Since the bursting of the tech bubble in March of 2000, we have witnessed a return to more "normal" standards for business success. During the bubble itself, we saw unrealistic company valuations, despite the fact that businesses were unable to produce a profit. Investors were basing their decisions on potential market-share increases and revenue projections not earnings. They were oblivious to the financial discipline that had previously been imposed by the free-market economy. Since then, we have seen a significant number of business failures and a return to more normal fiscal behavior on the part of businesses that survived. But how are start-ups doing now? What are the trends in financial behavior of new companies, particularly in the technology sector, that are trying to make an impact in the market? Here are eight trends currently in force in early-stage companies.
1. Forecast to be cash- flow positive in late 2003 or early 2004. This is a consistent claim by early-stage companies, despite the fact that these same companies previously forecasted that they would be cash-flow positive in 2001, then late 2002, etc. Beware the constantly moving "cash-flow positive" target (and the fact that "cash-flow positive" does not mean "positive net income").
2. Long sales cycle. Companies that sell their product or service to large corporations are experiencing a long sales cycle. While this is true in the best of times, the reduction or deferral of IT spending by large companies due to the stagnant economy has exacerbated the situation. This means it may take a long time (e.g., six to twelve months) for a start-up to make a sale and recognize revenues.
3. Failure to get user adoption/market traction. Most start-ups have a really great idea. The trick is to get people to use it. For example, despite forecasts that the overall market for the company's product is increasing 10 to 15 times by 2006, the start-up is not guaranteed its proportionate share of that growth. It takes hard work to get market traction, and competition is extreme. (Never believe a company that tells you it doesn't have any competition. It's simply not true!)
4. Choice of an inappropriate business model. That "great idea" may only be a product or an application not a business! Some companies select a business model that is impractical. An example is charging a high, up-front license price for software versus charging a recurring-usage price. Market forces are making enterprise buyers rethink how they pay for software, which can cause some traditional business models to be ineffective.
5. Failure to protect intellectual property. Companies need to protect their innovations. Even business processes are now being patented. The sooner you begin this process, the better, because it can routinely take three years to obtain a patent following application for the patent.
6. Access to capital limited (or drying up). A start-up that has obtained funding is tempted to think that the "original investor well" will never run dry. However, investors are increasingly expecting the company to execute on its plan and achieve predetermined milestones. They are not as willing as they once were to put more money in if the company continues to be unprofitable. Additional investments are often at valuations that decrease over time, thus making them worth less and less. Also, venture capital from new investors may also be very difficult to obtain, given the tight market and the company's lack of profitability.
7. Racking up negative equity as a result of the failure to match expenses to revenues on an ongoing basis. Burning through cash without generating sufficient revenues is a fact of life for start-ups. However, while this situation did not draw undue concern during the bubble, it now does. Some early-stage companies have accumulated quite significant equity deficits. At some point (now much sooner), if projected revenues continue to prove elusive, investors will expect the company to bring expenses into line with actual revenues.
8. No exit strategy. Start-ups once had a goal of "going public." However, in the new economy, the IPO window is virtually closed, and merger and acquisition activity is slow at best, not paying companies nearly what they think they're worth.
There will always be a place for companies with new technologies or new ways of providing customer value. However, it's a tough world out there for early-stage companies (and even some mid-stage companies as well!). Where once they could put forth a half-baked business plan and expect immediate success, now they are forced into creating a business plan that makes financial sense in a market that has room for innovation. Early-stage companies need to prove they can obtain and retain capital just like well-established companies. They are given a grace period, but not much of one. If they can't generate revenues and show fiscal discipline within 18 months to two years, they're usually toast. The market is no longer willing to float them for an indeterminate period of time while they get their act together. Start-ups with innovative products or services will continue to enter the market, but only those with the "fittest" business model will survive.
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