by Norm Brodsky
We began by figuring out what it would take to open the day care center for business. The obstacles were daunting. To minimize the financial risk, we decided, Malki would probably be better off buying her space than renting it. That way if she failed to get her license, she could sel the property and she wouldn’t be stuck with a long-term lease.
So somehow Malki had to find a property, work out a deal to acquire it, make the necessary renovations, cover the mortgage payments, and stil do everything else required to launch the business successful y when—or, rather, if—the license came through. I’m talking about doing market research, raising working capital, figuring out her pricing, and so on. What’s more, she had to do it al in her spare time. She couldn’t afford to stop working.
I thought Malki would quit when she realized what was involved, but I was wrong. She immediately threw herself into the market research, checking out al the day care centers in the area. She befriended an experienced day care operator in another state who gave her tons of invaluable advice. She obtained the various licensing application forms that she needed and figured out the steps she had to go through to become licensed. Meanwhile, she worked her Rolodex tirelessly to come up with the funds she needed, eventual y raising about $150,000, almost al of it from family and friends.
But Malki’s biggest coup was her real estate deal. She located a building that was in the process of being vacated. The guys who owned it were moving to another building and needed some flexibility on the closing date. Malki could give them plenty of flexibility. What she needed was time.
With no business history, she couldn’t get a mortgage right away, and she could afford only a smal down payment, but she thought she’d be in a better position after the day care center had been running for a while.
So they made a deal: Malki would assume the current mortgage on the property and pay a smal amount toward the asking price. The sel ers would then give her a second mortgage to cover the balance. After a certain period Malki would refinance the building and pay off the second mortgage. In addition, she and the sel ers agreed on a closing date that al owed her to begin the licensing process long before she had to start making payments. As a result, her costs during the pre-start-up phase were much lower than we’d anticipated.
In the end, it took two years for Malki to put al the pieces in place. She stuck with it, and her day care center opened for business in July of 1999.
It was a tremendous accomplishment. Malki felt as though she’d final y reached her goal. But in fact her biggest chal enge lay ahead.
Why? Because everything changes when you open your doors and start making sales. There’s a new kind of pressure and an increased sense of urgency about dealing with problems. Before you have customers, after al , a delay is not a disaster. If a piece of equipment is delivered late, you may be annoyed and frustrated, but the consequences aren’t al that serious. It’s a different story when you’re open for business and employees don’t show up for work or customers demand things you can’t provide. Decisions have to be made. Actions have to be taken. Suddenly, you find yourself inundated with problems, and they al demand immediate answers. If you’re a first-time entrepreneur, you tend to greet each problem with the same reaction: panic. It doesn’t matter that the vast majority of the problems are actual y quite manageable. To you, they al look like catastrophes.
To be successful you have to get over your panic. Not only must you develop confidence in your ability to handle problems, but your whole way of thinking about them has to change. You have to accept a never-ending flood of complications as a normal part of the business process, and you have to learn to enjoy that process. How? By getting caught up in the fun and excitement of finding solutions.
Some people can’t make that transition, and I thought Malki was probably one of them. For one thing, she felt uncomfortable making decisions.
She liked to get a lot of opinions and mul them over. That trait may be a virtue in some circumstances, but it doesn’t make the start-up process any easier.
In fact, Malki seemed miserable for the first few months. She was frustrated. She was overwhelmed. She didn’t know how to deal with the parents. She thought she’d never find the employees she needed. The ones she had came in late or left early, forcing her to scramble to get replacements so that the ratio of adults to children remained in compliance with state regulations. Every roadblock appeared to be insurmountable.
Every problem felt like the last straw.
After overcoming so many obstacles to open the center, Malki was discouraged to find she had more problems than ever. I figured she simply wasn’t cut out for business. Fortunately, we’d designed an escape hatch for her. Malki could stil sel the place and move on to something else without any dire financial consequences, as Elaine reminded her at one point.
But Malki kept going, and little by little her way of thinking began to change. I could see the change in the way she presented issues to Elaine and me. Instead of focusing on how bad a problem was, she started coming to us with possible solutions, asking what we thought. Meanwhile, her business was growing and so she had more problems than ever, but her sense of panic continued to dissipate. By the end of the first year, she was clearly in control.
That was almost a decade ago. The day care center has been wildly successful and today is bursting at the seams. There’s a waiting list to get in. As for Malki, she’s enjoying the business process more than ever. She admits that she hated it at first. There were moments when she wondered if she could last. But she held on, and her attitude gradual y changed as she began to realize she could handle whatever problems came along.
Was there a turning point? “Yes,” she says. “It was when Elaine told me I could quit.”
Malki doesn’t know what kept her going, and neither do I. Cal it passion, tenacity, stick-to-itiveness, true grit, or just plain stubbornness.
Whatever it is and wherever it comes from, it’s the most important quality an entrepreneur can have. Ultimately, it determines whether we succeed or fail.
The Bottom Line
Point One: Those who persevere win. Be resilient and welcome failure. That’s how you become a better businessperson.
Point Two: You learn by refusing to make excuses and looking deep inside yourself for the reasons things have gone wrong.
Point Three: Focus and discipline are more important than identifying opportunities, but they have to be balanced with flexibility.
Point Four: The solutions are seldom right in front of you. You need to learn how to spot them out of the corner of your eye.
CHAPTER THREE
Why Start-ups Fail
People get so much bad advice when they first go into business that I sometimes wonder how any new company survives. You often hear, for example, that to be successful you need a unique product or service, something nobody else has. Or that you should choose a business with as little competition as possible, that you’re better off having a market to yourself. My advice is exactly the opposite. I never want to be first in a market, and I always like to have a lot of competitors. Yes, I want to be different from them, but the more people who are making money in an industry, the better I feel about going into it. There are actual y three simple criteria I use in evaluating every new business I start. I suspect they’d work for about 80 percent of the people who are going into business for the first time.
Number one, I want a concept that’s been around for one hundred years or more. OK, maybe less than one hundred years. The important thing is that it’s an established concept, one that everybody understands. It’s not something new and revolutionary. Why? Because there is nothing more expensive than educating a market.
I found that out the hard way when I took my messenger business to Atlanta in the early 1980s. At the time, companies there handled deliveries by putting a secretary in a cab and sending her off with a package. The secretaries didn’t want our service—they liked having time out of the office
—and the companies didn’t know they needed it. We had to do mailers, run ads, develop a whole public relations campaign. And it was a delivery service we were educating people about, not some radical new technology. I’m tel ing you, it was very, very expensive, and we took a beating. I’d rather be in the biggest, most competitive market in the world and go head-to-head with a hundred other companies.
Of course, if you’re going to compete, you have to be able to dif ferentiate yourself with customers. Which brings me to the second criterion: I want an industry that is antiquated. I don’t necessarily mean “old-fashioned.” I’m talking about a business in which most companies are out of step with the customer. Maybe the customer’s needs have changed and the suppliers haven’t paid attention. Maybe they’re not up-to-date on the latest technology. In any case, there has been a change, and the industry hasn’t fol owed it.
My storage company, CitiStorage, is a good example here. When I first looked into the business, I noticed that, except for a couple of big players, records storage companies were asleep. They had ancient warehouses designed to store dead files for customers. Meanwhile, the industry had completely changed. Real estate had become so expensive in major cities that customers were looking to store their active files off site—that is, files they stil had to get at from time to time. The records storage business was turning into the archive retrieval business, and almost nobody seemed to notice. The two big exceptions were Iron Mountain and Pierce Leahy, the industry giants that later merged. They’d recognized the change and built huge, modern archive retrieval facilities out in the countryside. In the process, they’d become the driving force of the industry.
I sensed an opportunity here, but there was something I didn’t understand. How could the other guys stay asleep? Why were they stil in business? Why hadn’t they lost their customer base? The answer, I discovered, was that some of the biggest customers wouldn’t move their files.
They didn’t want their records to be so far out of town. What if they needed a particular file in an hour?
That gave me my third criterion for a successful new business: a niche. I would build a huge, modern facility in the city. I’d distinguish myself from the old records storage companies by designing the facility specifical y for archive retrieval, using the latest technology. I’d distinguish myself from the giants by my location. The customers would be close to their records.
In fact, having a niche is critical to every start-up, but not for the reason most people think. It has to do with the high gross margins you must have to make sure your start-up capital lasts long enough for your business to achieve viability. If you’re the new kid in town, you can’t compete on price, because you’l go out of business. On the other hand, you do have to get customers. That means offering them more value at the going rate.
But how do you offer more value without increasing your direct costs, cutting your gross margins, and running through your start-up capital? The answer usual y lies in the niche you’ve selected. I realized, for example, that the latest archive retrieval technology al owed me to cut my direct costs by building a facility with much higher ceilings than my competitors have. I could get more than 150,000 boxes in 10,000 square feet, whereas those guys were getting 40,000 or 50,000 boxes in the same space.
So those are my three criteria for starting a successful business: a one-hundred-year-old concept, an antiquated industry, and a niche. I know some people are thinking, “If everybody fol owed those criteria, we stil wouldn’t have the wheel.” Wel , they’re right. I don’t mean to discourage the visionary geniuses out there. I’m al for advances in technology and the creation of new industries. If you’re another Thomas Edison, Fred Smith, or Bil Gates, forget my criteria. Go right ahead. Change the world.
But most of us go into business with more modest goals. We’re happy to wind up with a company that survives and grows. If you’re one of us, take my advice: Don’t try to turn that revolutionary new concept into a business. Find a great old concept instead.
Buy or Start?
Here’s another piece of advice to ignore: you’re better off buying a business than starting one from scratch. A lot of people say you can reduce your risk, save money, and achieve your goals faster if you take over a company that’s already up and running. Don’t believe it. For most first-time entrepreneurs—especial y those who’ve never run a company before—the chances of surviving are much greater if you build the business yourself, from the ground up.
There are a number of reasons. For one thing, it’s harder to learn a business if you haven’t been with it from the start. You miss out on al the trial-and-error education that happens in the early stages. You don’t understand key relationships in the business. You don’t know what to do in emergencies. You make mistakes that are much costlier than they would have been back when the company was smal er and struggling to get off the ground.
No matter how fast you learn, moreover, you’re likely to find that the chal enges are greater than you bargained for when you bought the business.
Acquisitions are very tricky. You can do as much due diligence as you please, and you stil won’t know exactly what you’re getting until you’ve already paid for it—at which point it’s usual y too late to go back. Even experienced businesspeople often get burned. As for inexperienced buyers, they’re usual y at the mercy of the sel er, or the sel er’s representative, or the business broker (if there is one), al of whom have one thing in mind: getting the deal done. If you’re not careful, you could easily wind up buying a pig in a poke.
That’s what almost happened to Josh, a young fel ow in his early thirties who came to me for advice a few years ago. He said he was getting ready to buy his first business, and he needed my help. He had a meeting scheduled in a few days at which he was supposed to sign some papers and put down a $100,000 deposit on the business, 60 percent of it nonrefundable. His father, a Canadian business owner, thought he was making a mistake but said Josh could go ahead if he got someone with more experience to sign off on the deal. Josh wondered if I’d be wil ing to look it over and give him my opinion. I agreed.
It turned out that the company he wanted to buy was a smal packager of herbal lotions, which it sold through independent sales representatives to specialty stores and chains. The current owner had been running the company out of her home. She’d been in business three or four years and had done fairly wel , or so it appeared from her financial statements. Now she was pregnant and wanted to cash out. She was asking for $250,000.
The company seemed to be just what Josh was looking for. It was in his price range. It had plenty of growth potential. And although it was stil fairly new, it was already turning a good profit. According to the financial statements he’d received, the business had generated pretax earnings of $40,000 on sales of $201,000—a return of almost 20 percent. That was a significant improvement over the previous year, when the company had earned $17,000 on sales of $175,000. The year before that, it had lost $10,000 on $79,000 in sales.
So the numbers were moving in the right direction. Josh figured he could maintain the momentum and build a substantial business of his own—
something he’d dreamed about doing for years. He could hardly wait to get started. He sent me copies of al the material the sel er had given him and, a couple of days later, showed up at my office with a draft of a confidentiality agreement he’d received from the sel er’s lawyer. He said he had an appointment to sign the agreement—and pay the deposit—the next morning.
I told him I thought he should cal the lawyer and cancel the meeting.
“What do you mean?” he said. “They want to move fast. They have another buyer in the wings.”
I said, “Josh, you’re not ready to sign anything. You can tel the lawyer you’l get back to him in forty-eight hours.”
The problem was that he didn’t have nearly enough information to answer the most basic question in any acquisition, namely, what are you buying? He thought he was buying a comp
any with a good product line. But there was no way to tel how good the product line real y was—or whether the price was even in the bal park—because he didn’t have any information about what was happening in the market.
He didn’t know, for example, who the top ten customers were, or what percentage of sales each of them accounted for. He didn’t know how their purchases changed from year to year. Were the same customers coming back, or did the company have to keep finding new customers to replace the ones who left? Did one or two customers account for a disproportionately large percentage of sales, and if so, why?
And what was going on with the sales representatives? The company was supposedly paying them each a 15 percent commission on sales. So why did total commissions amount to 15 percent of sales in one year, 12 percent the next, and 7 percent the year after that? Were sales reps leaving, turning their customers into “house accounts,” or was there some other explanation? How many reps did the company have, anyway? How much business did each of them bring in, and how much were the biggest producers earning?
That was only the beginning, of course. There were dozens of other questions Josh would have to get answered before making a commitment to buy the company. But I didn’t see any point in going forward until we at least got a breakdown of sales by customer and by sales representative for the past two or three years. Those numbers would show us whether or not the company did, in fact, have a product line that customers wanted to buy and sales reps wanted to sel . Without that information, it wasn’t worth it for Josh to spend time investigating a possible deal, let alone hand over his money.
Josh contacted the company’s owner, requesting the additional information. She responded that she wouldn’t give him the names of her customers and sales representatives without a signed agreement. I told him, “Fine. She can label the customers 1, 2, 3, 4 and the sales reps A, B, C, D, but you need to see those numbers before signing anything.”