I just read an article on Slate in which Michael Idov details his experience with starting a coffee shop and the subsequent ruining of his life that this accomplished. This is a great read and lesson in the importance of coming up with a feasible business where the numbers actually work out. Especially when the business is burning an $18 000 a month hole in your wallet.

There’s no sense dwelling on his mistakes as he summarizes them well enough himself, but his reasons for starting this business are particulary noteworthy:

The dream of running a small cafe has nothing to do with the excitement of entrepreneurship or the joys of being one’s own boss—none of us would ever consider opening a Laundromat or a stationery store, and even the most delusional can see that an independent bookshop is a bad idea these days. The small cafe connects to the fantasy of throwing a perpetual dinner party, and it cuts deeper—all the way to Barbie tea sets—than any other capitalist urge. To a couple in the throes of the cafe dream, money is almost an afterthought. Which is good, because they’re going to lose a lot of it.

There lies the core issue. Starting a business can have many motives, but ultimately a for-profit organization should be able to do just that, profit. This means that some areas just shouldn’t be jumped into, a lesson I have learned myself a couple of times. Or more accurately, you can’t start a business on the idealism of what a wonderful place it would be. Michael points out that in order to get the sales necessary to sustain the shop, they would have had to had a steady stream of in-and-out traffic. However the store was built to host a small number of people for periods of half an hour as they sat, relaxed, and drank their coffee.

Ever dreamt of starting a business? Ever came up with all those wonderful things your business would provide to customers and employees alike? You can darn well bet that my dreams have always included the most perfect product, 24/7 service, and a cafetaria full of free food. However those things cost money and it’s very easy to miscalculate just how much they alter margins or the real cost involved (labour is often missed!). Even something as simple as free coffee for a small team is hundreds of dollars per month. I’m still surprised Google can provide all the benefits that it does, but I guess that’s a perk of revolutionizing the internet and having high investor confidence (see the stock price on Google Finance).

In the end the math just didn’t work out for Michael’s idea, but the lesson that results is something that many of us can learn from. We have to remember that all that addition, subtraction, multiplication, and division we learned does actually have an application outside of developing calculators in this world. It’s quite possibly the most important ability in a business plan - making the numbers work.

I recently attended a seminar put on by Infusion Angels at the University of Waterloo. This group of angel investors did a fabulous job covering what is involved in obtaining angel and venture capital funding, and what you absolutely need to be able to answer. Half the presentation involved others making pitches to us as a crowd, pretending that we were venture capitalists. Very enlightening experience.

There was a whole lot to be learned here, but the biggest take-away from the whole thing was a list of the top five things venture capitalists look for in a desirable investment. As an entrepreneur you should be hitting every point in your planning even if you don’t intend to seek venture capital, as these are key criteria for an idea that has strong chances of success. Here they are in no particular order:

1) Exit Strategy

This is the number one point actually and the presenters emphasized it very heavily. You absolutely must know how you will cash out and get the big upside from building the business. Venture capitalists and angels are looking for approximately a 10x return in 5 years on their money, so your venture must be able to provide this. A popular exit strategy is being bought-out by a massive competitor or partner, such as the Web 2.0 companies who have been or are hoping to be aquired by a giant like Google. Other strategies like going public or simply liquidating the business exist, but remember that ultimately your exit strategy has to have data and some realistic thinking behind it.

2) Entry Barriers

A great idea is a start, but you need to be able to show that you can stay in the game after the cat is out of the bag. Who will your competitors be? What protects you from a much larger company entering the market with their own product and wiping you out? The stronger your entry barriers the more of the market you can reasonably expect to claim and the greater the chance your company will be around long enough to get that upside.

This was a really interesting one to look at when the people who volunteered to pitch their ideas presented. Patents came up a couple times, as well as some strong legislation banning an existing product. My favorite response came from a really cool laser technology start-up. Someone had asked about the risk of another researcher coming up with a similiar technique tomorrow. These two folks pointed out that their product required high expertise in a number of complex fields, and that very little research was being done in the area worldwide. Furthermore their prototype already worked and the venture was ready to build a fullscale machine as soon as they received funding. This placed statistics and time on their side.

3)What is Product/Service Similiar to?

This was a point I had never really heard before in terms of what VCs are looking for, but it makes a lot of sense. Your proposed business should have similiar ideas out there, or be a combination of similiar ideas. This provides a reference point for the potential investor and allows you to show a proven market.

If you have a really novel idea you can certainly still get funding, but this uniqueness can actually work against you.

4) Existing Revenue

The general rule presented was that angel investors don’t require revenue to be present, but venture capitalists usually do. This ties back to a mistake that entrepreneurs often make - seeking out venture capital funding too early. It’s not all about making the VC happy either. By having real revenue coming in at the time of investment you will also protect more of your equity in the business. This is very important as your VC will end up owning most of the company.

5) How Much Money Do You Need? For What?

You not only need to know that you need money, you need to know how much and how you will spend. The VC will be looking for realistic estimates that show you have a real idea of how much your product will cost to bring to market. Don’t forget the operating expenses, marketing, and legal fees that will accompany your venture. One very good pitcher suggested that she and her partners will work for free until the product is selling. The presenter immediately pointed out that an investor would much rather put a few extra hundred thousand into a multi-million dollar investment and have you concentrating on it fulltime rather than working elsewhere too. So include a salary for yourself!

Another very interesting point was brought up here too - venture capitalists like to hear large numbers (not necessarily true with angels). A VC is obligated to invest a certain incredibly large figure in a very short period of time, and larger investments mean this can be done sooner. If your company puts $20 million to good use, that’s 4 $5 million start-ups that don’t have to be found.

Conclusions

I’m glad I attended this talk and I hope my recap conveys some of the very important information covered. It’s always important to understand where the other side is coming from in business, and in this case real investors were explaining what really matters. None of the presenters hit all five points completely even though some of these were ideas that had already been highly successful pitches in new venture competitions. It’s easy to miss important details and the best way to be prepared is to hit this criteria long before you are seeking funding.

Big thanks to Infusion Angels for putting this event on. They are a Waterloo, Ontario company located at the University of Waterloo’s new Accelerator Centre. Give them a shout if you need funding for an idea.