Platt Perspective on Business and Technology

Building a startup for what you want it to become 20: moving past the initial startup phase 6

Posted in startups by Timothy Platt on November 17, 2016

This is my 20th 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 1-19.)

I focused in Part 19 of this on the question of knowing when a business has successfully transitioned from early, pre-profitability into a state of being consistent enough in its revenue generation so as to qualify as having become a reliably profitable enterprise. I identify this as a point in which a new enterprise effectively enters its first early growth phase, and as representing an important milestone and a turning point in how a business is viewed and further developed.

I briefly noted at the end of Part 19 that I would strategically and operationally characterize young businesses as following one of three approaches when determining when that point has been reached, which I identified as normative, aggressive and a conservative. I will in fact focus on that as the core topic of this installment. But I begin that by noting that simply identifying and discussing how a business has been found to have made this transition is only part of this story. Each of these three approaches also has associated with it a basic normative, aggressive or conservative strategy that aligns with and grows out of its corresponding vision of business performance.

My goal here is to more explicitly define and discuss these three approaches, and to at least begin to offer insight as to when each of them might make sense for a business and its context. And contrary to my usual approach where I tend to begin with a more normative approach, I will begin here with the conservative one.

The conservative model: I have already in effect begun this line of discussion in Part 19 when I took a very conservative approach in identifying what incoming revenue even qualifies as profits for a business. Conservatively, profits and profitability are entirely functions of funds that are brought into a business and that are retained there for business growth and development – and certainly through its early stages and until it is at least relatively well established. This means incoming revenue net of all expenditures including those taken out as personal profits by business owners, and revenue paid out to investors. This also means, I add as a point of significance, profits being measured as revenue received net of any funds set aside as reserves and for risk management or related purposes – in case, for example, this new business experiences a downturn from unexpected challenges. Conservatively, a new business enters a true first early growth stage when it has begun to show at least modest profitability and on an ongoing basis, where profitability is determined according to this stringent criterion.

This is an approach that makes sense for a business that seeks to develop as a growth-oriented business, rather than a dividend generating business for owners and investors. And I have explicitly and I add intentionally skipped one crucial detail in the above paragraph: timeframes and how long a business needs to be consistently profitable for it to merit early growth stage as a designator under this conservative model. I will delve into that in the context of market and industry volatility among other factors, after briefly discussing the other two model approaches that I offer here.

The normative model: This is the approach that is, in one variation or other, most commonly pursued and in most industries and economies. All of the revenue streams that are collectively identified as profits under a more conservative model are also viewed as business profits here too. But so are at least reasonable, prudent funds paid out to owners and any outside investors with equity stake. There, reasonable and prudent simply mean that funds withdrawn do not reach a level as to create unacceptable risk of generating red ink and overt financial loss for the business. (I explicitly acknowledge my use of fuzzy terminology here with “reasonable and prudent” and acceptable, or in the case of this paragraph “unacceptable.” I will reconsider the issues that they raise when I address timing.)

Pursuit of this development model means some business growth and expansion is all but certain, and certainly if the business is to succeed long-term. But it also means that incoming revenue that exceeds business expenses per se, including payroll and any capital expenditures already in place, having to serve two masters: business growth and stakeholder wealth growth. And this brings me to option three.

The aggressive model: This approach, like the conservative model can take extremes. In its pure form all of the revenue streams that are collectively identified as profits under a normative model are also viewed as such here too, but so are any liquid reserves set aside for possible risk management need and purpose – to the extent that any funds are. And this, among other things is a model that would apply to shorter-term and pop-up businesses as would for example be run in order to capture value from fads or short-term opportunity. I generally write about and focus upon longer-term ventures and businesses that seek to endure and thrive long-term but a lot of businesses are in fact designed and business modeled, and run with shorter-term goals. Consider, to take this out of the abstract, short-running seasonal urban businesses that are set up with minimal overhead costs, as for example through sidewalk sales, for selling Christmas Trees. They pop-up in cities in the United States and other countries and run their course over a brief span of weeks, just to close down as the holiday they sell to arrives.

And this brings me to the issues of timeframes as acknowledged in this posting, but only to be put aside until later. Business evaluation timeframes that would be used when determining, as a due diligence assessment, that a new business has reached “stable” profitability, are longer for conservative model businesses than they are for their normative model counterparts, all else assumed to be at least roughly comparable. And businesses that pursue an aggressive model here tend to accept shorter timeframes still, in determining when revenue can be taken out as profits, to the extent that any due diligence delays are considered or allowed for at all.

That is an entirely qualitative description. I am going to continue this discussion in a next series installment where I will at least offer some organizing thoughts as to how these timeframes might be determined more quantitatively. I note in anticipation of that narrative, that more quantitative here does not mean offering specific one size fits all timetables or deadlines. Quantification here is a function on how income and expenses, and fluctuations in them, and business and market side volatility are coordinately measured and evaluated, as what should be considered a due diligence exercise. I will at least begin discussing this in my next addition to this series. And as noted above, I will also more explicitly discuss levels of funds that could prudently be taken out of a business as profits, according to the three basic models discussed here, and how they would be determined at least when one or another of these three business development models is strictly adhered to.

Meanwhile, you can find this and related material at my Startups and Early Stage Businesses directory and at its Page 2 continuation.

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