Learning From Mistakes
I like to believe that, with help, anyone can launch a business successfully, but from time to time I'm reminded that no new venture can succeed without a real entrepreneur. By that I mean someone who will drive the start-up process, making sure the available capital lasts long enough to build a viable company. Unless the person in charge has the will, the tenacity, and the skills to do that, the start-up is bound to fail.
Let me tell you about the gift and souvenir business I helped launch about two years ago. It all began when an artist named Pat Singer came to me looking for advice. (See " Help! I Need Somebody," November 2000.) She had built a fledgling business around her wonderful paintings of city scenes. Most of the paintings depicted the hustle and bustle near well-known landmarks such as Radio City Music Hall, the White House, Rockefeller Center, and Macy's. She would then reproduce the scenes on mugs, coasters, mousepads, postcards, and other items, which she would sell through high-end retail outlets and gift stores, mainly to tourists. The business had good gross margins and about $300,000 a year in sales, but there were cash-flow problems that Pat had no idea how to solve.
I helped her with them and, in the process, became convinced that the business had great potential if Pat could be teamed with a person who had more business experience than she had. As it happened, I knew a guy named Don who'd been a senior manager at a large express delivery company and was looking for a new challenge. I asked him and Pat if they would be interested in joining forces with me as their partner, and we started our new company, CitiDesigns, in 2001.
In the beginning, it went quite well. We focused on finding new distribution channels and new products that would allow us to offer a broader range of merchandise to retailers. Pat and Don approached the Fire Department of New York, for example, about licensing the FDNY logo. After checking us out, the department awarded us licenses to use the logo on 29 different types of products. In addition, Pat and Don put together deals with Toys "R" Us and other specialty outlets to sell our products nationwide. Between the new merchandise and the new retail partners, we thought sales would triple, from Pat's original $300,000 to $900,000 or $1 million in our second year. We were so optimistic, in fact, that we looked into buying a couple of other gift and souvenir businesses, with the goal of expanding our distribution network and our product range even more.
In the end, though, things didn't work as we'd anticipated. The owners of the companies we planned to acquire wanted more than we were willing to pay, and we backed off the deals. Instead of tripling our sales, we merely doubled them, from $300,000 to $600,000, which -- though not bad -- was a lot less than I'd expected. Along the way, Don lost interest. He recently told me he intends to go back to his roots and sign up with another delivery company. I now regard CitiDesigns as a failure. Of course, any failure can teach you lessons. In this case, I have learned at least two.
The first is, inventory businesses are not my cup of tea. I'd never had one before, and I didn't realize going in how much trickier they can be than service businesses. In retrospect, I should have known that inventory would add another dimension to the business, but it didn't really hit me until I found myself dealing with the consequences of having ordered more goods than we needed. The problem was partly a result of our long lead times. To be competitive in the market, we had to have our products made in China and then shipped to us by boat. That meant ordering them at least four months in advance. By the time they arrived, the economy, the threat of terrorism, and the prospect of war had combined to depress the tourism industry, and so there was much less demand for our merchandise. Instead of having a six-month supply of products, we wound up with a 12-month supply -- and the cost of carrying the inventory until it was sold. The experience gave me new respect for people who know how to manage an inventory business and convinced me that I didn't want to be one of them.
The experience also made me realize that not everyone knows how to get a new business up and running, which was the second lesson. Pat is a terrific artist, and Don is a fine manager and good salesman. If CitiDesigns had been an established company, they would have made a great team. But I should have recognized that this venture called for different skills. What we needed was an entrepreneur.
Even though we had Pat's sales from the beginning, CitiDesigns was (and is) a start-up, relying on outside capital to survive. The first challenge of any start-up is to get beyond that stage and reach viability -- that is, the point at which the business can support itself on its own cash flow. There are various ways to do that, but I generally advise people to build a solid base of repeat customers, especially small, low-volume customers. You can charge them more than you can charge high-volume customers, and they tend to be loyal (provided you treat them well). They also make you less vulnerable to the loss of any single customer.
But it takes time to build that base, and time is limited because capital is limited. The goal is to make your start-up capital last until you have enough customers to provide the cash flow you need to survive. So it's important to have a sense of urgency. You need to conserve your cash and focus relentlessly on building the base. Entrepreneurs are people who enjoy taking charge of that process, becoming involved in every aspect of the business -- raising money, making sales, working with vendors, directing employees, doing deals, whatever. CitiDesigns hasn't succeeded so far largely because it's missing that one key ingredient: a full-time entrepreneur.
So what should I do? I've put about $500,000 into the business, and I've guaranteed a bank loan of $250,000, which I will have to repay, for a total investment of $750,000. On the asset side, we have about $130,000 in receivables and $250,000 in inventory -- which is all good, by the way, but may take a year to sell. After eliminating Don's salary and that of another salesperson he hired, the company is close to breaking even. The problem is, I've lost my taste for the business. I want to get out.
As I see it, I have three options. The first is simply to follow the terms of our agreement with Pat, which requires us to give her back the portion of the business that she brought with her. We'd keep her inventory in our warehouse and give her a year's free rent. During that year, we would also finance her receivables, advancing her 50 cents in cash for every dollar billed. She would get the other 50¢ when the receivable was collected. It's a fair deal, except for two things. Pat has no money, and she doesn't know how to run a business. If we went by the contract, it would be a disaster for her. She wouldn't be able to earn a living. We started the business to help her. We can't in good conscience turn around and leave her high and dry.
That brings me to option No. 2: Sell the business as a whole to a company we could trust to honor Pat's contract. We do, in fact, know two other gift and souvenir companies whose owners we hold in high regard. Unfortunately, they're the people who tried to sell their businesses to us. Right now, they're looking toward retirement, not expansion. It's unlikely they'd be interested.
Which leaves the third option. I've told Pat that I would happily give her the whole business, including the licenses that we've bought together, provided she could find a partner who had at least $150,000 in working capital and who was ready to be CitiDesigns' full-time entrepreneur. We'd honor the terms of our agreement -- a year's free rent and 50% financing of receivables at no charge -- and we'd let Pat and her partner buy the inventory at cost as they needed it. If they don't use it, they wouldn't have to pay for it. In return, we'd be able to keep whatever we could collect from our current batch of receivables. Assuming that we could collect all of it, and that we'd eventually sell our inventory at cost, I would wind up with a loss of about $350,000 -- which I'd chalk up to my ongoing business education.
Inc. magazine can't vouch for the business, and I'm not asking it to do so, but it's a great opportunity for someone. He or she could walk in and take over a $600,000 business for nothing. After paying Pat's salary and other costs, the business would have about $130,000 left to reinvest along with the $150,000 Pat's new partner would provide.
I just hope we can come up with the right person.
Norm Brodsky is a veteran entrepreneur whose six businesses include an Inc. 100 company and a three-time Inc. 500 company. This column was co-authored by Bo Burlingham. Previous Street Smarts columns are available online at www.inc.com/magazine/columns/streetsmarts.
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