The Truth About Start-ups
The Truth About Start-upsWhy does one new business succeed while another quickly perishes -- and what can be learned from each? We revisited the 27 companies profiled in Anatomy of a Start-up over the past three years and came up with some surprising answers
Five bucks says we know your first question about the start-up companies we've profiled: How many are still around?
The answer, surprising to some, is a good two-thirds (although all but a handful missed their growth projections). Of the companies that aren't in business, some have failed in standard fashion, formally dissolving and closing their doors. And others have retreated in that more time-honored entrepreneurial way, collapsing back almost to square one, with a lone founder, encamped at a dining room table, continuing to pursue the long-held dream.
Other questions we hear: How are the companies that have made it really doing? What happened with the test site we read about, the expansion plan, the joint-venture idea? Did they end up raising that money? Who skipped town?
And what about those so-called experts who comment at the end -- who dissect a company's strengths and weaknesses? How often were those folks right, anyway? Are founders commonly blind to flaws that are obvious to informed and disinterested outsiders?
Finally, considering all the lost sleep, unfathomable debt, and enormous risk that come with starting a company, would any of those founders do it again? And if they would, then what -- given the benefit of hindsight and the experience of surviving the occasional disaster -- would they do differently?
But first, a bit of history. The Anatomy of a Start-up series made its debut in February 1988 with a profile of Video's 1st, a franchised chain of drive-through video stores founded by two former stockbrokers. Video's 1st is now out of business, but the series continues to thrive; it has, in fact, become Inc.'s most popular. By the end of 1990, we had profiled 27 companies, doing our best to get into the minds of founders. How did they plan to compete? How did they calculate sales projections and profitability forecasts? How did they think they'd raise money, find staff, persuade customers to buy?
Now we'll see what happened to them. We've tracked them down, updated their stories (see "Where Are They Now?" page 5) and reassessed all that expert advice (see "Truth and Consequences: What the Experts Knew," page 7). We've spoken to many of the founders -- some bankrupt, some rich, most something in between -- and examined their various tales in a search for patterns. Did the start-ups beat have lessons to teach?
Plenty. Here we give you six.* * *
If Cash Is King, Flexibility Is God
Many of the challenges in the start-up process are utterly predictable. You need a good idea, and you need a market that has at least marginal interest in that idea -- even if that market doesn't know it yet. You need good partners, unimaginable amounts of money, and the ability to charm in the morning and play hardball in the afternoon. Each challenge has its own pressures, but it's clear from the outset that you'll have to meet those challenges. Not only can founders foresee which challenges will come up, most can practically pinpoint when.
What has made or broken many of the companies we've watched, though, is this: the ability (or inability) to recognize and react to the completely unpredictable. To use enough managerial sense to plan and anticipate, yet have enough street savvy to know when things are going quite wrong. To be flexible, and not just in response to small surprises but to really big ones -- like discovering you're selling to the wrong customers or selling through entirely wrong channels.
Some companies even find they have to revamp from top to bottom in order to survive. They discover they're in the wrong business.
No Anatomy subject illustrates that kind of discovery better than Buddy Systems Inc. When we wrote about it back in 1989, Buddy Systems was a manufacturer of medical computer systems, providing machines for cardiac patients to monitor vital signs at home. The company intended to sell to hospitals and home-care nursing companies. Last year, when we checked in for an update, sales were slower than molasses, but Buddy Systems was still making machines.
Today? Buddy Systems has metamorphosed into a service business -- a provider of those very clinical services offered by the companies it used to pitch to. Why did founder Thomas Manning make that kind of fundamental change five years into development? Lack of success, partly, and inadequate financing. Target customers turned out to be "so caught up with other growth situations that the cardiac application was not the highest priority," he says. "It just didn't get the attention." That miscalculation led to a cash crunch, and when a new investor group offered $3 million if Buddy Systems would use its technology to become a clinical-services provider, Manning took the plunge.
He argues, though, that Buddy Systems hasn't switched businesses. "The original conviction, that there is a need for telecommunication between home and nurse and doctor, continues to be our guiding vision," he says. He had always imagined going into the service business, but he originally abandoned the idea because of scarce resources. The company now has contracts with clinics in Chicago and Cleveland.
Like Buddy Systems, Wall Street Games Inc. (WSG) went through a major metamorphosis. Timothy A. DeMello started the company as a toy business. Target customers for his securities game were general consumers and students; they purchased a box with instructions and an 800 number for buying and selling stocks in their mock portfolios. Because WSG was a standard retail product, DeMello had to confront the ensuing challenges of getting it onto store shelves and into college curricula.
No more. Like Manning, DeMello faced a crisis over what business could best be built on his idea -- in this case, that of a fake stock market. Retail wasn't cutting it; the $99 game sat like a ton of lead next to Monopoly games and boxes of Pictionary going for about a third of the price. The college market meant having to resell to academics each fall and spring. So after "an agonizing analysis," DeMello repositioned WSG as a company that conducted investment competitions.
With the transformation, media heavies USA Today and FNN signed on as sponsors, offering updates on the top contenders and lots of publicity. Contestants registered with the company directly. DeMello's focus was making sure operations ran smoothly and sponsors were satisfied. Sure, WSG had to add prize money to its expense line, but the number of customers soared and revenues reached $7.2 million.
Same product -- simulated stock market -- but different business altogether. One consequence is that DeMello has come to see his database of customers as not just a list but a pipeline for more products and services, a distribution network. "It costs me $20 to get a college student to pay me $50," he says. "A 40% acquisition cost -- pretty expensive. Could I get $60?" Already he's added a 900 number for contestants who want more details on their performance. He's also plotting completely different businesses -- such as fantasy sports challenges -- to feed into the network.
The marketplace pushed start-up after start-up to rethink strategy. MicroFridge Inc., with 11 employees, discovered that using wholesale distributors to move its combination microwave-refrigerator-freezer wasn't working as well as direct sales by "contract" salespeople might, so management chucked the original plan and began again. Rusmar Inc., which sells neutralizing chemical foam for landfills, didn't want to pursue hazardous-waste handlers since they wouldn't be annually renewing, but gave in when those handlers came calling. The National, the all-sports daily paper, scaled back its original vision of local coverage in each market.
Failure to act with that kind of flexibility would sometimes lead to a company's demise. Before it closed last year, Sanctuary Recording Inc. wasn't selling as much studio time as it needed to. Robin Halpin, who helped start the business with her husband, Tom Silverman, says they considered offering recording classes at night to fill the space. But with three other growing music companies, Silverman didn't have the incentive to work at developing Sanctuary Recording. "We didn't spend any time on the studio," concedes Halpin.
Says Buddy Systems' Manning: "To spend too much time overanalyzing the original plan is probably not productive. What comes out of this is that certain companies adapted well and certain companies didn't. The ones that did made adjustments -- in investors, strategy, organization, product -- from the simple to the complex. That adaptation spelled survival and success -- or at least the chance for success."* * *
Nobody Likes Your Product as Much as You Do Amazing to us, always, were the number of people who seemed to go into business with the barest information about the likelihood of making a living off their ideas -- people who just assumed there'd be a market once they got off the ground. The most successful entrepreneurs worked hard to assess the need for their offerings; others acted on blind faith, and for them the start-up process has been particularly rocky.
Frank Mitchell, for instance, has spent the past six years committed to a gut feeling. SportsBand Network, a provider of radio play-by-play for spectators at sports tournaments, had a yearlong stint, complete with employees, copiers, and paychecks. But when the company failed to nail down a big corporate sponsor for 1990 -- an anchor sponsor that would be the pivotal source of revenues -- it folded.
Mitchell contends that back in 1987, he had no choice but to barrel forward on instinct; he couldn't calculate the interest of potential corporate sponsors until he'd spent big bucks to produce the product. "Nobody would really take this seriously," Mitchell says. "You had to knock them over the head with it, let them see it and hear it firsthand. I would have loved to have researched and quantified this and sold it on market studies, but no one was willing to make the assumption it could be done."
That may be the case, but the result is that Mitchell, his former partner (Theis Rice), and several dozen investors sank $2.5 million into SportsBand before finding that, for 1990, no sponsor would bite. Still, Mitchell continues to pursue the idea on his own. He now works from his home and says he's talking with a broadcasting company, a radio manufacturer, and a possible sponsor about reviving the concept. If the partners are happy with the tests, maybe they'll sign on for 1992. Maybe.
It was a similar story in Albany, N.Y., where Todd W. LeRoy and Michael L. Atkinson started their Video's 1st chain of drive-through video stores in 1987. Dazzled by their idea, they boasted they would sell 5,000 franchises by the middle of 1990, and that each unit would rent 116 movies a day.
They figured wrong on both counts. By the middle of 1990 Video's 1st New Releases Inc., the parent company, had shut down. So, too, had the 10 Video's 1st kiosks that had dotted the country.
The founders had made grossly inaccurate projections because they hadn't investigated what was involved in setting up franchisees and because they failed to quantify how much customers really wanted the drive-through service; they started selling franchises before their corporate-owned units were even two months old. Franchisee Rick Taylor, who owned three Video's 1st kiosks, says he's learned something about due diligence: "I had an M.B.A., but this experience was my doctorate. If I did it again, I'd spend more time analyzing the market and the product, and I'd talk to competitors rather than rely on the information provided by the franchisor. I was so enamored of the concept that I jumped, then looked."
How did the successful companies approach the market differently? Some, such as R.W. Frookies Inc., a cookie company, or Appliance Control Technology Inc. (ACT), a manufacturer of electronic controls for appliances, made sure their products were unique but not so different that customers didn't know what to make of them. Others, such as VideOvation, a purveyor of video yearbooks, took a year or more to test their programs and customer response, making sure they weren't misjudging demand or their ability to execute the concept.
"We've learned to pilot things," says Alan Khazei, who with cofounder Michael Brown runs City Year Inc., a nonprofit urban peace corps for 17- to 22-year-olds in greater Boston. The venture was originally approached as a nine-week summer pilot rather than a yearlong project. And changes in the program have been tried in small groups before being launched full-scale.
"We've really tried to build in time to evaluate what we've done," says Khazei. He and Brown hope to take their volunteer-for-a-year concept nationwide but don't plan to expand until they've honed the program a few more years in Boston.* * *
If You Don't Have Experience, Buy It
The strongest companies were led by people with experience in their industries. Companies started by people new to their fields didn't fare as well. It's all about respecting the marketplace -- why waste time and money managing from ignorance? You have to know your business, and if you don't, you'd better find someone who does.
ACT, Rusmar, and The Plastic Lumber Co. have all carved out somewhat comfortable niches for themselves. ACT founder Wallace C. Leyshon says experience has made the difference. "Most of us here have been at this business a decade," notes Leyshon, who was business director of a division of Motorola Inc. before starting ACT. "We probably have a little higher probability of developing proper strategies than people who thought out their businesses over a shorter period of time."
Rusmar, the landfill-foam company, was founded by a scientist who was quick to bring in another chemist with experience in marketing and sales. Founder Paul A. Kittle also hired Arthur Andersen Co.'s emerging-business group as a resource. As a team, they brought revenues last year to a profitable $1.5 million. Similarly, the founder of Plastic Lumber (a manufacturer of "faux wood" lumber products) hired a key technical specialist in plastics manufacturing right at the start. Today Plastic Lumber is negotiating with some large companies that would, in return for processing, provide it with capital, long-term raw-material contracts, or technical assistance.
When expertise was needed, smart companies didn't just make educated guesses or even turn to consultants. They made seasoned people part of their crews. Those that didn't hire the necessary know-how -- including Video's 1st, Sieben's River North Brewery, Oualie, and Landmark Legal Plans, all of which are now dormant -- didn't fly.
Your Competitors Aren't Dumb
Smart founders knew that starting out without the benefit of experience would hurt them. They also recognized that competitors are to be respected. Because even if you'll be pushing a product or service that represents an improvement on what's out there, your competitor still has one thing you don't: a viable business. When start-ups ignore that, they turn arrogance into red ink.
When our expert panel reviewed the plan for Sieben's River North Brewery Inc., for instance, one competitor cautioned that food at the Chicago restaurant should be kept simple. Another warned that unless one person took responsibility, details such as "making sure the salt-and-pepper shakers aren't greasy" would be missed.
Sieben's shut down this past September. Cofounder Bill Siebel concedes the main mistakes were underestimating the challenge of running a restaurant properly, and not having a restaurateur for a partner. "There were 180 people working on the restaurant side, and one on the brewery," he says. "That's how our headaches balanced out."
When we talked to our experts about the Queen Anne Inn Ltd.'s prediction of reaching 80% occupancy in its third year, four of them said it was unrealistic for the Denver operation to base its profit-and-loss projections on such high occupancy. Four years later the inn is finally profitable at nearly 70% occupancy -- after raising its prices each year.
Richard N. Keener and Leif Blodee, founders of furniture manufacturer Keener-Blodee Inc., in Holland, Mich., thought they could sell $1.7 million worth of chairs their first year. But one analyst said, "For them to expect to be able to whack 7,100 units out of somebody else's hide is a gross miscalculation." This past December the bank auctioned off the company's equipment. "We overextended ourselves," says Blodee. "We tripled the size of the plant and then tried to build sales, and the sales didn't arrive."
The point is, all these companies should have learned more about what was coming down the pike by studying the competition -- really studying what worked, what didn't work, what expectations other players had developed about the market. There rarely is a reason to think life is going to be easier for a new business just because it's new. "What would make companies smarter? Look at the examples of others, and don't assume those companies make mistakes," reflects Buddy Systems' Tom Manning.* * *
It Isn't the Sales. It's the Sales Cycle
No founder has ever overestimated the amount of capital necessary to get started or the amount of time it will take to be legitimated by the marketplace. You know that; it's boring. But what a lot of companies repeatedly miscalculated was the sales cycle -- the length of time between the first sales pitch to the customer and that customer's actual purchase.
Robert P. Bennett, founder of Micro-Fridge and a management novice when he started out, was caught off guard when sales to hotels didn't take off as he'd anticipated. Bennett proposed that they test the company's units in their lobbies and survey their patrons. Bennett found that 80% of those who tested the MicroFridge ordered within 45 days -- faster than expected -- but the test period still added an unplanned month and a half to his sales cycle.
Says Frederick A. Cardin, founder of the O! Deli Corp. chain of franchised delicatessens, "Our growth was substantially slower than I had hoped, because it can take a long time to get stores up and running in an office building." Landlord negotiations took longer; sites in new buildings had to wait until the facility was built and leased before opening; units replacing existing delis had to wait until leases either ran out or were bought out by the landlord.
"Those are timing issues, and over the long run those problems even out and go away," says Cardin. "But in the short run, we have a backlog of franchises waiting for sites" -- and a cash flow problem, since stores can't generate revenues if they're not open, and corporate overhead costs still mount. New investors not only bought out Cardin's share of the company last year but put additional money into operations. Miscalculating sales cycles led to similar cash flow problems, from the mild to the ruinous, with other start-ups as well.* * *
Don't Underestimate How Much Time Simply Being the Boss Will Eat Up
Founders were thrown for a loop by the responsibilities of being CEO. Not only were they expected to be chief technologist or strategist or salesperson but interior decorator, human-resource director, and office manager, too. Those who delegated well didn't get overwhelmed by minutiae. Others got buried.
"Never having run my own business before, I didn't realize all there was to it," muses MicroFridge's Bennett. "I didn't have a concept of all the administrative aspects. They sound trivial when you try to list them -- you know, expense reporting, supervision, sick days, holidays. But when you throw them all together, they're a huge chunk of management time. I had no idea."
More painful, though, is Daniel J. Dart's experience. In July 1987 Dart and his partner, Ann O. Hartman, opened Blackstone Bank & Trust Co., in Boston. Today Hartman is gone and Dart is a consultant to Blackstone, after resigning last fall in the wake of a crackdown by the Federal Deposit Insurance Corporation. The bank's loan losses reached $2.2 million on its relatively small portfolio of $50 million; the bank is shrinking its asset base to maintain required minimum capital ratios.
What frustrates Dart is that this tenuous situation has stemmed in part from the distractions inherent in starting up. "You end up spending an incredible amount of time and management effort on things that other banks are taking for granted," he says. "Like designing our logo. Developing plans for our office space. Building facilities. Purchasing furniture. Installing computer systems. Training people. Developing personnel policies.
"At the same time," he continues, "you're hemorrhaging red ink, and you can't just sit back and say, 'Gee, I'm kind of conservative.' " Result: the bank made loans, says Dart, before it had airtight procedures to oversee them. And it made mistakes.* * *
Dart's main aim now? It remains, despite his troubles, similar to the one most start-up founders take to bed. "My number one goal is to have the bank survive. Pure and simple. Basically, I'd do anything to ensure that happening."* * *
THE HARD PART
Forget the strategic challenges a start-up presents; the emotional ones can be worse
Granted, leaving a $175,000-a-year job to start a business at home is probably not the prototypical entrepreneurial experience. Nor is doing that at age 27. Nor is pocketing about a million bucks, just a few years later, for 40% of the equity. Tim DeMello isn't representative of people who run four-year-old companies; he's been successful.
On the other hand, DeMello, founder of Wall Street Games Inc. (WSG), a marketer of national stock-market competitions, has struggled with at least one thing common to every company founder who sets out, as most do, utterly alone: an exposed and very vulnerable sense of self. "This is a way of life," DeMello explains, echoing countless others. "It's not a job, it's not a career, it's a way of life. I started a business for the sense of accomplishment, period." Trouble is, that sense of accomplishment takes a while to happen. And the lack of it can destroy confidence, summon doubt, and breed a paralysis no founder can afford.
"I came out of an environment with phones ringing a zillion times a day," says DeMello, who spent four years at Kidder, Peabody & Co. and two at L. F. Rothschild. "I believed if I reached for more, the rewards would be there, right then. I felt pretty confident of my skills."
He knew that new challenges -- marketing, accounting, advertising -- would tax that confidence. As difficult, though, was keeping his emotional balance without the support of a workplace. No more helpful, motivating colleagues; no more affirmations of personal worth from above (promotions, bonuses, commendations in the company newsletter); toughest of all, no more perspective of the sort you have when a job is something you do only at the office.
"When I started Wall Street Games, that was the loneliest period of my entire life. Those months I worked at home, I used to attack my wife in the driveway when she'd pull in, because I needed some form of companionship. Plus, you're focusing on something no one can truly appreciate. It's one of the scariest things in the world to sit there with an empty yellow legal pad and understand that nothing's going to happen unless I initiate it, so what in God's name do I do now?"
That vulnerability kept him from asking for help. "You don't want to try out your ideas on everyone, because you don't want a lot of people to say, 'This is crazy.' You're going through so much self-doubt as it is, you don't need anyone else's. You end up waiting until the idea is totally together before you start presenting it. I think you've got to go through that stage, but it's tough."
When outside investors paid $500,000 for a 20% stake, WSG moved into the marketplace. DeMello added managers and a flock of part-time student workers to staff the telephones over which customers buy and sell mock stock. As the personnel and infrastructure grew and changed -- there are now 10 full-time and 125 part-time employees -- so did the way the world dealt with DeMello. He started to become a star again.
"Perceptions are funny. In the office, new students will ask someone, 'Can I meet Tim?' And it's like, 'Yeah, you'll probably meet him next to the urinal.' But I used to think that way, too. We paint people to be bigger than life."
To maintain balance, DeMello says he "revisits the vision constantly" and doesn't look back on past victories -- or even perceptions of victories. "I read the Inc. story only once. I remember saying to people, 'It doesn't mean anything.' Hopefully it gives you a little boost of self-esteem, and you use it in your business if you can, but you go on."
Still, DeMello no longer feels like just another stockbroker. "I know how much work it was to get where I am -- and I don't mean I think I'm at the top; as soon as I say something like that I'll crash in two seconds. But I feel I've done something that isn't that simple."
TRUTH AND CONSEQUENCES: WHAT THE EXPERTS KNEW
Sometimes, a critic is a founder's best friend
We called them The Experts, or commentators; one start-up chief executive sniffed that they were simply pontificators. Whatever the tag, each one's assignment was the same: read our start-up story and say what you think.
Our aim, of course, was to counterbalance the superheated plans of the founders we profiled (most of whom made seductively convincing cases for their companies) and to tell readers The Rest of the Story. The commentators pulled back the curtain a little, pointing out oversights, faulty logic, or calculations that raised positive thinking to an article of faith. And it's no wonder they weren't always popular. Whether competitors, academics, financiers knowledgeable about the industry, operators of similar businesses, potential customers, or editors of trade journals, the experts dumped hard reality all over somebody's dream.
Were they right? Yes, they usually were. The companies they received with heavy skepticism are the ones doing poorly.
More interesting than the experts' thumbs-up, thumbs-down verdicts, though, was that certain criticisms came up month after month, start-up after start-up. It began to seem as though there were intrinsic entrepreneurial blind spots. And the follow-up done for this article shows that 95% of the time the warnings -- listed here -- were wise.
* Sales will not grow as quickly as founders project.
* Miscalculations are usually made in what it costs to sell -- including everything from salaries for salespeople to budgeting for conferences.
* Most companies pursue too many kinds of customers or too large a geographic territory, or introduce too many products, given limited resources.
* People with key experience ought to be given stock or some other incentive to keep them fully involved, and too often are not.
* It's easy to let operating costs and overhead slide up, and too often that's what happens.
* Selling someone once doesn't make that customer a loyal buyer.
Which category of experts was best? Hands down, the financiers -- who, most frequently, were managers of venture capital funds with positions in companies comparable to the start-ups they were evaluating. Consistently, they got to the heart of the business under scrutiny, explaining what its competitive advantage was and how to give it leverage. Sometimes they'd simply say that there didn't appear to be any competitive advantage. The financiers didn't flinch when it came to stating what to them was obvious.
An example: Bruce V. Rauner, a venture capitalist in Chicago, reviewed two companies, including O! Deli Corp., a franchisor of delicatessens. When he looked at O! Deli he said the founders' gargantuan projections for franchise expansion made them seem too top-line oriented. And the way they'd gone public, merging with a shell company trading on the pink sheets, might make it difficult for them to raise additional capital down the line. But just as troubling was the simple fact that no one connected with the operation had ever run a deli. The CEO had spent his career as a consultant, and as Rauner pointed out, "the start-up desert is littered with the bleached bones of former consultants." This business, he stressed, comes down to selling sandwiches, not franchises.
Today O! Deli has 21 shops; the prediction of 500 for 1993 now seems pure whimsy. The founders, bored with the deli business, left to start new businesses.
Perhaps the venture capitalists are good critics because they routinely do for a salary what we ask them to do for fun: figure out whether or not founders know what they're doing. Unlike consultants or industry observers or even customers, they inherently use a tough but telling criterion: will this company make money for its investors? Are there people who want this product or service, and will the founders really be able to get it to them at a profit?
Other experts may not have been so consistently insightful, but their advice was always worth hearing. Operators of similar businesses or direct competitors, for instance, were good at cautioning against overestimates of swift market acceptance and assumptions about product or service uniqueness. They did, however, shy away from embracing new approaches. And in retrospect some of those new approaches worked -- sometimes they turned out to be as good as, or better than, the tactics the "experts" were using.
Fact is, perspective like that provided by our experts comes pretty cheap. It's often readily accessible. And it's shocking how infrequently it's sought. There ought to be a rule: Before you start a business, find 10 smart people who know the industry and ask them: How am I going to screw up? How else? How else? How else?
A confession: When it came to grading the experts, we were easy. Why? Because any advice is better than none. (Even bad advice can help by forcing you to consider why one tactic may be smarter than another.) Better, we say, to pick every available brain than to skip a single critic.
VENTURE CAPITALISTS -- Grade: A
Advantages: Evaluate businesses for a living; adept at spotting weaknesses and suggesting solutions; focus not on "Is it a good product?" but "Will it sell?"
Disadvantages: Usually return Inc.'s calls, but might not return yours
OPERATORS OF SIMILAR BUSINESSES -- Grade: B+
Advantages: Know customer attitudes and margins necessary for profitable operation; have survived mistakes; know industry swings