The Scales of Time

Success in business is almost always about scalability. Making one of anything takes time and money, and of course you have to put in that time and money to create the first one. That's called investment. But after the first one, the second one should be faster, and cheaper, and hopefully better as well. As a lifestyle, you might enjoy doing custom work for every customer, and there are a few businesses that can grow and thrive this way. But if you want investors and they want to be able to monetize their investment (i.e., sell their shares for a lot more than they paid for them) in a few years, the business has to scale to a large enough size and then be sold, bought back, or go public in order to get their money out.

How far how fast

This brings us to the question of how much it has to scale and how quickly it has to do so. And the answer is generally, the further and faster the better. But be realistic. If you tell me that you will be going from one unit tomorrow morning to a million the next day, I am unlikely to believe it, even though on the Internet it is theoretically possible. What angels need to see is a clear plan to get from here to there. If you are reaching a million customers in a day, or a month, or a year, or ever, you will need to show me the nature and size of the market, the paths to reach it, historical reasons to believe your claimed growth curve is possible, how you will get what share of it, how you will defeat the competition, how you will support it, and so forth. And likely one of the folks I will be working with will have a lot of very specific experience in a very similar thing.

Back to the back of the envelope

In last month's article, I identified an example of growth of a factor of 6 every year for two years as being infeasible per the plan in place. To be clear, a growth of 6x per year for two years is completely reasonable for many startups. I have a company that can easily achieve that level of growth. In fact, almost a year ago, we did the calculations and analysis to show a growth of a factor of 20 in a year and more than 100 in 2 years. The only thing it lacks is the ability to generate that many sales that quickly. That scaling requires sales people with a proper sales sieve, which we do not yet have. I will get to that in a few months...

Economy of scale

Part of the thing you had better get from scaling is economies of scale. Otherwise, to double your profit, you have to double everything else. At first, that might seem acceptable, but pretty soon you come to realize that you cannot double yourself, at least not very many times.

The shoemaker who makes one pair of shoes at a time, custom fit to the individual, still exists. The most successful shoemaker of this sort today does what they did centuries ago, perhaps a bit better and faster because of tools and dyes, and they have a lifestyle that they support this way. It can be a good life and is likely to still be here for quite some time. They sell over the Internet and make shoes that cost hundreds of dollars, or sometimes thousands. And some of these shoes fit like a glove! But as an investor, I cannot put $25,000 into a shoe business of this sort and expect any reasonable chance of getting $250,000 out of it in 3-5 years. And that is the minimum start for a serious angel investor.

Both the economy and the scale

To be clear, (1) staying at the same net per unit while scaling or (2) staying at the same scale but reducing costs or increasing price, will almost never get you to where you need to go. You need to do both at the same time.

The problem of scaling without economy is that until the bottom of the cost factor is met, competition has the potential to eat your lunch, particularly when have already built the market for them and they don't have to experiment as you did to get to where you are. Economy brings barriers to entry as well as higher profitability and a capacity to sustain longer in a more competitive environment.

The problem, of economy without scaling is that you increase margin on each item, but you can only go so far in economizing. Even if you get to $0 in cost per unit, you are limited by the number of sales times the price per unit.

Finally, business is almost always a race. No matter how good or advanced you are, time waits for no one. Eventually competition will show up if you have a business worth having. Fast and steady beats slow and steady every time.

Weighing my investments

It's worth returning to the factor of ten in three years as a minimum expectation. First off, it's hard to do this in reality. While starting at $0 gives you an infinite growth factor as soon as you get the first penny, getting the rest of that dollar, and ten more of them, then a hundred, thousand, ten thousand, hundred thousand, and million get progressively harder. A good wage for a worker today in many fields is about $100,000. Add 50% for overhead, and you need to produce sales after cost of goods sold of $150K per worker to break even. Another way to think of this is that you could make $150K in effective wages (all those benefits are expensive, aren't they?). So that's the starting point for your time. The first factor of ten increase that counts will have to get you to $1.5M/y in pre-tax net in 3 years. The next factor of ten will have to get you to $15M/y, the next one to $150M/y, and so forth. In order to sell for a handsome return on a substantial investments, you will need to reach $50M/y in sales and suitable profits. A factor of 10 return on investment in 3 years starting at one person at $150K/y means $15M/y in net in 3 years and lots of growth potential left.

Why do you have to be that good? It's simple. Because most businesses are not. As investors, we cannot always tell which ones will work and which ones won't. We have to get that kind of return from some companies to make up for the losses and lesser returns from others. So every investment (read bet) we make has to have a lot of potential and a clear path to achieving it in order for a small portion of them to realize their potential and make our investments worthwhile.

I would be exaggerating (lying?) if I said I could do this

Don't exaggerate or lie. And don't worry that this goal is beyond what you think you can do today. I look at 100 proposals per month and most of them don't have a realistic chance of getting from here to there. Exaggerating doesn't change that. It just costs more time and effort for me to find out that your asserted facts are not true. That means you might get to due diligence but not likely through the other end of it. And that means that you will make the angels unhappy with you. Like the little girl who cried "wolf!!!" you will then be ignored when you have a really good opportunity, and eventually you could get eaten by the wolf.

Rather than exaggerate to get from here to there, get in touch with the angels. They are not just sources of money. They often help turn pretty good ideas into great ideas and pretty good businesses into great businesses. That's why they call it "angel" investment.

Copyright(c) Fred Cohen, 2016 - All Rights Reserved