Startup Companies Are Unwise Speculations By William Cate July 2004 [http://home.earthlink.net/~beowulfinvestments/] [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]Business is risk. Wise investing requires creating a favorable balance between
odds of capital loss and potential of profit from company's success. Investing should always be a question of finding a favorable Risk/Reward Ratio. Investors who speculate in startup companies are betting against very long odds. They can’t make a profit speculating in a series of startup companies because Risk/Reward Ratio is always against them.
The U.S. Small Business Administration (SBA) reports that about fifteen business startup companies out of one hundred succeed for at least five years. However, their fifteen success stories include franchises and professional services companies, which have a far higher success rate than average Startup Company. Local businesses require less risk capital than a business with a potential national market for their product or service. Thus local business startup companies are somewhat less risky to capitalize. The odds of a startup company, with a new product or service, succeeding in national market are less than 1-in-100.
To breakeven with those odds on speculations in these startup companies, investor must recover one hundred times his risk capital. A hundred-fold return on any investment is extremely rare. The startup company investor is about as likely to pick right number on a roulette wheel in Las Vegas three times in a row as break even speculating in startup companies. They are bad bets for many reasons.
It Isn't Always Lack of Money
Entrepreneurs usually put blame for their failure on lack of capital. But often, problem is how they use capital they raised. It's often misspent.
In my 24 years in stock industry, I've advised assorted public and private investors funding startup companies. Here are a few examples of how their money has been misspent:
1. The entrepreneur spent $1,000 on a hat rack. The rest of office was furnished in equally expensive 18th & 19th Century antiques. 2. The phone sales entrepreneur leased penthouse office in financial district. 3. The entrepreneur bought new, expensive cars for his seven managers, who were to run used clothing stores. Keep in mind that late billionaire, Sam Walton of Walmart fame, drove a beat-up old pickup truck. 4. Most of risk capital was used to buy a condo in Aspen so that staff could develop business plan.
Here are a few of common misspent risk capital funds mistakes made by Entrepreneurs:
1. The first risk capital investor's funds are used to find second risk capital investors funds and so on. Somehow, entrepreneur never seems to have any money to implement business plan. 2. The risk capital is spent on R&D. Even when company has a viable product, management continues to spend risk capital on improving product. This is a common failing of entrepreneurs with engineering degrees. 3. The entrepreneur spends risk capital on some project unrelated to startup company's business. This is often done in false belief that investment in unrelated business will show a quick return and keep entrepreneur's investors happy. 4. The entrepreneur becomes victim of crooked advisors and consultants, who overcharge him or her for their poor services. I've seen payments to attorneys that have been anywhere from four-fold to fifty-fold standard hourly rate. I've seen a private company spend US$15 million in a failed attempt to be taken public. Unfortunately, these examples are far too common.
