ROSE-COLORED PLANNING (OR NONE AT ALL)
Passion-trapped entrepreneurs are unrealistically optimistic. Secure in their belief that they’ve discovered a can’t-miss idea, they view the startup journey through rose-colored glasses. Best-case assumptions drive plans and projections. Projected revenues and expenses are based on what’s possible, rather than on what is practical or likely. As a result, founders caught in the passion trap are blissfully unaware of how long it will take, in realistic terms, to reach their financial breakeven point and what it will cost to get there.
As entrepreneur/investor Guy Kawasaki notes in his book The Art of the Start, aspiring entrepreneurs often fall into the trap of “top down” forecasting when sizing up a business idea.1 The founder starts with a large number, representing a population or a market to be targeted, then works downward from that number to generate expected revenues for a new product. As an example, let’s say you’ve developed a new technology for restaurant owners, priced at $10,000 per unit. There are about 215,000 full-service restaurants in the United States, and you believe that you will be able to capture 1 percent of this market over three years. This would result in 2,150 product sales or $21.5 million in top-line revenue over a three-year period. Sounds good. And even if you forecast only one-fifth of that number for year one, 430 units, you’re on track for more than $4 million in sales in your first year.
But startup plans must be executed from the bottom up, where the math works differently. Suppose you can afford to begin with a team of three sales professionals, working full time, who can each sift through two hundred leads a month to generate twenty onsite demonstrations. Let’s assume these twenty demonstrations will land each salesperson an average of two sales per month, equaling 1 percent of monthly leads (if you think that’s a pessimistic number, you’ve never tried to get a restaurant owner to part with $10,000). This sales rate would generate twenty-four sales for the year for each salesperson, or seventy-two sales for the team as a whole. That’s $720,000 in first - year revenue, with a lot of assumptions baked in about having skilled, active salespeople on board, supported by marketing, technology, and infrastructure, all of which will require significant upfront costs and ongoing management and servicing expenses. Based on these bottom - up assumptions, you would need a team of thirty salespeople working over three years to achieve your goal of capturing a 1 percent market share. This is not outside of the realm of possibility, with the right product, the right plan, the right funding, the right talent, and the right breaks, but cracking one percent of any market generally requires a herculean effort. Simply forecasting downward from a large available market won’t make it so.
Although passion can lead to over-optimistic planning, a surprising number of fast-moving founders avoid planning altogether. They plunge forward and manage by feel, without an accurate read on where the business stands. They tend to operate in a financial fog, and, lacking the focus of a clear game plan, they can be pulled and distracted by an endless stream of new money-making ideas. As someone who hears a lot of new business pitches, I’m struck by how often ambitious entrepreneurs visualize global expansion or exotic product extensions long before they have won their first paying customer. As management researchers Keith Hmieleski and Robert Baron noted in the June 2009 Academy of Management Journal, highly optimistic entrepreneurs often see opportunities everywhere they look, a distracting tendency that can interfere with their ability to effectively grow their new ventures.2
This challenge applies to seasoned businesspeople as well as firsttimers. In fact, Hmieleski and Baron have shown that experienced entrepreneurs are actually more likely to suffer from overconfidence and “opportunity overload” than those with no startup experience.3 Entrepreneur Jay Goltz may be a case in point. He writes a highly insightful column for The New York Times’s Small Business Blog, has launched many ventures over the past two decades, and employs more than one hundred people in five successful businesses. “Did I mention that four of my businesses failed?” he writes. “In my case, it wasn’t market conditions or competition or lack of capital. . . It was my penchant for jumping into things with blind optimism and not enough thought. I’m a recovering entrepreneuraholic. I’m trying to stop.”4