepreneurship easier.
Third, carry plenty of “hope.” Ninety-nine per cent of us start out with dreams of striking success immediately. The reality is that it rarely happens. When it does not happen immediately, hope is the only thing which will help you carry on. However, there is a rider—use your “hope” wisely. When you are in the market for six months and you keep getting negative reactions, hoping against hope can be dangerous and can easily turn to “blinders.”
Finally, pack up your “ideals” and stow them away. The market is cruel and your only objective is to survive. Do not throw them—you will get the opportunity to use them later. But, do not ever confuse your ideals with your main objective. You might want to be a philanthropist, you might want to help people—but first you have to survive. I have seen enough people who try to implement their “ideals” before they survive and end up with neither ideals nor a business.

START-UP: KEY ISSUES

How Do You Set Up a Team?

Two important aspects are composition of the team and delineation of responsibilities. If you start out fresh, most often your team would comprise friends where everyone is equal. You tend to confuse friendship with professional equality. Everyone in an organization cannot be equal. If the line of responsibility is not clear, how does the organization take decisions? Is there one person with whom the buck finally stops? We need to realize that responsibilities can never be equally shared. You need a leader. If something is not working out, there has to be someone who will stand up and say, “I am responsible.” And, when it comes to the crunch, somebody has to say, “this is the way we will do it, may be it is wrong or may be it is right. This is the only way to go ahead.” I am not advocating autocracy but a clear understanding—not only an intellectual understanding but also an emotional understanding that when it comes to the crunch, there is one person who will take the call.
With start-up among friends, the first and foremost rule is “do not start off with clones”. Most of us are friends because we are from the same background with the same expertise. That does not work in a business setting. The whole idea of a team is to complement each other. So the first rule is to try and get variety into the team.

How Should Equity be Divided?

Let us look at a situation where four or five of you are starting up. How will you divide equity? I recommend unequal sharing of equity. The leader should have the highest equity even if it is higher by one share. A company cannot be run as a cooperative. Higher responsibilities have to be matched with larger equity. For most of us, it is an extremely difficult step to take since it is counter-intuitive and does not feel “right.” When friendship is involved, it can be quite difficult.

When and How Should You Go for Fund Raising?

A fundamental question today’s entrepreneurs face is whether to start with or without funding. As I read somewhere, the three traditional sources of money are friends, fools, and family. You can still start a company with these three options.
However, if you decide to go for fund raising, guard against unscrupulous financiers. When you are young and desperately want to see your ideas succeed, you can make a wrong choice and get eaten up. People might tell you “I will give you x amount and I will take 75 per cent of the company.” And, you might take the money rationalizing that “you still have 25 per cent of the company.” If you really require large funds for starting up, may be this is the only way to start out. But, in that situation, you should go to people with track records instead of “fly by night” operators. However, if you can generate revenues by less capital-intensive service models, why should you raise funds?

Do You Consider “Equity” as Cash?

In the initial stages, entrepreneurs need advisors, lawyers, and “contacts” for business development. One common mistake is to overuse the option to pay for service with your equity. When you are starting up, equity seems the cheapest currency. Unfortunately, as the company keeps growing and valuation changes from a notional valuation to a real valuation based on revenues and cashflows, the true value of equity becomes clear. You should conserve equity to the maximum extent possible.

FIRST THOUSAND DAYS

Let us assume you have crossed all these hurdles and have actually started out. What happens now? Once the business starts, there is a saying that “the first 1000 days define success or failure.” It is in these first 1000 days when you really experience the emotional roller coaster associated with entrepreneurship.

Initial clients take advantage of you:

You will struggle very hard to capture clients. When you are starting out and have no track record, clients are unlikely to pay market rates. When you go to a client, he immediately thinks, “here is a bright young guy, I can get a project out of him by paying him Rs 100,000 when I am paying an existing guy Rs 1 million.” So he will tell you to do the project for him at Rs 80,000. At that point, what do you do? You have a company to run. So you go ahead and do it.
You will constantly fight this pricing war. The only way to get out of this pricing cage is to grow stronger and stronger till one day the equation changes. Obviously, this is applicable only to a garage start-up. If you have sufficient financial muscle, you will not necessarily go through the
above experience. I am narrating the worst-case scenario.

You face delays in payment: 

It is a truism that the strong crushes the weak. You do not get paid on time. They will tell you “I will give you Rs 100,000” but at the end of the day, they will not give even Rs 80,000—that too after a three month delay. What can you do? You have to face it and understand the fact that this is the name of the game. You cannot get depressed about it.

You become Jack-of-all-trades:

When you are starting out with a small team, you have to be jack-of-all-trades. Unfortunately, you cannot have a specialized finance or an operations guy. You might have to do accounting, coding or whatever the situation calls for—the bottom line is this : nothing is beneath dignity. At the same time, you necessarily have to be the master of all. There is nobody else who is going to stand up for you. If your accounting is not done properly, if you have not planned your cashflows properly, you yourself will pay the price.

Have your priorities clear:

I had this interesting experience. We went to the office of a newly funded company and we were actually amazed to see a state-of-the art “recreation room” filled with dart boards, TT tables, video games, etc. The company’s argument was “we want to keep our employees happy. They need to be motivated so that tehy can both party and work hard”. The company did not have a single product or any revenue in its books. It later faced cashflow problems and was on the verge of closing down. The moral of the story is— have your priorities clear. Dart boards can happen later. Your first priority is to succeed. Make money. All the rest flows automatically. This is obviously not to say that you cannot have employee satisfaction programmes or benefits. But you have to spend money appropriately—if you do not absolutely require a glass-fronted, four-storied corporate house—do not take it.

Change is constant : 

Everything changes constantly. You will change. Your original ideas will change once they hit the market and your business itself might change. You have to be flexible. Typically, you start off with an idea and hit the market. You might succeed or realize that probably it is not doing very well. You still keep on thinking that the market is just not “seeing” the true value of the product. You do not change. You become so wedded to your idea in its original form that you cannot do anything else. You will fight on this sinking ship and see it go down.
On the other hand, if you are intelligent enough to listen to the market signals, you might realize that your product is not what the client wants. You realize that adding two extra features can make you succeed. You change your plans and hit the market once again.

Changing relationship dynamics: 

When you start out, you tend to form a very close-knit team—almost a family. But, over time, people change and some of them might leave. It might be because you cannot pay salary on time or things are not working out as expected. A typical entrepreneurial reaction is to go into depression. You tend to think, “he/she was my friend, he/she was my family, how can he/she leave?” This is going to happen to all of us. The earlier we learn to accept this reality and be focused on our objectives, the better it is.

You are not your own master:

There is a common feeling before you start up that once you are an entrepreneur you are your own master: “I do not have a boss. I can do whatever I like.” I can guarantee you one thing—if you start coming to the office at 12 noon, your employees are likely to be there only at 11.45 am. If you take a vacation, they will also demand a vacation. Your responsibilities are going to be the sum total of the responsibilities of the organization. There is no running away from that. Your responsibilities will increase rather than decrease.

“HARD” ISSUES

Finance

You start a company, you have a product, you have a solution. You go into the market and slowly money starts coming in. Typically, what happens now? The first flush of money makes you lose your balance—you may buy a swanky car, move into a plush office, and have an acre-wide director’s table. You think that your investor will support you even if you run out of money. You have made your first critical mistake which is not building up a war chest to tide over bad days.
You have to understand this vital point—“cash is king.” Only after you go through a cycle where you do not have cash would you actually understand the importance of this truth. Even if you cannot appreciate its importance today—hoard cash during early days. If you are one of the lucky few who built a company without going through a cash flow crisis, you will find one day that some unfortunate decisions you took have impacted your cash flow and led to a crisis. On that day, you will realize that even though you have clients, even though you have built up your reputation, even though you have employees — they are of no avail when you run out of cash—because cash is the life- blood of an organization.
If cash is king, then debt is the prince. Even if you have investments from a venture capitalist, do not blow up your investments. I am assuming that you have a product or a service that is capable of generating a cash flow. Go and raise debt. Put the investment money into a fixed deposit and raise a loan against that. Do everything possible to stretch your cash—your margins might suffer, but it will be for a worthwhile cause.

Marketing

You should hit the market early. Many entrepreneurs succumb to the temptation to keep on refining their product or service instead of hitting the market early. This is especially common if you are developing a technology product. You must realize that market is the truest advisor you can get. Even if it is version 0.9, go to the market and test it out. The market might give you signals that ‘feature x’ is not right or ‘feature y’ is required or the pricing is not right or even that the entire product is of no value.  If you realize that early enough, it is better for you.
            Secondly, getting your product to speak for itself is the most efficient marketing method. If you do a good job with the first client, he will talk to five other people. You can then leverage this cycle.
Thirdly, you should not use expensive options when cheaper marketing options will suffice. You should do cross-selling, cross-subsidization, partnerships, in fact, anything that can give you reach at low cost.

Technology

Technology can be one of the most powerful weapons an entrepreneur can have to steal a march over competitors. If you build appropriate technology to reduce your costs or improve quality, you have a very powerful asset for success. However, the operative word is “appropriate.” I knew this example of a company which started off with a sizable investment. The first thing it did was to make a website with the latest technology and host it with the most advanced hardware available which cost it Rs 6-7 million. Almost 50 per cent of its investment was put into a website to which customers never came since they could not spend enough on marketing. They ran through 60 per cent of their investment in just the first three months.
Essentially, your motto should be :  if having cutting edge technology is not critical, low tech is high tech. If you can work on 486 machines, work on them. However, if technology is a core focus, by all means, go out and build technology which is better than your competitors.

Partnership and Alliances

Partnerships and alliances are theoretically very useful. However, for a start-up, when you are small,  it is quite difficult to build any kind of meaningful partnerships or alliances.
To have real partnership, you need to own something of value. Ideally, both of you also need to be of comparable sizes. In the initial stages, you are unlikely to have anything of value to a large partner — your discussions and meetings frequently come to naught. So, before you get into partnering, figure out whether you have what the other guy wants. That is a useful lesson we learnt the hard way—krills are good only as food for whales. It is much better to grow fast and then talk as equals.

THE JOYS OF ENTREPRENEURSHIP

In the midst of all the gloom and doom, is there happiness? Yes, there is! You slowly start seeing your dream take shape. You see clients starting to show respect, you get excited about new possibilities, and new faces join the organization. You realize that you are on a winning track. So, during your initial 1000 days,  what is your primary objective? Your objective is to grow at any cost. Grow, grow, and grow more. You should do whatever is required during the first 1000 days. You have to work very hard—that is the only way you can succeed.

GROWTH

Suppose you are one of those lucky few that have made it through the first 1000 days. You have actually built a company which is showing profits. You  can  see  a healthy client list, your revenues are increasing,  and your company is taking shape. Then comes the difficult part.
I have heard from people that the most difficult part in the lifecycle of a company is when growth happens and success is at hand. Even moderate success can be dangerous. In the initial stages, things are so tough that you are just trying to survive and nobody has any time to think about anything else. When money comes in and you feel the survival pressure lifting, suddenly, egos start kicking in.
Apparently, Indian entrepreneurs are happiest during tough times because this is something that really gives them moral courage and certainty. When things are bad, they will fight. But, they cannot handle success. They go to pieces at the first sign of success. The moment money comes in, they will take an extended vacation, join industry association, and will generally do everything but focus on the business. This invariably ends up in disaster as business goes down and clients suffer. The organization achieves a fraction of the potential it could have achieved if sustained focus had been generated in growing the business.
So, the first question an entrepreneur should ask himself is—“do I want to grow? What is it that I want to get out of entrepreneurship?” You really do not have to go through growth pangs if your psyche is not built for that; you have to decide whether growth is right for you and be prepared for the issues arising out of growth.
Second, if your objective is to build something substantial, something really world class, you should not lose focus. Great companies are built by continuous effort which pushes the organization from moderate success to great success.
Third, to keep growing, you have to constantly separate out the investor in you from the “entrepreneur-manager.” Your returns are going to come not from salaries but from appreciation of the equity. While your role as an employee in the initial phases of the organization is critical, in the later phases, your role as a financial investor becomes more and more important. On many occasions, your equity appreciation might happen through somebody else playing the role of a CEO or a Chief Marketing Officer. You might be most effective as a sleeping partner. You have to learn to let go and start trusting other people. Only when you separate your two roles would you realize that your potential returns could be hundred times more than what is evident today. You will then have the motivation to focus on organizational growth on a sustained basis.
The fourth issue is recruitment and retaining. You always go through a chicken and egg situation where good people would not join you because you do not have money—but to generate money, you need good employees. You have to break out of this vicious cycle by necessarily building enough money via internal accruals or by getting an investor. Only when you break this cycle can you get to the next level.
Fifth, as your company keeps on growing, your importance as an individual to the company inevitably keeps on diminishing. Your organizational evaluation and reward structure needs to reflect this reality. Initially, you would have brought in all the business but today your marketing chief is bringing all the business. So, you may not continue having the same equation you had in the initial days. If important people in your organization do not have equity, you have to give them equity. This ensures that they are aligned to a common organizational vision.

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