Startup Companies are Unwise Speculations

Startup Companies Are Unwise Speculations
By William Cate
July 2004
[http://home.earthlink.net/~beowulfinvestments/]
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]

Business is risk.

Wise investing requires creating a favorable balance between the odds of capital loss and the potential of profit from the company's success. Investing should always be a question of finding a favorable Risk/Reward Ratio. Investors who speculate in startup companies are betting against very long odds. They can’t make a profit speculating in a series of startup companies because the Risk/Reward Ratio is always against them.

The U.S. Small Business Administration (SBA) reports that about fifteen business startup companies out of one hundred succeed for at least five years. However, their fifteen success stories include franchises and professional services companies, which have a far higher success rate than the average Startup Company. Local businesses require less risk capital than a business with a potential national market for their product or service. Thus local business startup companies are somewhat less risky to capitalize. The odds of a startup company, with a new product or service, succeeding in the national market are less than 1-in-100.

To breakeven with those odds on speculations in these startup companies, the investor must recover one hundred times his risk capital. A hundred-fold return on any investment is extremely rare. The startup company investor is about as likely to pick the right number on a roulette wheel in Las Vegas three times in a row as break even speculating in startup companies. They are bad bets for many reasons.

It Isn't Always the Lack of Money

Entrepreneurs usually put the blame for their failure on lack of capital. But often, the problem is how they use the capital they raised. It's often misspent.

In my 24 years in the stock industry, I've advised assorted public and private investors funding startup companies. Here are a few examples of how their money has been misspent:

1. The entrepreneur spent $1,000 on a hat rack. The rest of the office was furnished in equally expensive 18th & 19th Century antiques.
2. The phone sales entrepreneur leased the penthouse office in the financial district.
3. The entrepreneur bought new, expensive cars for his seven managers, who were to run used clothing stores. Keep in mind that the late billionaire, Sam Walton of Walmart fame, drove a beat-up old pickup truck.
4. Most of the risk capital was used to buy a condo in Aspen so that the staff could develop the business plan.

Here are a few of the common misspent risk capital funds mistakes made by Entrepreneurs:

1. The first risk capital investor's funds are used to find the second risk capital investors funds and so on. Somehow, the entrepreneur never seems to have any money to implement the business plan.
2. The risk capital is spent on R&D. Even when the company has a viable product, management continues to spend the risk capital on improving the product. This is a common failing of entrepreneurs with engineering degrees.
3. The entrepreneur spends the risk capital on some project unrelated to the startup company's business. This is often done in the false belief that the investment in the unrelated business will show a quick return and keep the entrepreneur's investors happy.
4. The entrepreneur becomes the victim of crooked advisors and consultants, who overcharge him or her for their poor services. I've seen payments to attorneys that have been anywhere from four-fold to fifty-fold the standard hourly rate. I've seen a private company spend US$15 million in a failed attempt to be taken public.
Unfortunately, these examples are far too common.

Simple Success for Startup Companies

1. Forget about image.
2. Forget about making a splash in the Market.
3. Forget R&D
4. Don't hire anyone until you can no longer expand your growing business without the potential employee's help.
5. Get the least expensive quarters you can find...then stay there until your successfully growing business is pushing out the walls. If the quarters aren't "pretty," remind yourself of #1 above.
5. Sell your product and use every penny of risk capital to expand your customer base. Making money is your Prime Directive. Once you have consistent revenues, I'd be interested in helping you increase your earnings by taking you public and funding your acquisitions.

The Smart Cowardly Angel's Viewpoint

1. Never risk money in a startup company. You can't win.
2. Never loan money to a business. The Risk/Reward Ratio is against the lender.
3. Invest only in public companies. They offer any investor a way to recover their risk capital and leverage their profits.
4. Ensure that your Risk Capital is used to increase company sales by buying related private companies that evolve the company into being a multinational corporation.

While business is risk, there is no reason to justify gambling against the odds. Anyone outside the United States, who has a business investment proposal that might appeal to a smart cowardly Angel, should contact me.

To contact the author: Visit the Beowulf Investments website: [http://home.earthlink.net/~beowulfinvestments/] Or, visit the Global Village Investment Club Website:
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]