Finance for entrepreneurs: five myths and one idea
Are you the chess player of the chess piece?
This article summarizes a lecture that I gave at the Universidad Favaloro last week. The class was part of a degree for health tech entrepreneurs.
The key message was that every financial challenge has a solution. In fact most situations have multiple solutions.
As in many other areas in life, the key is to adopt the right ideas as early as possible.
Unfortunately for entrepreneurs who are focused on creating products and services, it is usually hard to know which ideas are valid in the realm of finance. If you are in this group, I have a simple suggestion: don’t do anything that you don’t understand.
It is possible to feel like you’re walking on solid ground when making financial decisions. If you don’t feel this, keep searching for a solution that you can understand fully.
As the great Anthony De Mell says: “What you are aware of you can control, what you are unaware of controls you”.
My version of that: make sure you are the chess player and not the chess piece.
Five myths
Myth #1: to build a large business in a short period of time you need capital from outside investors
There are multiple examples that disprove this myth. A simple one: the t-shirt brand True Classic. In five years this company went from zero to $500 million in revenues without taking any money from investors.
How did they do it?
First they believed it was possible. Its founder has an extreme view against venture capital and other forms of third party investment. So he chose to do it his way, using credit cards, financing from their manufacturers and profits generated by the business.
The company has an intense focus on efficiency, achieving a revenue per employee of $4.5 million, which is better than what most of the top technology companies generate. This is just one example of a comprehensive approach to financial management that has a clear north: self sustainability.
As Warren Buffett points out, if you depend on the kindness of strangers to build your business you are putting yourself in a vulnerable position.
Myth #2: a startup or any new business must accept operating losses at first
This assumption is a self fulfilling prophecy. It’s easy to understand why entrepreneurs would think this is true. The venture capital industry is predicated on this premise. It will give millions and sometimes billions of dollars to companies that have yet to prove that they can be profitable.
It’s hard to say no to money when you have a big dream.
But the reality is that many businesses achieve profitability from day one.
A personal example on this point is the school that I co-founded. We accepted operating losses for a while, until one of the partners decided to dig deeper into the numbers and found all kinds of cost saving opportunities.
The school went from operating losses to operating profits in a matter of months just by choosing a different assumption about what was possible.
Many technology companies are profitable from day one. It can be done.
Myth #3: in order to give investors a great return the company must grow very quickly
If we look at the top performing companies in the stock market for the last 20 years we find names like Nvidia and Amazon.
It’s easy to create a narrative from those names. To achieve extraordinary results you need world-changing technologies and massive revenue growth.
The problem is that right up there with Amazon and Nvidia we also find Monster Beverage, the energy drink company.
Monster sells water with sugar and caffeine. It launched its energy drink 12 years after its main competitor and to this day it is not the number one company in its niche.
It has grown its revenues at 23% per year for the last 20 years. Very good but not what we have in mind when we think of a stock that appreciated by a factor of 1,700x in 30 years.
A simple product, a number 2 market position and decent but far from extraordinary revenue growth have all led to investment returns that rival two of the best technology companies ever built.
How come? It turns out that consistency over a long period of time can create surprising financial outcomes.
The point: if you’re in a hurry to grow, that's a choice. There’s another way to do this.
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Myth #4: you can convince an investor to invest in your company
I’ve learned this lesson the hard way. More than once.
I will try to save you a lot of time and pain. Read this carefully.
You cannot convince anyone of investing in your company. Not now, not ever.
Investors create the decision in their heads before getting to know the company that they invest in. Before meeting you they are already convinced of what they will do and what they won’t do.
Your job is to find investors who have already decided to invest in you even though they’ve never heard about your companyl.
Three instances that illustrate how this happens:
But what happens if you want to raise capital and don’t meet any of these 3 conditions? You will suffer.
Myth #5: some financial challenges can’t be solved
This is the most dangerous belief out there. A personal example will illustrate.
My dad had triple bypass surgery at Favaloro’s hospital in the early 90s. The surgeon was Dr. Rene Favaloro himself. For those not familiar with thim, Dr. Favaloro is credited for developing coronary artery bypass surgery while working at the Cleveland Clinic.
He moved back to Argentina to create a center of excellence, which he did. It includes the university where I gave the talk that originates this article.
Dr. Favaloro committed suicide in 2000. He was overwhelmed by his institution’s financial problems.
His death was preventable. His university and hospital are still standing today, so clearly there was a solution to the financial challenges that they were experiencing back then. But in the depths of a financial crisis it’s hard to see a way forward.
If I can leave you with one thing it is this: there is always a way forward. It might not be perfect or comfortable, but financial issues can always be solved if the institution is offering a product or service that the world wants.
One idea
Return on invested capital.
The calculation is simple: it results from dividing the profits that a project or business can generate by the capital required to produce those profits.
Opening a new Starbucks coffee shop requires a $700,000 investment and produces $450,000 in pre-tax profits. That’s a 64% return on invested capital. You don’t need a PhD in finance to understand that this is a good business.
Google will generate around $95 billion in net profits in 2024, which represents a 32% return on the equity capital invested in the business. Also easy to understand.
Whether you are raising money for a technology startup or opening a restaurant, the same calculation applies. There will be some capital invested early on and it will generate a given amount of annual profits.
The return on invested capital is the most important signal in capitalism. It indicates what the world thinks of your products and services. A very high return means that you are on to something good. A low return means that you either correct things or your business will end.
Don’t worry about coming up with a fancy way to calculate this number. If you use something reasonable and keep using it to evaluate your business you will be ahead of 99% of people in business.
Some closing thoughts
Dr. Favaloro saved my dad’s life. He created the bypass surgery, founded the hospital where my dad’s surgery took place and performed the surgery.
He gave my sisters and me two more decades with our father. My kids had the chance to meet their grandfather. My mom had her life partner with her for many years.
And he did this for thousands of people directly and millions indirectly.
It is beyond sad to know that someone like this would take his own life and die in despair.
My message to you is this: you don’t have to do this alone. Ask for help. If you are going through a financial challenge, you can reach out to me or anyone in your network who has a financial background.
The world needs more entrepreneurs who risk themselves for the benefit of others. But we need healthy and happy entrepreneurs who will see another day no matter what challenges lie ahead.
There is always a path forward.