Much as I liked Marc Andreessen’s series of posts on start-ups at his blog at pmarca.com, it’s bothered me that he’s talking about a very select subset of business start-ups, the cream of the start-up crop, and not the mainstream. It brings up a general problem with expert advice on starting a business, which is that start ups include a very wide range of businesses and business plans.
With that in mind, I’d like to suggest three general sizes and shapes of start-up businesses. I don’t mean to suggest some kind of general categories or classification of start-ups with this, but rather, just to point out how the nature of the start-up process is completely different at different levels. At the high end, the process is reserved for a few thousand of the best new ventures, with the best management teams, highest growth possibilities, and the most likely defensibility. At the low end, we have the millions of grass roots entrepreneurs jumping into their own businesses because they can. While all of these businesses have some start-up costs, and some needs for financing, and good reasons to plan, the needs are quite different.
1. The “just get going” start up
This encompasses the majority of real-world start-ups. There ought to be a business plan, but it isn’t about getting financed by investors or lenders, it’s just about getting going. You need customers, not a lot of money. You can bootstrap this business.
There are 20 million no-employee businesses in the U.S. alone. The average cost of a start-up is just $10,000. These are graphic artists, bookkeepers, business plan writers, freelance journalists, landscape architects, Internet search engine experts, massage therapists, fitness trainers, personal shoppers, or bloggers. You don’t need to buy inventory, you don’t need to design and build a product, you’re not worried about product packaging, or high-end website design, or renting and fixing up a location.
Your start-up costs are likely to be your computer, maybe some office equipment, maybe some design for logos and stationery and such, maybe some website design, maybe some legal expenses to get you registered correctly so you can get a business bank account. This is usually a few thousand dollars, enough to finance with credit cards.
What you really need to get going is customers. Planning is good for this start up not because you have to jump some hurdle to get somebody else’s money, but because you want to start right, focused and differentiated, aiming at a definable target market, understanding the benefits you offer your buyers, and getting it right.
Summary: start up costs are low, planning is about doing it well and doing it right, and what drives this start up is customers.
2. The middle ground
These are the start-up businesses that need financing beyond the normal bootstrapping level. These businesses need a plan to determine how much it’s going to cost them to set up the location, equipment, the prototype and early versions, the design, the packaging, the relationships with distribution channels. They can’t really do it right without financing. Think of business loans, friends and family, angel investment, personal funds, and betting the house.
One quick example is a restaurant. There are always exceptions, but in general, you can’t get a restaurant up and running without spending six figures for kitchen equipment, furniture, signage, fixing the place up, and market launch expenses. Another example would be the Web 2.0 businesses and software businesses that need a few hundred thousand dollars to get going.
My company, Palo Alto Software, was one of these. At one point we had three mortgages on our Palo Alto house and $65,000 in credit card debt, but we didn’t have outside financing. We grew more slowly than we might have if we’d had venture money, but now, years later, we’re doing fine and it’s all ours.
Summary: these middle-ground start-up companies need financing, they need a business plan to estimate how much financing they need, and to organize their ideas as part of the process of getting that financing. What drives these start ups is a combination of factors involved in the plan, including identity, strategy, sound marketing, execution.
3. The elite
Professional venture capital firms annually invest in a few thousand, maybe 6,000 last year, of these new ventures. They are the cream of the crop. Some VCs look at the management teams first, wanting to invest only in proven people who have already been involved in successful or notable start-up companies. Some look first at the new markets involved, the technology, preferably proprietary technology, the positioning, and other factors to give these ventures a reasonable shot at exits in 3-5 years generating huge returns.
These are hit or miss businesses. VCs look to generate huge returns on each one because they know only a few will hit, and those that do make it big have to generate enough money to pay for the majority that fail.
It’s easy to read about these high-end start ups. Search the blogs for “venture capital investment.” Read Guy Kawasaki’s How to Change the World, David Hornik’s Ventureblog, or Marc Andreessen’s Pmarca blog, and the VC blogs they recommend. It’s also easy to learn about these high-end start ups at business schools.
Summary: excellent management team, excellent prospects, solid planning, and millions in start-up financing, but only for a few thousand companies. And oh-oh, lately some of the best only need a few hundred thousand dollars, which complicates the taxonomy some, but we’ll ignore that for now.