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the firm to the point where its cash flow is positive. Showing how a new venture’s start-up costs will be covered is an important issue. Many entrepreneurial ventures look promising as ongoing concerns, but have no way of raising the money to get up-and-running, or are never able to recover from the costs involved. When projecting start-up expenses, it is better to overestimate rather than underestimate the costs involved. Murphy’s Law is prevalent in the startup world—things will go wrong. It is a rare start-up that doesn’t have some setbacks getting up-and-running—whether it involves unanticipated expenses or delays getting to market. In terms of raising the money needed to start a firm, you will read many anecdotes throughout this book of savvy and creative ways that entrepreneurs cover their start-up costs. For example, as we discussed earlier, David Bateman, the founder of Property Solutions, raised $100,000 in cash and in-kind services by winning two prestigious business plan competitions. Similarly, Derek Gregg and Justin Swick, the entrepreneurs featured at the beginning of Chapter 10, raised over $250,000 through business plan competitions and grants to get their firm, Vandalia Research, off the ground. While participating in business plan competitions and applying for grants is hard work, in many instances these and similar types of efforts make the difference between a successful start-up and an idea that has to be dropped because of lack of funding. Financial Performance of Similar Businesses. The second component of financial feasibility analysis is estimating a proposed start-up’s potential financial performance by comparing it to similar, already established businesses. Obviously, this effort will result in approximate rather than exact numbers. There are several ways of doing this, all of which involve a little ethical detective work. First, there are many reports available, some for free and some that require a fee, offering detailed industry trend analysis and reports on thousands of individual firms. The most promising sources are shown in Table 3.5. Bizstats.com (www.bizstats.com), for example, provides a wealth of information for free. On the Bizstats Web site, entrepreneurs can type in the projected revenue of their firm, by industry classification, and receive a mock income statement in return that shows the average profitability and expense percentages of U.S. small businesses in the same category. Similarly, Bizminer.com (www.bizminer.com), which is a for-profit company, sells a wide variety of industry-related data and statistics. A portion of the company’s Web site is designed specifically for start-ups and provides information to help entrepreneurs understand how businesses similar to theirs are doing financially. Substantive reports can be purchased for as little as $99. There are also ways that entrepreneurs can track sales data, in particular, through simple observation and reviewing public records. For example, the fictitious firm New Venture Fitness Drinks, discussed earlier in the chapter, could gauge the type of sales to expect by estimating the number of people, along with the average purchase per visit, who patronize similar restaurants, like smoothie shops, in their area. A very basic way of doing this is to CHAPTER 3 • FEASIBILITY ANALYSIS 87 TABLE 3.5 Resources to Help Entrepreneurs Understand How Businesses Similar to Their Proposed New Venture Are Doing Financially Source Description Cost Bizminer.com Has a wide variety of industry-related data, statistics, and other Fee-based information. A section of its site is dedicated to new ventures. Bizstats.com Has a variety of detailed financial data on various retail categories. Free On the site, entrepreneurs can type in the projected revenue of their firm, by industry classification, and receive a mock income statement in return that shows the average profitability and expense percentages of U.S. small businesses in the same category. Hoover’s Online Brief histories and financial information on companies, industries, Typically free if accessed people, and products. Provides access to detailed financial information from a college, university, and 10-K reports for publicly traded firms. or public library. Marketresearch.com In-depth research on industries and various retail categories. Fee-based Provides data on more difficult-to-understand industries, such as biotechnology, health care, and all forms of technology.
88 PART 2 • DEVELOPING SUCCESSFUL BUSINESS IDEAS frequent these stores and count the number of customers who come in and out of the stores during various times of the day. Another technique, which may be less precise for a start-up, is to study the annual reports and 10-K forms of similar publicly traded firms. For example, some restaurant chains actually report their average sales per restaurant. This type of information could help the owners of New Venture Fitness Drinks sharpen their own sense of the financial potential of their firm. The purpose of this entire effort is to get a general sense of how firms that are similar to a proposed new venture are doing financially and whether the financial performance of similar firms is excellent, good, moderate, or poor. This is admittedly harder to do for a start-up that’s unique and doesn’t have a good set of peer firms. But for a start-up like New Venture Fitness Drinks, there is plenty of information available to get a good sense of how small beverage restaurants are doing. The information collected to complete this stage of feasibility analysis can also be used in preparing pro forma financial statements at a later time. Overall Financial Attractiveness of the Proposed Venture. A number of other factors are associated with evaluating the financial attractiveness of a proposed venture. Typically, these evaluations are based primarily on a new venture’s projected financial rate of return (i.e., return on assets, return on equity, and return on sales). At the feasibility analysis stage, the projected return is a judgment call and is based primarily on comparing a proposed venture to similar businesses, as just discussed. A more precise estimation can be computed by preparing pro forma (or projected) financial statements, including 1- to 3-year pro forma statements of cash flow, income statements, and balance sheets (along with accompanying financial ratios). This work can be done if time and circumstances allow, but is typically done at the business plan stage rather than the feasibility analysis stage of a new venture’s development. Detailed information about how to prepare pro forma financial statements is provided in Chapter 8. At a macro level, the following factors should be considered to determine whether the projected return is adequate to justify the launch of the business: ■ The amount of capital invested ■ The amount of time required to earn the return ■ The risks assumed in launching the business ■ The existing alternatives for the money being invested ■ The existing alternatives for the entrepreneur’s time and efforts There are conclusions that can be reached from evaluating these factors. Opportunities demanding substantial capital, requiring long periods of time to mature, and having a lot of risk involved make little sense unless they provide high rates of return. For example, it simply makes no economic sense for a group of entrepreneurs to invest $10 million in a capital-intense risky start-up that offers a 5 percent rate of return. Five percent interest can be earned through a money market fund, with essentially no risk. The adequacy of returns also depends on the alternatives the individuals involved have. For example, an individual who is thinking about leaving a $150,000-per-year job to start a new firm requires a higher rate of return than the person thinking about leaving a $50,000-per-year job. 34 A number of other financial factors are associated with financially promising business opportunities. Again, in the feasibility analysis stage, the extent to which a proposed business TABLE 3.6 Financial Feasibility • Steady and rapid growth in sales during the first 5 to 7 years in a clearly defined market niche • High percentage of recurring revenue—meaning that once a firm wins a client, the client will provide recurring sources of revenue • Ability to forecast income and expenses with a reasonable degree of certainty • Internally generated funds to finance and sustain growth • Availability of an exit opportunity (such as an acquisition or an initial public offering) for investors to convert equity into cash
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