Rewriting The Book On Entreprenuership
Robert Ronstadt wrote and taught about entrepreneurship for years. You'd think that would have helped him when he started a company of his own
As an academic, Robert Ronstadt developed one of the first college programs in entrepreneurship and even wrote what has been used as the standard textbook -- Entrepreneurship: Text, Cases and Notes. Now, two years after leaving the security of tenure to run a business of his own, Ronstadt has found that real life and his book don't match. What will he write next time? -- J. H.* * *
W hat does this clown know about running a business?
That's what you want to say as you watch him, so self-assured, philosophizing in the comfort of a classroom about "venture formation" and "cash outflows" and "product life cycles." You can tell by the smooth timbre of his voice that this entrepreneurship professor has never once tumbled down a learning curve, never sat up all night plugging numbers into a pro forma just so a banker could say no the next morning, never faced the sobering reality of meeting payroll. "It's frustrating to watch these academics," Robert Ronstadt says. "I see it, and I want to say something."
Which is odd, because Robert Ronstadt -- that's Robert Ronstadt, doctor of business administration -- spent years teaching courses with such titles as Fundamentals of Entrepreneurship and Starting New Ventures. In 1983 he took a six-month sabbatical from Babson College, in Wellesley, Mass., to write a 770-page textbook, Entrepreneurship: Text, Cases and Notes. Not exactly, if you will, the gritty stuff of true-life experience.
That will certainly not be said, though, about the next version of the book, should Ronstadt find the time to write it. "I've learned plenty of things I could add," he says. In 1976 he and his wife, Rebecca, launched Lord Publishing Inc., "a small lifestyle venture." A decade later they pushed Lord into the software business; Ronstadt resigned from his tenured position to serve as chief executive of what he hopes will grow into a $10-million firm within seven years. "I wanted to learn about fast-growth ventures by doing it myself," he says.
Not the best motivation, perhaps (think about those situations from which you've learned the most). "I don't want to fail," Ronstadt counters. "But whatever eventually happens, I like to think I went in as well prepared as anyone could be."
No argument there. The 47-year-old Ronstadt earned his doctorate at Harvard Business School. When Ronstadt decided to teach at Babson -- a small college that was at one time so devoted to replicating the business world that students punched a clock and had their own secretaries -- he was one of a handful of academics who pushed for developing a program in entrepreneurship. By 1980 undergraduates could major in the field, and graduates could concentrate in it. The college also boasted a $1-million endowed chair in entrepreneurship studies and an annual research conference.
In the meantime the Ronstadts had sidled into the publishing business. In the mid-1970s Ronstadt wrote a 189-page book for his students called The Art of Case Analysis. When publishers rejected it because the market sounded too small, Ronstadt published it with the help of his wife, who was then working as a marketing consultant. Using her grandmother's maiden name, Rebecca Lord, she appealed to college bookstores all over the country. In its first year more than 3,000 copies were sold. In under two years Lord Publishing was selling about 7,000 copies annually, netting some $30,000 per year.
When professors started asking whether Lord Publishing could publish their books and collections of their cases, the Ronstadts gladly obliged. By 1979 the company's sales were up to $100,000.
Next came Ronstadt's textbook, which, despite its scattershot approach, got good notices. One reviewer wrote that the book "included a substantial amount of research-based knowledge . . . and should be useful to both practitioners and academicians." Company sales shot up to $250,000 by 1985. Shortly after Ronstadt's textbook appeared, the Ronstadts acted on a suggestion from readers and spent $5,000 to transfer some data from the case studies in the textbook to a disk. It was difficult to use, though, and not many schools were fully equipped with personal computers in 1985. The Ronstadts just about recouped their costs.
But the project did encourage them to pursue Ronstadt's Financials, the rock on which their corporate ambitions stand. It's a software program that provides small-business executives with a relatively easy-to-use tool for evaluating the effect of different assumptions on cash flow, the income statement, the balance sheet, and all key measures (see Executive Software, "Consultant in a Can," June 1989, [Article link]). Ronstadt figures he has raised more than $2 million since September 1986. In 1988 the company posted sales of about $450,000, nearly 65% of that from the software. Ronstadt had hoped to reach a user base of 5,000 by March of this year; he hit his goal by May. Money problems have forced him to make severe cutbacks. Last September, for example, the company burned through $190,000. By May monthly expenses amounted to just $47,000 -- and it was still bleeding $10,000. "You don't really appreciate what this is like," Ronstadt says, "until you have it all on the line."
Having it on the line has changed him. Ronstadt still makes his points by drawing on the grease board in his Natick, Mass., office, and copies of his textbook are all around the company. But reflecting on the experience, he sounds, at times, frustrated ("Venture capitalists sound like they know what it's all about. But in their hearts, I don't think they do"), defensive ("People have to realize that projections are projections. If everyone had a crystal ball, that would be great, but we don't"), and isolated ("There's an encompassing myth that this country is the quintessentially ideal environment for entrepreneurs. It isn't, in a lot of ways").
In short, he sounds like everyone else who has gone out and started a business.
It shows just how much distance there is between the theory and the practice of entrepreneurship. "There was a great deal I wasn't prepared for," Ronstadt admits. "Most academics have no clue about how tough it really is to cre-ate a high-growth venture. There are a lot of things I wish I had put into that book."
Such as? Well, what follows are some chapters we might see in a future edition of Ronstadt's textbook -- "I can't stop to do it now. My investors would kill me" -- all based on his experience over the past four years. To anyone who has started a business, the lessons may sound fairly simple. But as Ronstadt is quick to explain, that doesn't mean they have come easily.* * *
Where Money Really Comes From
You want money? At one time Professor Ronstadt would have offered a few obvious choices. Go to a bank. Or a venture capitalist. Or a rich person.
In his textbook, Ronstadt writes about squeezing money from institutional sources. In the true life of his venture, he's had trouble just getting them to return his phone calls.
Not that Ronstadt was all that naïve when he left academia to fire up a fast-growth software company. He knew what kind of money he needed -- we're talking millions of dollars -- and he knew he'd have to be creative to get it for a start-up in an industry that has lost more luster than most industries ever had in the first place. What surprised him was how informal his investor groups turned out to be.
As Ronstadt readily admits, a college professor is hardly in a position to bootstrap much beyond an expensive dinner. All told, the Ronstadts have spent about $150,000 of their own savings on their venture. Their first official investor came in September 1986, when Ronstadt's brother-in-law, Graham Fallon, invested $50,000 for an equity position now worth 14% of the company. Soon after, a cousin of Fallon's agreed to invest another $100,000 for what is now a 4% stake.
With that capital, Ronstadt hired two independent programmers to work on designing Ronstadt's Financials. Then, convinced that the product was feasible, Ronstadt began searching for several hundred thousand dollars to finish the design and convert Lord Publishing into a real company that could sell and market it. "We were tired," Rebecca says about working at home, "of worrying whether the UPS truck would hit the dog."
To get his hands on the money, Ronstadt made a dangerous move: he took advice that he often gave his own students. He opened up his address book, flipped through it, and made a list of people who were not only well heeled, but also relatively sophisticated investors. Some he had met while teaching; others lived in his neighborhood; a few were parents of his children's friends.
He wrote to about 30 of them, simply letting them know that he had an investment opportunity, should they be interested. About 10 asked for more information, so he sent them a venture summary. About half of those requested a business plan.
As it turned out, one potential investor was interested, but not for himself. Nearly 10 years earlier then-professor Ronstadt had helped him get his business off the ground. Now, he told Ronstadt, it looks like you need big bucks, so why don't I put you in touch with the folks who invested in me? Ronstadt agreed and got a surprisingly warm reception from the group, headed by Charles W. Sullivan, a Boston lawyer who had attended Babson College some 40 years earlier. "A couple of us knew about Ronstadt from our kids at Babson," Sullivan recalls. "They used his textbook."
Just after tax time in 1987 the group invested $400,000 in two stages for 16% of the company. About a year later, with the product nearly ready to go, Ronstadt figured he would need another $2 million or so for marketing -- educating the public that Ronstadt's Financials was not another spreadsheet program. To raise the money, Sullivan brought four more investors into the group. In March 1988 the eight of them agreed to invest about $1.3 million for 22% of the company. They also signed an option to put in another $1.1 million for an additional 18% of the company in November 1988. "We all wanted to see some sales and marketing develop before putting any more money in," Sullivan says. As it turned out, they were deeply disappointed.
Ronstadt now realizes how expensive and time consuming it is to raise money. He hadn't anticipated the costs of traveling to New York City, for example, to meet with potential investors. Or having various groups spend half a day traipsing through the company, distracting employees. He has had to put up with whatever requests potential investors make. "That's the way it is as soon as you stop dealing with investments coming from a personal savings account or your parents," he says. "You don't know where the money is coming from, you don't know your investors, and you don't know what might come down."
Ronstadt's Lessons on Finding Funds: 1. Go beyond appealing to obvious targets, such as wealthy people. 2. Unless your venture is in the hot industry of the moment -- which software certainly is not -- don't expect much from venture capitalists. 3. Make sure you have enough money to absorb the costs of raising more.
Customers Count, but Management Counts More
What, ultimately, drives a business? "Customers," Professor Ronstadt had often preached in the past. These days, the CEO of Lord Publishing offers a different notion. "It's the founding team, as well as the customers, that are critical," he says. "Whatever binds the members together drives the business in a certain direction."
Because he had few industry contacts, Ronstadt put too much emphasis on credentials when he began hiring. He didn't think about how important it was to build a harmonious team. In one case, he hired an executive whose personality, he could see, was going to cause problems. "The person was so good in so many other ways that I said, 'Well, we'll take the chance. This will be a high-risk, high-yield situation,' " Ronstadt recalls.
It was more like high anxiety. The employee grated so much that Ronstadt believes it left scars on the team. "He got people irritated," Ronstadt says. The executive lasted only about a year, but changed Ronstadt's hiring criteria permanently. "At this point, if I wasn't sure somebody would wear well, that person would be out of the running," Ronstadt says. "Somebody outspoken and abrasive can be destructive as hell."
Ronstadt now says entrepreneurs should try to hire prospective executives as consultants for a three-month trial period. He also advises that no equity change hands during an employee's first year. "It complicates the termination process if you've got someone with 1% or 2% of the company," he says.
Once a venture team exists, Ronstadt advises that the members talk honestly about what motivates them to come to work every morning. Are they after power? Celebrity? Or -- gulp -- money? "It's a difficult exercise," Ronstadt says. "But it will end up circumventing a lot of problems. You see situations where team members are saying, 'I want to start a high-growth venture,' or 'I want to go public,' but their actions don't match up. What they really want is to take long vacations or go trout fishing." Which, it happens, is what one of Ronstadt's senior employees wanted to do. The employee is now gone.
Since, as Ronstadt puts it, "the venture team you start out with is rarely the one you keep," it's important to build some slack into the team. Fortunately, Rebecca could step into several different roles, such as marketing, production, and development. Ronstadt himself could handle various financial functions between CFOs. "You have changes," he says, "and the company can't stand still."
Ronstadt's Lessons on Building A Venture Team: 1. Look for team members who are likely to wear well. 2. Get to know the compelling interests of team members by talking honestly about one another's goals. 3. Build some slack into the team -- either hire an extra person or make sure some members can handle different responsibilities.
The Main Marketer Has to Be You
Forget product life cycles, marketing mix, and consumer-behavior analysis. Those were the marketing concepts Ronstadt had taught. They weren't the ones he needed. "What we're doing isn't like a preexisting company rolling out another detergent," he says. "I needed some ideas that were more tailored to a start-up." What distribution channel best suits a new product? What is a reasonable expectation for return on marketing dollars?
Unable to answer these questions, Ronstadt put himself in the hands of "experts." First he spent $50,000 to bring in Regis McKenna Inc. for marketing research. Later he spent $20,000 using a headhunter to find a top-notch marketing vice-president.
In both cases, he believes the experts did the best they could. According to McKenna's research, a $600 price tag for the product might just fly. The new vice-president of marketing suggested Lord forgo distributors and deal directly with retailers, thereby preserving fatter margins. A software veteran, he had plenty of contacts among retailers, Ronstadt says. This was in 1987.
Trouble was, by the time the product was finished in 1988, the marketing vice-president's connections didn't count for much. Retailers had learned about "vaporware" (promised programs that either never materialized or didn't perform as promised) and relied on rigorous testing to decide which software to carry. Lord's marketing man couldn't get the product into a single store. He was soon gone, and Ronstadt began selling the product directly, buying ads in such magazines as PC World and The Journal of Accountancy. "Yesterday's marketing expert is not an expert anymore," he says. "The market just moves too fast."
By 1988 few software consumers were willing to gamble $600 on an unfamiliar product from an unknown company. "Consumers would pay as much as $400 only if they really knew the product," Ronstadt says. "And short of having me crouched under the counter, ready to give a live demo, they weren't going to get enough information." Through tinkering with the price, Ronstadt eventually reduced it from $499 to $199 in August 1988. August sales more than tripled to 175, but Ronstadt ended up spending as much on marketing as he did on research and development.
Still, Ronstadt says he would have been better off had he stayed closer to the market while developing the product. "A lot of entrepreneurs are so technology and product driven that they never recognize that marketing is important," he says. "I knew it was important. I just didn't know enough about it."
Ronstadt's Lessons on Marketing: 1. Don't simply hand over marketing to an alleged and expensive marketing expert. 2. As you work on the product, keep monitoring the market to see how it is changing.
Selling Equity but Keeping Control
Ronstadt knew the dreaded scenario too well: determined if naïve start-up entrepreneur deals equity to everyone wanting in on the game. Soon he has dealt himself out of control, which becomes clear at the first hint of trouble. "I've seen too many instances where a supposedly bright venture capitalist gets upset with somebody because he has had a bad year -- and he's out," Ronstadt says.
The solution sounds obvious. Keep majority control yourself. Good advice, unless you happen to need to raise, say, a few million dollars. Ronstadt figured he'd burn through at least $3.5 million before bringing in a dollar of profit. As of this writing, he possesses only 42% of his company. "I'm surprised I own that much," he says, sounding glum.
While hunting for cash, Ronstadt looked for ways to keep management control in one hand while doling out equity with the other. Could he create two classes of stock, voting and nonvoting? Not if he wanted to remain an S corporation. Instead, he decided to set up a voting trust, which means that certain investors let him vote their stock for the next 20 years.
Good thing, too, for Ronstadt soon learned that investors can get awfully edgy. When Ronstadt's Financials hit the market in June 1988, investors expected to see the projected 200 units a month flowing out the door. Instead, Lord sold a mere dribble of 30 in June and 50 in July. Ronstadt felt like a student who had just received a bad report card. Why aren't you doing better? investors kept asking. How are you going to fix this? "You need to have a thick skin," he says.
A poker face doesn't hurt either, as he discovered last December. During a quarterly board meeting, which focused on the company's financial problems, an investor stood up and offered a novel proposal. Given that there isn't adequate capitalization, he began, and Lord might very well run out of money, why not liquidate the venture now? He looked around the room for signs of agreement. "That way," he added enthusiastically, "we can take the tax advantages in 1988." Ronstadt, watching about three years of his life pass before his eyes, was horrified. That's out of the question, he replied quietly. The investor, Ronstadt now says, "lost his long-term perspective because of some personal setbacks." Ronstadt had never really thought -- or written -- about the fact that investors' concerns may not always be in the best interests of the company. Nevertheless, "I felt terrible," he recalls. "I couldn't believe that someone was so willing to say, Let's jump ship." He also felt a burst of gratitude for his voting trust. Without it, he says, "we might not be here."
Ronstadt's Lessons on Maintaining Management Control: 1. Set up a mechanism, such as a voting trust, to separate management control from equity ownership. 2. Be prepared to deal with anxious investors; remember that their priorities are not always the same as yours.
Circumstances Beyond Your Control
"One of the mistaken impressions in my book is that entrepreneurs are doers, drivers, people who are always making things happen, making decisions," Ronstadt says. "But a lot of times you just have to sit and wait. And things happen that the most imaginative Hollywood screenwriter couldn't think of."
Not the stuff of comedy, either. Ronstadt contends that his company's misfortunes have less to do with the business than with the 30-month pre-start-up and start-up period it has endured. "The longer it lasts," Ronstadt says, "the greater the probability that uncontrollable events will happen that either mess you up or help you terrifically." In the fall of 1987, for example, a group of investors were set to invest $2 million in Lord when the stock market crashed. We'll have to wait, they told Ronstadt, we need to see how things shake out. Six months later they finally invested a smaller sum. "That wait hurt us," Ronstadt says.
Even more painful was last November's surprise. Ronstadt fully expected that the group of eight investors would exercise their option to invest another $1.1 million for 18% of the company. Granted, his sales projections had been way off, but the company had unexpectedly had to overhaul its marketing approach, selling the software directly rather than through retailers. And still, by October 1988 Lord was selling some 500 units a month, enough for retailers to begin to take note. "We were going along fine," Ronstadt says. The investors didn't think so. Sullivan, who heads the group, explains that Lord was "not selling enough units for us to make a further investment. People are not going to continue throwing money down a hole." At 500 units, Lord was selling only about half the number it needed to break even.
What Ronstadt had not thought about is that "delays in raising money cause the whole venture to slide backward." Almost immediately Ronstadt saved about $30,000 a month by cutting some ads and R&D and dropping his PR firm. Soon after, he laid off three of his four outside salespeople, slicing another $20,000 from monthly salaries and overhead.
"Operation Grassroots," Lord's marketing effort, became another casualty. Started in August, it had called for the company to spend up to $125,000 a month in marketing and sales -- $45,000 of that in advertising alone -- to reach such "influencers" as academics, reviewers, journalists, and potential customers. By mid-November, it had ground to a halt. "Suddenly, we went back to being totally finance driven," says Rebecca, who is serving as executive vice-president and vice-chairman of the board. "It was ridiculous because advertising takes three or four months to make an impression on the end user. We were just reaching that point." Sales withered from 500 to 300 units a month.
Ronstadt set about looking for some short-term capital. In March he signed a deal with a group of Canadian investors who had seen an ad for the product. It was perfect: roughly $500,000, mostly debt. But on April 14, a few days after the money had been scheduled for transfer, the investors abruptly pulled out. Ronstadt had no choice but to let go of three more employees, ask his five senior team members to take pay cuts as deep as 50%, and tighten every conceivable expense, such as overnight mail. "If we hadn't known so much about controlling funds, this might have killed us," he says.
Now he is back to waiting and hoping; it's hard to believe that only six months ago, "I thought I had raised my last funds," Ronstadt says wistfully. "You just have to wait sometimes and find out what is going to happen before you can do anything."
Ronstadt's Lessons on Facing The Unknown: 1. If your venture requires a long start-up period, expect completely unforeseen events to take over from time to time. 2. Try to insulate your venture from financial calamity by "having a little more money than you need," he says. "I've played it too close." 3. Be prepared to wait -- for investors, distributors, suppliers, and others. Unlike the folks in case studies, Ronstadt says, "most real people don't move on a dime."
Living with Fear
The fear of failure. Ronstadt's textbook doesn't mention it; he never talked about it in his courses. But now that he is living with it from day to day, he believes it deserves scrutiny. "The emotional traumas have not yet been fully understood," he says.
He hopes to write about the "near-failure experience" someday, from the perspective of a survivor. "I get scared of failing," Ronstadt says, "but it's a question of not flying off the handle. There are great uncertainties. You have to learn to live with them." So too do employees and investors. It's very easy for them to lose their resolve. I've seen the fear expressed in deep depression, and I've seen people panic."
Ronstadt himself has felt much humbled. "If you need to find humility, go start a high-growth venture that requires a large capital investment and a long pre-start-up time," he says. "I think we are misled and deluded by the success stories. People have to be made aware that the line between success and failure at a certain point is very thin."
Robert Ronstadt is walking that thin line. He has mortgaged his house and given up a job that offered lifetime employment. If he's lucky, Lord Publishing will post sales of $750,000 this year. But given its current financial base, CFO Barry Abrams says, "the company will have to grow very, very slowly."
Avoiding failure, Ronstadt believes, involves holding the fears at bay, just keeping the business afloat for another day. "The game is survival because next week may be the breakthrough," he says. "People say to me, 'How could you fail? How could you not be incredibly successful?' I feel some pressure. But because I've studied this, I know there are no universal rules or principles.
"Maybe someday I'll be able to write something that will help the teachers teach entrepreneurship better. I knew a lot about it when I started; I know much more now. That's not surprising. After all, nobody denies that experience is still the best teacher. The problem is that in this case, it is an expensive teacher."
PROFESSOR RONSTADT STARTS A BUSINESS
The chronology of Lord Publishing Inc.
Robert Ronstadt receives a doctorate from Harvard Business School; he begins teaching at Babson College, in Wellesley, Mass., in September.
Ronstadt, with his wife, Rebecca, founds what will become Lord Publishing.
As Babson's director of planning, Ronstadt develops graduate and undergraduate courses in entrepreneurship.
Lord starts publishing books and case studies for professors around the country. Lord's revenues: $100,000.
Ronstadt takes a six-month sabbatical from Babson to write Entrepreneurship: Text, Cases and Notes, which Lord will publish.
An 18-wheeler drops 11 tons of Entrepreneurship textbooks at the Ronstadts' suburban Boston home. Lord sells 4,000 copies.
Thanks to its new textbook, Lord revenues jump to about $250,000, netting roughly $70,000.
January: The Ronstadts take the first step in turning their "lifestyle" venture into a fast-growth business requiring full-time management. They commit roughly $30,000 to designing a software program, Ronstadt's Financials, and bring in two independent programmers.
May: Robert Ronstadt takes a leave of absence from Babson. The Ronstadts commit another $123,000 to Lord's software venture and begin raising money to write product code -- eventually securing $150,000 through relatives.
March: Regis McKenna Inc. researches the market for Ronstadt's Financials for about $50,000.
April: Four investors put up $400,000 for 16% of the company. The product coding is still unfinished.
July: The Ronstadts move their business out of their house and into a 3,000-square-foot office.
May: Ronstadt resigns from his tenured position at Babson to run Lord.
September: Lord hires a CFO. The Ronstadts figure they need at least $2 million in additional capital, mostly for sales and marketing. They begin writing documentation.
March: The investor group, expanded to eight, puts in $1.3 million for 22% of the company and takes an option to put in another $1.1 million for an additional 18% in the fall.
August: Lord starts advertising Ronstadt's Financials, slashes the price from $499 to $199, and provides rebates for early buyers; 175 units are sold, much fewer than anticipated. The company spends about $165,000 on marketing.
September: Though sales rise to more than 370 units, monthly revenues of $75,000 fall well short of the $190,000 in expenses, Lord's highest monthly outlay ever.
November: The investor group declines to exercise its option, citing lack of sales. Faced with a cash crunch, Lord slows advertising considerably and starts revising its business plan to raise money. Expenses are cut to $120,000 per month. Revenues: $62,000.
December: Ronstadt lays off three of Lord's four salespeople and cuts expenses to $80,000. Unit sales fall.
March: The Software Publisher's Association names Ronstadt's Financials a finalist in three categories of the 1988 Excellence in Software awards, and the program appears in 189 Egghead Software stores. To support retailers, Lord raises sales and marketing expenditures to $43,000, bringing total expenses to $90,000, an $8,000 increase over February. Monthly loss: about $40,000. A Canadian group signs a deal to invest some $500,000.
April: The Canadian deal collapses. Lord bleeds another $40,000.
June: The Lord staff now numbers 8, including the Ronstadts, down from a high of 16. Cost cutting has reduced expenses to $45,000, yielding a slim profit on revenues of $63,000. Lord says it has opened negotiations with three possible strategic partners.