When ideas and opportunities meet…

Juanito CamilleriSeptember 2004

Five young graduates meet in a pub- an electronics engineer, two computer scientists,

an accountant, and a marketing guru -all enterprising, all enthusiastic,

all bursting with ideas…

in fact the ideas seem to increase as the number of pints consumed increases…

all determined to quit their jobs to dedicate their time to exploiting their ideas…

Is this a sound basis for starting an IT business? 

Do five brilliant guys with loads of zest make an IT business?

 On the other hand, can you create an

IT business without at least some brilliant guys with loads of zest?

Not surprisingly, as the evening progressed the technical guys got entangled more and more

in technical jargon…

each trying to impress the others…objects, modularity, actors, libraries, functions,

application interfaces, specifications, robustness were all subjects of discussion…

after all if the technology behind an idea is good then success is just around the corner… Right?

the marketing guru who by now assumed the role of brand manager

- for the evening’s selection of beer that is -

was wondering whether any of the ideas floating around addressed any

perceivable need and if so whose?

the accountant…clearly lost to the conversation around him

was nodding from time to time and nodded with greater frequency

as pints were lined up…

and was wondering where the money was?

At the end of the evening, feeling rather frustrated

the accountant and marketing guru challenged the technical guys

to write a short note not exceeding a few pages written in laymen’s terms

describing how each of their ideas can be translated into a product or service…

For each product or service they needed to identify: 

The target market;

The projected unit price;

Existing and emerging competing products or services;

The cost and lead-time of service and product development;

The sensitivity of the targeted market…

Of course, feeling brave and definitely intoxicated

the technical guys

took up the challenge dismissing

it as trivial…

they agreed to meet the next day for an hour

to draft the blueprint

of their future success

Next day the technical guys did meet but after three hours

they could only agree that in fact only two or three of the flood of ideas

they had the previous day could be

translated into some product or service which they could describe clearly…

A few brainstorms later the technical guys honed in on two products

which they had described simply and concisely and for which they believed there was

a market demand that was untapped… so they decided to meet the accountant and

marketing guru again… this time in a more sober environment

Both the marketing guru and accountant

were impressed with the proposed products

as they too could perceive a need for them

BUT

were still unimpressed with the level of

market research conducted by the “techies”

and with their appreciation

of the operational logistics involved

in the production and roll-out of the new products…

The marketing guru set out to do some research and felt that one of the proposed products was a non-

starter as there were competing products already emerging on the market

– albeit using a different underlying technology – BUT addressing the same underlying need

 The innovative underlying technology presented by

the “techies” did not really provide any value-added to the target market and the target market was small…

…before dismissing the first product the marketing guru exchanged his views with his

mates but the accountant wanted to ascertain whetherthe use of the new technology involved less

development-costs than that of the competing products as whether this

could translate in a competitive advantage…or merely into an opportunity to sell the new

technology to the established players…

alas this turned out not to be so…

The second product seemed to have much more promise

as there did not seem to be any competing products on the market at that moment in time

although there were several established companies that seemed

to be well positioned to develop such a product…

…some targeted market surveys and

a few carefully conducted customer focus groups

confirmed the prospective demand

for such a product and

gave an indication of how much the target market

was willing to spend per unit…

admittedly the demand though real was niche and

rather limited

The marketing guru called his mates up for another meeting…

of course the technical guys were very excited

as they were quite confident that the product could be developed within twelve-months

BUT

this is where the accountant kicked in again…

How many people do we need to employ?

How much do we need to pay them?

What equipment do we need to purchase?

Do we need to lease offices?

office furniture, stationary, company registration, lawyers, overheads…

branding, advertising, promotional collateral, packaging… the marketing guru added…

In short, what is the initial capital investment and working capital

required to bootstrap and sustain the costs of development, marketing and sales of the product…

will the projected volume of sales of the product at the unit price determined by the marketing guru

suffice to create enough cash-flow for the business to survive and indeed…

will this ultimately create additional value for the

shareholders?

Shareholders? The technical people asked…

Yes, those people who need to be convinced to fork out money to bootstrap and partially finance the

venture…

and these are at least expecting an Internal Rate of Return greater than the Opportunity Cost and a Payback period

that reflects a healthy Liquidity…and all this before the intrinsic risk of the venture is factored in

The shareholders’ expected return on investment will be greater,

the greater the perceived risk of the venture and this has to be an intrinsic part of

business projections… 

Why? 

Because venture capitalists usually don’t risk money in a venture which does not promise to

give them a sufficient return in proportion to the risk of the venture…

The accountant continued to explain to the “techies” that any capital used in a company

comes at a cost and this cost has to be factored into the business plan…

and this is where he started blurting about…

Cost of Capital being a weighted average of the Cost of Debt and Cost of Equity and how this had to be factored in the valuation of a venture

At this point the ‘techies’ felt that they were being given a doze of their own medicine so they asked for a simple text book to help them understand the

financial jargon and to help them read the projections they were being presented…

Anthony RiceAccounts Demystified 4th Edition

How to understand financial accounting and analysis

The accountant went away with the list of capital and recurrent costs and projected income

volunteered by the technical people and marketing guru…

the melee that had evolved in the cross-questioning driven by the accountant made the “techies” and marketing guru

refine their operational and organizational perspective…

They started to think not only in terms of what needed to be done and how, but, also when and how much…

The accountant came back with a story of gloom and doom…

there was no way anyone would invest in this venture as it stood

because it was intrinsically very risky and the initial and recurrent capital outlay

was far too high for the projected returns on investment…

  

The End?

The accountant asked the “techies” and marketing guru

to sharpen their pencils on the initial capital outlay and to delay certain

recurrent costs for as long as possible until a projected inflow of revenue was in sight…

moreover to mitigate the risk, the project was divided into two phases…

The first phase, to be conducted with skeletal staff willing to be paid with minimal

wages and some equity, would aim to build a prototype of the product,

which could be adequately protected as intellectual property

of the company and which could be used to secure the first clients

before further investment in the development of the full-blown product

By lowering the initial investment and by structuring the project differently,

the overall risk was reduced and a new business plan was drafted with a tighter budget,

which the accountant was comfortable enough to discuss with a bank for seed capital…

The plan was that in phase two when the development of the prototype is complete and

hopefully initial customers are secured, the company would seek further venture capital

The company was set up, the seed capital secured, the prototype was developed

but ended up requiring a great deal of modification from the original design

as prospective clients were engaged … 

an initial client for the final product was secured…

in the interaction with prospective clients the company got a better insight of the market and the opportunities

and risks that lay ahead…

With some valuable experience under their belt

and an initial modest success story

the five young graduates met at the pub again

a year and a half later

to plan the launch of their first product…

Thankfully the bank was willing to extend some further bridge financing to cover the additional

costs incurred in the delay…

…now they all knew that business is about catering for a market need

- ideally ahead of competition -in a timely and competitive manner always

with an eye to increasing shareholder value…

it is always wise to minimize the upfront costs; seek ways to minimize risk; and

secure revenue flow as early as possible

When you perceive that your

ideas and market opportunities are likely to meet…

start writing your business plan

Juanito CamilleriSeptember 2004