If you are aiming to start up a business, you are making a long term commitment of time and money. Spending a little time now sieving through the possibilities looking for the best type of business to suit you will lead to the best long term outcome.
The main focus of this article is choosing a business/industry likely to maximize your wealth but operating inside your level of comfort and resources. If you have a particular skill (e.g. accounting) and just want to start a business that markets that skill rather than being open to looking at other types of business, this article may only be of general interest.
If you are still reading, we assume you are interested in wealth creation so now read on!
Robert Kiyosaki’s excellent book “Rich Dad, Poor Dad” points out that your chances of being wealthy improve as you move up the ladder from:
- Employee: all you will ever earn is a salary.
- Self-employed: more chances but limited largely by your time since that is what you are selling eg. Accountant, brain surgeon, florist.
- Employer: leveraging employees to grow your wealth.
- Investor: living off and growing your accumulated wealth.
Being an employer separates you from those who choose to be employees and from the self-employed. It is what will let you create far more wealth and well-being for yourself than is likely for someone who works for wages or who doesn’t have the amplifying effect of several staff to help boost their income.
For maximum wealth creation, it is important from the outset that you realize that your job is to create a business that employs people to do the work of the business while you work on making the business work as well as possible. If you persist in trying to do the day to day work yourself, you will remain a self-employed person and probably never achieve the wealth levels you can as an employer of others.
It is simple maths really. If one person can do X units of productive work, then 100 people, properly managed, can do up to 100 times X units of productive work. It will probably be less than 100 times what you can do because they won’t have your motivation, and perhaps not your skills, but it is nevertheless an awful lot more productivity than you can achieve yourself.
One of the principle lessons offered by the 5 star read “The E-Myth Revisited” by Michael Gerber (Gerber, 2004) is to “work on your business, not in it!”. You must internalize this to succeed. (see Great Business Books menu here).
This article covers the first of two of the most important business decisions you will ever make:
- What business should you get into.
- When and how will you make an exit sale to consolidate your wealth.
The whole success of your time in business depends on these two decisions!
Many miss the first decision by making the serious mistake of getting into the first business that comes along. Remember the power of the Compound Interest Accelerator (see Compound Interest article). If you pick the right business, the same amount of work and money as inputs can easily produce 10 times the wealth at the end of the race. You only have so many input resources, so why waste them on a second class business?
No matter how well you build your business, if you botch the exit strategy you botch the opportunity to maximize the wealth you may have worked years to assemble. This is why the exit strategy is the second important issue. It is why you must set out to put your business together with the end – the exit strategy – in mind from the outset. Some business models only last a couple of years. You put together a great idea, build it up quickly, possibly never get it to profit but sell it to someone bigger in just a couple of years for a great exit lump sum. Other businesses will run for years and earn you a good annual income many times an employee’s salary until, in the fullness of time, you want to exit and/or someone comes along and makes you an offer you can’t refuse.
There is potentially an enormous amount of material that could be covered in this article. Just the choice of business alone is a big issue because every reader will have a different set of selection criteria and a different business model in mind.
Our mission here is to alert you to things to consider and then point you to other resources to flesh out your understanding.
Look Before You Leap
One of the Profit Savvy team writes:
“After I had started a business for someone else, I started to become a bit restless and thought I should have a go at starting my own business. In partnership with a colleague, we purchased a flower shop as a going concern with the thought that the income from that would help to cashflow the startup of our proposed flower delivery company. I didn’t give a lot of thought to the alternative businesses that I could start or buy; I really just got enthusiastic to start something and charged into the first thing that happened to come past my nose."
He was lucky as it turned out. He could have crashed and burned very quickly because of his poorly thought out approach to choosing his business. As it happened, the flower shop part really was a bust and they exited that in less than a year after it drained time and money they could have used in the floral relay part of the business. The flower delivery part worked out OK because they had accidentally lucked onto one of the formulas for a successful business that will be written about shortly.
This was luck; not science!
"I hope the material in this Chapter will make you smarter than I was.”
No Shortage of Possibilities
The process of reducing the cosmos of possible businesses to a list of candidates and then to eligible ones and finally your new business is much the same process as fossicking for gems.
With sapphire mining, you dig a hole in an old creek bed and throw the soil (a list of possible businesses) into a sieve that has successive layers of finer and finer mesh. Soil too fine to contain sapphires gets washed right through the sieve and is discarded. Rocks of various sizes get trapped at the increasingly fine meshes below each other in the sieve. Some rocks are too big to be sapphires and some are so small that, even if they were, they would not be commercial grade. In the middle, you are left with stones of various sizes that you wash and go through by hand looking for sapphires.
The same applies to choosing a businesses.
There are hundreds of thousands of business owners in Australia and a similar ratio in any other country so there is clearly no shortage of types of businesses that you can get into.
The first thing to get into your mind is that there is an abundance of business opportunities. So many in fact that your job is not so much trying to think one up but rather a problem of trying to wade through the mass of opportunities to find the very few that will really work for you. We can show you how to generate a million ideas for new businesses in under an hour (see
In this article we will:
- Set out to do a quick and dirty rough cut through the opportunities for a type of business start-up that suits your personality.
- Discuss how to generate a range of businesses that are worth your further consideration. We call this the ‘eligible set’ of businesses. This will still have tens, if not hundreds, of potential businesses in it.
- Look into how to reduce the ‘eligible set’ to the one or two in the ‘candidate set' that are worth your detailed attention.
- Finally get down to the one you are going to go with.
This might seem a tedious process when you are bursting to get going and might already have a bright idea for a business you just want to get going with. Based on personal experience, that would be a stupid thing to do!
A little time now can make you ten or more times as much wealth for the same time and money inputs as doing the first thing that pops into your mind. This is one of the most important things we can pass on to you.
You can probably only run one business at a time. You only have so many hours in a day and you only have so much in the way of resources like money. It is simply common sense to spend a bit of time choosing the right business at the outset so you don’t squander those resources on something likely to fail or which won’t do as well as some other business you might have started.
WARNING: No matter how experienced you are or how much you agree with the process suggested below, you are going to find it very very hard to resist just starting something; anything! The drive that sends you off to run your own business wants to get going right now. Resisting this temptation will be hard.
As we regularly point out in Profit Savvy, you should “begin with the end in mind” rather than just start a journey. If you don’t know your destination, you will only get there by accident!
Filter 1: Bound or Unbound
Early on when considering a Business Start Up, you first must decide if your potential business is going to be "Bound" or "Unbound". Meaning that it is in some way, in your mind, a comparatively limited activity (Bound) or an open-ended idea (Unbound).
Speaking very broadly, there are two types of businesses that you might consider when you are dreaming about your ideal Start Up business.
We will call these two broad directions "Bound" and "Unbound" businesses.
This is an important decision to make because it will govern the future maximum size of your business. See the Profit Bound article for full details of "Bound" and "Unbound" businesses.
Which Direction From Here
Neither of these approaches is right or wrong, sexy or unsexy, bold or wimpy.
They are just different and equally deserving of life and both are necessary for our economy to be well balanced.
But, if you later want to get bigger, an early choice of a “bound” business may severely limit your prospects, so choose wisely now.
You can probably convert an “unbound” business into a “bound” one at any time but it will likely be exceedingly difficult to convert a “bound” business to an “unbound” one at a later date.
Because many of the issues facing these alternative Start Up models are going to be different, we have built two Start Up Business menus; one for each of them.
Filter 2: Your Attitude to Risk and Resources Required
There are a range of ways to start a business. They cover a wide spectrum of risk, of resource inputs and not all will suit your personality.
Our first step is to explore these alternatives and slice away those types of start-up that don’t suit you.
Draw a horizontal line on a piece of paper. At the left hand end, write ‘high risk’ and on the right hand end write ‘low risk’. This is the risk continuum that we will place types of business start-ups onto.
Blue Sky business start-ups are at the risky left hand end of the continuum.
They are businesses starting out in areas and industries that probably don’t even presently exist. They are the Facebook types of start-up. Businesses that break entirely new ground.
Because they are launching into such uncharted waters, there can be very little certainly about how well they will do. Research into US blue sky businesses, backed by experienced venture capitalists, indicated the following exit values:
|Exit Valuation||Percentage Achieving||Cumulative Percentage|
|Earning zero to $1 million on sale||67%||67%|
Consider that there was an average of $9 million invested in these blue-sky start-ups by experienced venture capitalists who had already picked only the best candidates. It is clear that money was lost on the majority of these start-ups (probably about 80%) and it is only a tiny minority that struck it rich. What are your chances?
Slightly less risky blue-sky businesses can set out in areas that are already somewhat developed so a bit more is known about the business. At the time of writing, mobile phone applications are getting going big time. For pretty much any conceivable type of mobile phone app, there are several businesses setting up in competition with each other to build the ‘next big thing’. They are all competing for the same customer and naturally only a few will survive with any sizeable market share. In fact, marketing gurus five star read, “The 22 Immutable Laws of Marketing” (Ries & Trout, 1994) will say only 3 have much of a chance.
Typically, a blue-sky start-up will burn through a lot of money before they will become profitable (if ever) because they have to experiment a lot to find a workable formula – so much of what they are trying to do is in unknown territory. Many are sold before they ever make a profit on the strength of their estimated future profits and/or their complimentary aspect with some other blue sky startup ahead of them in the development cycle that wants their product as a ‘bolt-on’ to what they have already. For many, their exit strategy is not to make a profit but to make good capital gains on sale in a fairly short period of time; a couple of years at most. They are ‘built to flip’.
Blue-sky start-ups are probably the most beguiling. Who wouldn’t be excited about using other people’s money for a few months, or a couple of years at most, and then exiting with the millions these successful entrepreneurs get from sale or from floating on the stock exchange. It’s a bit of a dampener to realize that you have maybe a 10% chance of making much money this way.
A very interesting book on how blue-sky start-ups have to maneuver can be found in the 5 star read "The Lean Startup" (Eric Ries, 2011).
New Entrant, Existing Industry
Closer to mid-range on the risk continuum line we drew is a startup that is launching into an existing industry.
A big chunk of the risk is removed because there is an existing and measurable industry. A lot is known, or can be fairly accurately guessed, about the customers and there are existing business models you can study looking for some tweak you can put into your business to out compete the existing businesses.
Your likelihood of success can be further refined.
If you are launching an undifferentiated product into a market, it’s less likely that you will do well. One flower shop is pretty much like another so winning over customers is difficult.
Alternatively, if you can find a new niche that is attractive to customers and you are the first into it, your ‘first mover advantage’ may be such that you can do very well. In fact, writers like Ries & Trout, 1994, set out to show that the most probably viable strategy for a very successful new entrant is to create a niche of your own. He instances the evolution of computing and the fact that each new niche has its own most successful company:
- Mainframe computers: IBM.
- Mini computers: DEC.
- Micro Computers: the IBM PC format – Dell, HP and Apple in a niche of their own.
- Mobile smart phones: Apple iPhone and iPad.
If you are lucky, you may be launching into a market with sleepy competitors who are complacent about the market. You might be a brand new, highly motivated, very nimble and competitive fox put into the comfortable hen house. Over time, your competitors, may wake up and start to compete more assertively but by then you may a toehold and be pretty secure. One might expect it to then turn into a slug fest for market share.
In summary, there is less risk with this type of start-up because more is known about your environment.
That said, if you start up an undifferentiated business, your risks are likely greater than if you start up one that has its own niche.
As we will set out to show in the discussion on choosing your candidate businesses from the eligible set, the differentiated business will probably earn many times what the undifferentiated business does, so, from the profitability viewpoint, the undifferentiated business is quite a bit more risky.
Troubled Business Turnaround
There are always businesses that have lost their way and are experiencing financial or other problems.
You can get into these businesses by injecting money and your own labour and talents.
They are more towards the ‘less risk’ end of the risk continuum line because they are already operating so there is a lot known about their markets, competitors and profitability, you have a functioning business to work on straight away rather than having to go through all the uncertainty of starting your own.
The fact that they are in trouble means they come with their own problems.
If you are so inclined, there is no reason why such a business should not be in your ‘eligible set’ of business that you consider. But, it is still critical that you apply the same types of test to these businesses to see if they are suitable candidates for your final choice. It is rather easy to get seduced into the romance of thinking you can turn this ship around and forget that it is a sail boat and will never go as fast as a power boat profit-wise.
Much of the material in Profit Savvy is focused on business turnaround so you will find other advice on the potential of a troubled business.
Acquire a Going Concern
This is rather like getting into a troubled business without the trouble!
It has the advantage of being a known and measurable business so the risk is a lot lower.
Consequently, it is probably going to require more up front capital to acquire but at least that figure is known whereas with the blue sky business, you don’t really know what it will eventually cost to get going.
In some instances, you might inherit a business like this from your parents or other relatives. In this special case, you need to think about the possible future of the business. If you were starting out, would you move this business from your ‘eligible’ set to your ‘candidate’ set worthy of further consideration? If not, you are destined to run a business with your limited time and money that may never be as great as one that does deserve to be in the candidate set.
On the other hand, if the business is sound, maybe you should not look a gift horse in the mouth as the saying goes. (Did you know this refers to telling the age of a horse by its teeth? The implication being it might been given to you as a gift because it is over the hill.)
Filter 3: Opportunity for Future Gains
Our third filter is the opportunity any proposed business represents for you to maximize your gains in the future.
A distillation of the work of many business authors can be reduced to three things when constructing a filter that manages the opportunity for the future of your business.
When discussing risk above, we discussed finding your niche. Because of its importance, we revisit that recommendation here in the context of possible future earnings rather than risk.
So many authors say you should try to ensure that you are working in a niche that either does not presently exist or where there is no clear leader that it is now pretty much conventional wisdom. To read more on the reasoning, try five star reads by Al Ries (Ries & Trout, 1994).
Reasons for supporting this follow:
- People only remember about 3 brand names in any niche – say three brands of energy drinks. If you are a startup in a crowed niche, chances are that you won’t have very high brand recall.
- The first business into a niche tends to have such an advantage that there is a whole phenomenon named for this - “First Mover Advantage”. Al Ries (Ries & Trout, 1994) writes about this.
- The first mover advantage leads on to a rule of thumb that suggests that the vast bulk of a niche is made up of just a few players (see The 80/20 Rule for the reason behind this). Further, some have argued that there is a sharing of the market that approaches equilibrium. It is said this happens when the largest firm is twice the size of the second which is, in turn, twice the size of the third. So, out of 7 units of market, the largest has 4 (57%), the second has 2 units (28% and the third has 1 unit (14%).
- All the other players have insignificant shares. If the market is not in these ratios, there is a chance it will sort itself out by one or more growing or contracting until equilibrium is reached.
First movers in a niche tend to be there for life unless they really drop the ball. If you can get there first, you can ride along with the natural growth of the niche.
Interestingly, Ries argues that you actually want competitors in a niche because it takes several players for consumers to believe it is a legitimate niche. You just want to be the first and largest in that niche!
Clearly you want to aim to be number 1 in the niche and that is much easier if you start your own.
Long Term Sales Growth
But it is no good picking a niche if you cannot foresee many years of growth, in excess of 10% per annum. More years and/or more annual growth is better due to the accelerator effects of compound interest.
There are so many business opportunities that picking one with a low growth rate is just masochistic when you could get several times the gains from a high growth niche over the same time.
Our Profit Savvy team member writes:
“ When we launched the flower business, we first brought an existing florists thinking that would cashflow us into the long distance delivery business.
Unfortunately, we lived in a country town and the next town of a reasonable size was 100 km in each of the four compass points. Very quickly it became obvious that we had purchased a dead-end growth business. If we wanted to grow by getting more shops, we would spend a huge amount of time just traveling from town to town. Of course, the problem would not have been there if we lived in a major city where we could just go to the next suburb.
Later we launched in England and New Zealand and it was actually easier than reproducing the florist shops in other towns.”
The moral of the story is to make sure that, as well as growth in the niche, the niche can scale quickly and easily so you can get out of a growth trap if it appears.
Another scale problem that often arises is the expense of capital equipment if you are in a manufacturing business. In comparison, a web based business just buys another cheap computer to grow. If you want to grow fast and cheap, better to be virtual than physical.
Growth in some businesses such as retail require multiple outlets. Each of these comes complete with the expense of leasing, hiring and managing staff, installing equipment and so on. Such a decentralized model is a lot more expensive and difficult to scale than the centralized model where as much as possible is done in one location at one set of expenses.
Our team member reports:
“ At one stage we had a business in England but closed down the office and ran it more successfully and cheaper with a night shift in Australia than it was to run out of England. We did the same in New Zealand. Along the way we saved ourselves a fortune in plane fares flying over periodically to check out the staff and operation at the overseas offices.”
The essence of this filter is to choose a niche that is likely to grow for many years and set yourself at the top of the brands in that market so you can float along with the growth in the sector.
A 5 star read on this topic is Koch’s “The Star Principle” (Koch, Richard, 2010)
Of necessity, this discussion has been very broad. We can’t know your motivation, attitude to risk and your available resources so we can’t give you any firm answers.
What we can stress is that it is better to take a little time before starting your business to consider your general preferences so that you then have a set of ‘sieves’ to run any idea through.
If you just rush out and get started, you are committed to that path for quite a long time. You only have so much time in the day and so much money to put into a business so it seems very wise to put those scarce resources into a business that best gives you the returns that you want; whatever they may be.
Because it is difficult to juggle the plus and minuses of the several businesses that you might be considering, we suggest you consider a spreadsheet using the Weights And Score Technique (see Weights and Scores article) to help cut through the clutter.