Letter to a Young Entrepreneur

Background

The past year and a half I have watched a friend build and launch a new business. This article shares ideas that are important when building a new business. Some concepts I have taught in a Math for MBAs course. Other concepts I wish were taught in such a course. The terms in this article are important to identify paths to profitability. Perhaps, more importantly, this article can help identify when a business will not be profitable.

Capital

As a child, I watched an interview on TV featuring a man named Ted. Ted referred to large sums of money as capital. I thought that Ted was conceited. Why not just say money? I thought capital just meant large sums of money. It wasn’t until I read an economic text that I actually understood what capital means and is.

You probably heard the economic terms goods and services. Goods are items that are to be sold. Services are, well, services that people demand. A business generally will provide goods, services, or some combination. Reading an economic text, I ran across the term capital good. A capital good is defined as a good that is involved in the production of other goods. So a banana tree is a capital good that produces bananas. The bananas are either consumed as consumer goods, or the bananas could, in turn, be capital goods, which are used to produce banana chips. That’s when it clicked for me. When Ted referred to capital, he wasn’t referring to money; he was referring to how the money would be used. The money would be used in production, that is hopefully, to make more money.

Given that you are starting a consulting-type business, I would argue your most valuable capital is your brain. You invested, through study, to make your brain more valuable. You are selling your knowledge and know-how to your clients. In any business, the brain that initiates and nurtures its growth is perhaps the most important form of capital.

Know Your Numbers

In some entrepreneurial circles, you’ll hear the phrase know your numbers. It’s basically a platitude, but there is some value in this saying. What we should be concerned with is the question, Which numbers?

Now every business is going to have numbers important to that industry. A general article can’t identify all the numbers you should know. There are, however, two numbers that are important to any startup. They are:

• Runway – The amount of time a business can operate on existing money and assets.
• Burn Rate – The amount of money per time that a business spends to remain operational.

This is the metaphorical “keeping the lights on.” The runway is how long you can keep the lights on without any revenue. The burn rate is how much you pay per time to “keep the lights on,” that is, to operate the business. Runway is the common startup vernacular. I also think of the runway as the float. How long can you keep the business afloat. I even think of the float of my household. How many months can I fund my family without needing money?

The important takeaway is that runway, or float, is measured in time. It’s important to think in terms of time. As your business grows, your burn rate will grow with it. It’s important to make sure your runway does not shrink too much as your burn rate grows. In fact, after revenue comes in, you might find your runway grows over time. This is precisely what a successful business does. It’s also probably the reason start-ups call it runway. It’s how long you have before you take off. This analogy is more apt for capital-intensive companies. That is, companies that need to spend significant money before generating revenue. Float might be a better word for smaller businesses and households. Your particular enterprise had a significant time investment before you launched.

Thinking this way is valuable; you can identify problems before they become critical. If your runway is shrinking month after month, you know something will need to change. One possible solution is to generate more revenue by acquiring additional clients. Maybe that is reduced take-home pay. Maybe you can reduce your burn rate to increase your runway. As an example from my own business, I’m establishing a new server to replace three existing servers that I rent. That will free up money I will use to build out a different part of my business. I will maintain the same burn rate while I work on expanding my productivity.

Money isn’t everything! Runway is measured in time. In fact, time is perhaps even more important to budget than money. One travel time to see three clients is cheaper (in time) than three travel times to see the same three clients. In economics, the term opportunity cost refers to the value of what you forgo when you choose one option over another. What you spend time doing comes at the cost of not doing other things.

Segregate Finances

In New Hampshire it is fairly cheap and easy to register an LLC. You can put yourself down as the registered agent if you live in New Hampshire, avoiding expense. Once a separate LLC is established, you can open up a bank account in the LLC’s name and keep business finances separate from your personal finances. Even if you don’t want to go the LLC route, having a separate bank account for the business is helpful. Your taxes and accounting will become more complex as you expand. A single account for all your deductible expenses is extremely beneficial. It can delay the need to pay money for expensive accounting software as you grow. Having a separate LLC allows you to establish separate PayPal or Venmo accounts, which helps you keep track of what’s taxable revenue or someone paying you for splitting the bill at a restaurant. It’s an unsettling feeling to question what’s taxable at the end of the year.

(Don’t) Pay Yourself First

Another platitude is, pay yourself first. I find this advice to be misleading. In any business, there could be times of low demand or revenue. In those times, what is one to do? If you prioritize paying yourself first, how? If the choice becomes pay yourself or keep the business running, then either you need to cease the business or pay yourself. Why is the platitude not keep your business running first? For larger companies, I can understand saying pay your employees first. Shutting the business down might forgo value created by your previous effort.

This platitude only makes sense to me if you have already achieved success. After you have money. If you’re starting with substantial profits from last year, then it makes sense to put your income or pay aside and fund your business with six months of runway or so. Paying yourself first is a luxury that not every business can afford during its startup phase. In practice, I like to do strategic planning every six months or so. That’s when I can decide what I want to live on and what I want to grow into more.

Along my path here I asked for advice from a friend. He bought me a copy of The Only Investment Guide You’ll Ever Need by Andrew Tobias. I bought a second copy for you, and I’ll give it to you next time I see you. I feel this book has good solid financial advice, both personal and business. I feel you know much of what’s in this book, but it’s beneficial to see everything organized in one place.

Keep Doing What You’re Doing

As an outside observer, I see you making excellent choices to grow your business. You explain your reasoning well, and it is sound. I’ve enjoyed seeing you progress to the level you’re at now and look forward to learning what your future holds.