The US dept. of labour statistics shows that 44% of small businesses fail within 2 years, and 66% within 4 years…within 10 years, 95% have failed.
In terms of risk, that’s like flipping a coin and waiting 3 years to know whether you’ve failed already or will almost surely fail in the next few years instead. Put simply, the odds of your success as an entrepreneur are dismal.
If you were badly advised and ‘bet the farm’ by putting all your life savings into your first venture, then you’re probably reading Finweek at the reception of the company where you’re applying for a job. On the other hand, if you “kept some of your powder dry”, cut your losses and tried something new, then chances are that it would also have failed. In fact, most successful entrepreneurs have failed 3 or more times before they eventually succeed. (This is one of the reasons why despite what you read about a few lucky young dotcom millionaires, most the founders of successful businesses tend to be 40+).
So why are these failure rates so high? Over 80% of failed entrepreneurs surveyed cited a “lack of an understanding of finance and financial management” as a major factor.
That’s where this column comes in: over the next few months I’ll be writing a weekly column in Finweek through which we aim to help entrepreneurs like you use the principles of what large companies call ‘corporate finance’ to improve your own businesses.
Corporate finance is a discipline that aims to maximise the value of the firm. It’s as applicable to large corporates as it is to the smaller more entrepreneurial business, albeit with some modification and a lot less complexity. To make it clear that we’re addressing entrepreneurs with rolled-up sleeves and customers at the door, and not a bunch of bean-counters in suits at a soulless head office somewhere, we’ll call this stripped-down version ‘Finance for Entrepreneurs’.
Here’s what we are going to cover in the next few weeks and what I hope you’ll learn and apply to your business over the time:
Firstly, despite all the passion and emotion that is such a vital part of being an entrepreneur, when it comes to your business and money you need to step back and treat it like any other investment you could make. We’ll show you how to value your business in a way that allows direct comparison with other investment choices you all have, so that you can make unemotional financing decisions.
Secondly, you can only manage what you measure. If you’re not preparing monthly accounts in your business then now is the time to do so: get a bookkeeper or account on board in your business now. For those who are we’ll show you how to get the most use from the effort you’ve already made. Sound decision-making requires sound underlying data and there are no ways around this.
Once you have the numbers and the approach right we can get on with using ‘Finance for entrepreneurs’ to maximise the value of your business. In a nutshell, this is what it entails:
1. The Investment decision: to grow your business you need to invest in assets that earn a return greater than your hurdle rate. This hurdle rate should reflect the risk of the investment and the mix of debt and equity used to finance it. The return should take into account the size and timing of cash flows and side effects.
2. The financing decision: the value of the firm is optimised when you have the right kind of debt for the firm and the optimal mix of debt and equity to fund your operations.
3. The dividend decision: if your business cannot find investments that make the hurdle rate, then it should return cash to the owners. How much cash depends on the opportunities it faces, and it can choose to return cash as dividends or share buy-backs.
The good news is that the principles of what we’re going to discuss here are universal and that while they require a logical mind, they don’t require any formal accounting or statistical training. We’ll keep the language simple and the break the learning into weekly bites. I’m looking forward to it!
Feel free to share your story or ask questions @valuationup