Platt Perspective on Business and Technology

Building a startup for what you want it to become 19: moving past the initial startup phase 5

Posted in startups by Timothy Platt on October 12, 2016

This is my 19th installment to a series on building a business that can become an effective and even a leading participant in its industry and its business sector, and for its targeted marketplaces (see Startups and Early Stage Businesses and its Page 2 continuation, postings 186 and loosely following for Parts 1-18.)

I focused in Part 18 of this on early growth stage businesses: businesses that have just reached and passed their break-even point financially where their incoming revenue has reached and begun to surpass their outgoing expenses and of all types. These businesses have just reached a point in their development where they have begun generating an at least modest profit, and on a recurringly ongoing basis: not just for a single month or a single quarter from an unexpected and not to be repeated windfall.

I offered three test case possibilities in Part 18 for characterizing and understanding organizational growth and development as a business passes through its early stages: a normative baseline growth scenario, a poorer performance than expected, slow growth scenario, and a faster and more favorable than expected growth and development scenario. And I recommend reviewing them for their details as background for this posting. More specifically for purposes of connecting that posting’s discussion with this, I ended Part 18 with a fundamental question that I repeat and will discuss here.

I left open the issue of what precisely determines early stage profitability, and particularly where that means distinguishing between periodic and perhaps unrepeatable success and early but “reliable” ongoing profitability.

• How can you reliably, prudently know when you have passed the transition point between near-break-even revenue generation with good months where you actually surpass a financial break-even, and true reliable profitability?

This distinction becomes vitally important as soon as longer-term growth and development start being considered, as is often the case when a new business really starts to take off. This is the point in a new business’ development where it first becomes possible to really plan in a meaningful, actionable sense for real growth with the longer-term resource and infrastructure development expenses that that entails, and that would have to be planned and build for in mapping out a business’ operational and strategic next steps.

If a business is to grow and succeed long-term, a point is essentially certain to be reached in it, where longer-term development commitments are going to be faced, and they can arise in any of a wide range of ways – all of which can be expected to carry significant expense obligations. But taking on such expenditure obligations prematurely – before a business is ready to service them and still meet their other high priority ongoing needs, can sink it and without a trace.

I ended Part 18 with the following question and I continue its discussion here by at least beginning to address it here:

• How can you know when a new business has reached a point where it is stably, reliably bringing in sufficient revenue and on an ongoing basis, so as to consistently generate genuine profits?

And to be explicitly clear here, profitability simply means revenue received as it exceeds ALL expenses that have to be paid out: salary and other personnel expenses included – including salaries (and any other funds) drawn out by a business’ owners and senior managers and by any outside investors who hold a stake in it.

• Profitability and certainly at this early stage, and to take a very business growth-oriented perspective here, is incoming revenue that would be available to be rolled back into the business for its growth and development, net of all expenses paid and at least short-term due, and all personal revenue diversions for personal gain.
• Note: this is only one possible take on defining profits and profitability that I could take here. Another that is also widely followed would roll all incoming revenue that is taken out of the business as personal profits, in with funds that are retained and used for business expansion and development per se. I will have more to say about this second approach later, and simply note for now that I am pursuing a more prudent and conservative definition here, where I have seen owners take out sufficient “profits” sufficiently early and sufficiently imprudently so as to risk the viability of their new businesses – making their “personal profits” very different from “business profits” per se.

Those points raise what can be very contentious issues, and certainly when outside investors such as venture capitalists are involved, and when they expect and even demand a take from a new business’ revenue stream, and from as early on as it begins moving into profitability. Owners and outside investors can and often do take differing views as to when that turning point has been reached, with each side determining when that has happened according to their own criteria.

To continue with this example where venture capital investors have bought a stake in a business, these are generally savvy professionals who enter into new businesses specifically to make a profit from them, and as large a return on investment profit as reasonably possible. Conflict can and does arise when there is fundamental disagreement between owners and senior managers on the one side, and outside investors on the other as to when a business is ready to pull out owner or investor profits from it.

• More objectively, how can you tell when a business is ready, and how do the types of disagreements that I have just noted here, come about?
• How do you best determine how much of the incoming revenue stream can be diverted out of the business as profits taken too?
• I will simply add that the types of conflict in understanding and resultant decision making and action that I just noted, by way of owner versus outside investor differences, can arise strictly within a new organization too, and for both of these closely related questions. And those in-house differences in understanding and the conflicts that can arise from them are in many cases going to be more challenging, as owners and outside investors generally have pre-agreed to contracts in place that would be written both to reduce the changes of surprise disagreements there, and to make any profit allocation discussions go more smoothly.
• I will offer three possible scenario-based answers for how to determine when a new business has in fact started to be reliably profitable: a normative one, an aggressive one and a conservative one, that seek to address the specific issue of knowing when a business has become genuinely profitable and has entered its first early growth stage as a result.

Before doing so, I am going to lay a foundation for that discussion by stressing a point of distinction that I have often overlooked in this blog, but that requires explicit mention here in this series and in this posting’s context: the distinction between operational development and expenditures per se, and capital development and expenditures.

• Acknowledging up-front that I am taking a somewhat controversial approach here, you can often think of capital development and expenditures in large part and for many purposes as representing a point at which operational development and expenditures meet long-term planning. This certainly holds from an overall cash flow and overall budget balancing perspective.
• There are circumstances where capital development and operational development and their respective funding, can be viewed as simply representing different lines on the business’ same ledgers and budgets, and certainly when long-term capital development is coordinated with long-term and open-ended significantly scaled “operational” expenditures, and both for what is to be done and how – and when all of these expenses would be coordinately planned for and managed.
• But for areas of discussion of the type offered here, I would explicitly draw a firm line of distinction there.

I am going to continue this discussion in a next series installment which I will begin by explicitly laying out and discussing the three revenue stream scenarios that I have starting discussing here, and that I have attempted to justify as being necessary to consider – and certainly when competing stakeholders disagree over which should apply. Meanwhile, you can find this and related material at my Startups and Early Stage Businesses directory and at its Page 2 continuation.

As a final thought, and with a concurrently running series about business theory in mind, I want to add a clarifying note as to why I wait the way I do before explicitly introducing points of distinction such as operational versus capital, as I did in this posting (see my series: Some Thoughts Concerning a General Theory of Business, at Reexamining the Fundamentals directory, Section VI.) I follow what might perhaps best be considered an Occam’s razor-approach to theory elaboration, only adding and developing new points of distinction when and as a specific need for them and context for them arises. One consequence of this is that by now in this blog, I have introduced a fairly extensive number of more novel points of distinction, and supporting terms for discussing them. And another is that I continue to add and use more standard terms and concepts that for whatever reason I have not previously seen need to explicitly offer as points of clarifying distinction. Contextually irrelevant distinctions only add to confusion and loss of focus.

Occam’s razor and its reasoning, holds a place in any body of general theory that seeks to focus on the essentials as it describes, and predictively models complex systems. Hence I finally make this point of distinction here. And to add one more detail, along with distinguishing here between strictly operational and capital for development and expenditure, I also separately carve out project development and expenditures. Project management systems per se, as standardized systems of processes, are operational and in the strict sense of the term. But individual projects as one-off, non-repeating exercises and their direct project-specific expenses are not necessarily so. I usually focus on operational processes, and project systems that fit into that when addressing projects per se and certainly from a business process perspective. I will delve into some of this in my next series installment too, for its implications there.

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