Prior to forming a corporation, selecting a brand name, appointing officers and directors, hiring salespeople, making a deal with the first customer and all other considerations that a new business must address, the entrepreneur needs to evaluate the business opportunity. An entrepreneur with a new business idea needs to assess whether the business idea is a good one.
This proposition, while seemingly self-evident, is often ignored in substance. Embarking on a new venture requires a leap of faith and instincts – but only to a point. The tendency is to grab at the first idea that presents itself. To be sure, energy and spontaneity are an important for a new venture, but the key is to maintain this energy while acting intelligently. Evaluating an opportunity is a business decision, capable of analysis, and the skills to make that evaluation are not entirely instinctive; they can be learned.
This is the first in a series of articles that will explore various aspects of entrepreneurial finance and management from both a legal and business perspective. The goal of this first article is to construct a basic framework for approaching and evaluating a new business venture or concept, both from the perspective of the entrepreneur and the potential investor.
In assessing whether a potential business opportunity is good, the entrepreneur should look at four basic issues:
- whether the idea is an opportunity;
- the plan for implementing the idea;
- people who will implement it;
- the resources that will be needed and where they will come from.1
- If this structure seems formalistic, rest assured that other businesspeople evaluating your venture, from loan officers to potential investors, almost certainly will be making the same evaluation.
Idea v. Opportunity
There is a widespread fallacy that a successful business requires a unique idea – a secret formula. Most would-be entrepreneurs waste countless hours of precious time trying to come up with the great unique business idea that no one has ever thought of before. The reality is that the overwhelming majority of successful businesses stem from ideas that are not new. Most “unique” ideas have been devised, and implemented, by someone else. Moreover, an idea that has already been tried may still make for a successful business. An entrepreneur must recognize that there is a difference between an idea and an opportunity.
Good ideas are a dime a dozen. The real question is whether the idea presents an “opportunity” – does the idea offer an ability to develop a business that can make an acceptable profit? This may seem like another obvious concept to some readers, but a surprising number of people start businesses and invest capital into new ventures without truly analyzing whether their great idea can be turned into a profitable business.
A proper analysis requires that a person assess whether there is a customer need and determine the window of opportunity. An opportunity must address a customer need, otherwise it is nothing more than an interesting idea. The basic questions that have to be asked are:
- What is the product or service?
- Who will want to buy it?
- Who else is offering the same or similar products or services?
- How will this product or service be different or more desirable than these competing products or services?
- The entrepreneur must also assess the timing of the opportunity. No opportunity lasts forever, and therefore, each opportunity has a window that will close with time. All other factors being equal, the longer the window remains open, the greater the opportunity.
The Plan for Implementation
The true thing of value in a new venture is very often the plan for implementation, rather then the mere concept. Given the customer need and window of opportunity, entrepreneurs must have a plan for turning the basic opportunity into a profitable business.
We cannot overemphasize the importance of preparing a business plan. The best way to understand how to implement the opportunity is to prepare a good written business plan that makes a practical, honest analysis of the product, the customer need, the competitive advantage, the risks or variables in the plan and the projected revenues and costs. Entrepreneurs should not, as is often done, treat the business plan as having the sole purpose of selling the company to investors or bankers. The business plan, if done properly, is an invaluable tool for evaluating the strengths and weaknesses of the venture, as it forces the managers and owners to focus on and analyze each essential component of the business, and to put that analysis in black and white. The only reason for the business plan’s brief treatment here is that it will be dealt with in more detail in a subsequent article.
Another important factor in a new venture is the group of people that will implement the idea. Georges Doriot, the founder of modern venture capital, was quoted as saying “Always consider investing a grade A man with a Grade B idea. Never invest in a grade B man with a grade A idea.”2
Entrepreneurs should have experience in the same industry as the proposed new venture, or a similar one. No investor wants to put money into on-the-job training. If the entrepreneur does not have sufficient industry experience, then he needs to get it first or find other partners who have it. The odds are heavily stacked against the novice. While some newcomers do succeed, this is the exception to the rule.
In addition to industry experience, a new venture needs management experience. Specifically, the entrepreneur, or someone on his team needs experience in managing and controlling a budget, profit and loss. New ventures are often sorely lacking in this regard, resulting in an inability to control costs and more profoundly, a lack of ability to recognize the appropriate revenue/cost relationship. The less managerial experience, the more limits on the size of the business he should handle.
An entrepreneur needs to determine how much capital will be required to get started and how to allocate that capital amongst the various possible uses for it. To do these things, she must identify the resources that are crucial for the venture’s success and then prioritize them, so that precious capital is not squandered on secondary needs. For example, in a software business, the crucial resource may be the programmers who make ongoing modifications to the program. If so, it may be best to allocate the company’s resources to hiring and retaining experienced programmers, rather than supplying a state of the art sales office. The correct strategy is to identify the key resources and be thrifty in acquiring anything that is not key.
Entrepreneurs also must identify the sources of the capital that will be used to acquire those resources. She should also identify the possible sources of additional capital in the near future, if her projections call for it. Once again, the subject of raising capital is too broad for this article, but will be dealt with separately in the articles to follow.