So you want to launch a business...

What is a spin-out, anyway?

Question from a reader: What is a spin-out?  I've heard the term, but I'm not sure what it really is. 

In physical terms, a spin-out occurs when centrifugal force overpowers whatever is connecting a rotating object to some central hub.  The power acting to make the object independent is stronger than the power constraining it within the existing system.  Objects would fly off the earth, for instance, if the earth were spinning fast enough to cancel the power of gravity.

In business, a spin-out is a new corporate entity formed to exploit some opportunity that is not directly aligned with the core business of the parent organization out from which it is spinning.  (Pretty good, huh?  Only an English major could construct a sentence like that.) 

Not all spin-outs become free-standing enterprises.  The new entity might be set up as a “division” of the parent, rather than a totally  independent company; but it is managed independently as a consequence of its differences from the parent.  Typically, the defining difference is a new marketplace or target demographic, for which the parent provides no economies of scale or special knowledge.

New market.  New buyer group.  New business model.   Spin-out. 

Notice I didn't include "new manufacturing technology."  A new manufacturing technology that improves profitability will not typically trigger a spin-out.

I also did not include "new ways to address the needs of the customer."  Once you have customers, you should always be working on new ways to address their needs.  Otherwise, you will surrender them to competitors who manage to do just that.

Spin-outs are appropriate when there is a truly fresh market opportunity, a chance to serve a different batch of end users, with its own particular compelling needs.

Sometimes the spin-outs continue to take advantage of some "commodity" parenting services, such as accounting, payroll, or central computing power.  Typically, however, they do not share marketing and sales staff because of the clear market differences that caused the spin-out in the first place.

I hope that helps.

Don't pay bills with equity!

Equity for services is a risky deal for everybody.

Bootstrapping is a trendy topic right now because early stage investment is hard to find, particularly for businesses that do not promise extraordinary growth potential.  One of the bootstrap financing techniques often suggested is the trading of stock in the enterprise for products or services needed by the start-up.  I have a strong opinion on this practice. 

It's a terrible idea.  Here's why...

As I have pointed out in other posts, equity is forever.  Swapping shares in your company for one-time needs might be compared to paying for an oil change by giving the mechanic partial ownership of your car.  Without the oil change, your car might eventually grind to a halt; but do you really want to enter into a long-term relationship with the mechanic?

Let's get specific.  Suppose you offer an attorney a share of your company for preparing incorporation  papers, and she accepts.  Now, as a shareholder, the attorney has permanent access to your corporate records and the right to participate in all ownership activities.  The dream, of course, is that the company is on a fast track to outside investment and on to liquidity.  The lawyer will get to draw up all the financing documents and then the merger or IPO papers for a healthy fee; and the tiny share of ownership that you gave her will be insignificant to the fortune you will make when you sell the business. 

Here's what really happens most of the time.  The company, if it survives beyond its first year or two, grows nicely, but slowly.  It doesn't need, or warrant, serious outside investment.  The best way for you to make real money is not through a liquidity event, but through handsome personal compensation.  You have occasional need for a lawyer, but you try hard to avoid those inflated fees whenever possible.  They are, after all, money right out of your pocket.  The lawyer now has a marginally profitable client relationship and a meaningless share of a company that will not be sold.  BUT she also has all those pesky rights I mentioned earlier.  If she gets grumpy, she is in a position to create some real pain.  This is not a good deal for you, and its also not a good deal for the lawyer.

Now suppose, instead of trading for legal services, you trade for a salesperson, as proposed by more than one author.  The dream this time is that the salesperson will be a huge success and a liquidity event will occur on schedule.  The reality, more often than not, is that the salesperson has some early success, but not enough to foster venture capital or an early liquidity event.  Then the company's growth settles in to the typical modest upward trend, and the commissions earned by your minority-shareholder-salesperson do not meet his financial needs or aspirations.  The bloom is off the rose.  You're unhappy with the results.  He's unhappy with the results.  You part ways.  BUT he still owns a piece of your company and has all those pesky rights, including the right to assert that you are over-paying yourself to the detriment of minority shareholders.  Does this still sound like a good deal?

Jim Flowers (that's me) has said this before:

Cash is the recommended medium for acquiring products and services that are not strategic to the business.  Bestowing equity on any entity in lieu of cash payment amounts to paying forever for products or services that may not even remain relevant a short time into the future.

The use of equity in bootstrapping is sometimes very smart, and it is sometimes unavoidable.  It is, however, always risky.  I strongly recommend that it be employed only as a last resort and only for strategic requirements, not commodities. 

@nametagscott goes for the throat!

Three Tweets from @nametagscott...

LET ME SUGGEST THIS: If your idea is your passion, but doesn’t have a viable market, you lose.

LET ME SUGGEST THIS: If your idea is intrinsically appealing, but something you suck at, you lose.

LET ME SUGGEST THIS: If your idea is sellable, but something you would hate doing for thirteen hours a day, you lose.

If you're an entrepreneur, or might-be entrepreneur, or wanna-be entrepreneur, and you haven't stumbled on @nametagscott, you're missing a great chance to be profitably uncomfortable.

Scott Ginsberg tries his best, and usually succeeds, to jolt people out of their warm, fuzzy places, and to enable them to take a fresh view of reality.  He's a little bit crazy, but that's what makes him memorable.  And he knows he's a little bit crazy.  That's what makes him effective.

A while back I posted about mental mildew, its effects, and some ways to combat it.  Where mental mildew is concerned, Scott and others of his ilk, are full strength Lysol.

So why did I pick these particular bon mots from among Scott's 3,569 tweets to date?  To be honest, they first caught my eye because they were all tweeted together, and had a nice symmetry of construction.  They were well-constructed from a presentation and persuasion standpoint.  (I said Scott was a little bit crazy.  I didn't say he hadn't mastered his craft.)  Once they had caught my eye, however, I noticed that they validated my own assertions for entrepreneurs.  That was flattering to old Jim Flowers, believe me.

Validated how, you ask?  Here's how. 

Scott, the Mentor, tweeted a set of three go-for-the-throat assertions that landed squarely on Market, Magic, and Moxie.  Yep!  Every successful startup involves a real market, not one the entrepreneur dreams up.  And the new company has to execute in a magical manner that sets it apart from the crowd.  And the founder give everything to the venture.  He has to outwork his competition.

Thanks, Scott.

There really isn't that much new stuff in the world of business.  But there can always be new ways of expressing the ancient truths.  And those new ways can provide moments of high insight to people who have been lulled to sleep by the old words and phrases.

Four ways to make sure your startup flops

"Fail fast.  Fail cheap.  Live to fight another day."

- Anonymous

Well, these four tips, if you follow them carefully, can almost guarantee that your startup business will fail.  Fast and cheap are always relative.

• Come late to the party.  It's scheduled for 8.  8:30 or 8:45 should be no problem.  You have plenty of time to wash the car before you get cleaned up.

You've probably managed to arrive late for a party at some time in your life.  I have.  What was it like?  See if this sounds familiar.

First, nobody notices that you have arrived.  The host is no longer hovering by the door to greet you.  All the timely guests have formed closed groups and are engaged in earnest conversation.  The best hors d' oeuvres are gone.  And everyone is at least one drink ahead of you. 

Palm Pre was late to the smartphone party.  Need I say more?

• Copy the most successful competitor.  It's the music that sells, not the band.  I have hundreds of CDs by bands I've never seen in person.

See if this is who you want to be.  I just grabbed it off the web.

"Almost Famous is one of the best cover bands around today. That's a bold statement, but it's exactly what you'll be saying after you experience one of their shows. With a completely fired-up & kickass stage show, Almost Famous combines pure hedonistic rock & roll debauchery with some of the most talented musicians in the NY Metro Area...the majority of whom have been signed to major labels or recorded & toured with major acts around the globe."

And now they're almost famous.  I'll bet they're almost rich, too.

And don't forget the all the rich Elvis impersonators.

• Don't sweat the details.   Attorneys and accountants are always crying wolf, just to grab some big fees.  Charge ahead.  You can always clean up any small messes later.  Right?

OOPS! 

"BlackBerry maker Research in Motion agreed to pay $612.5 million to patent holding company NTP to settle a long-running dispute that had threatened to shut down the popular wireless e-mail service for its 3 million users." Their PR team tried to spin that as a reasonable licensing fee.  Um hm.

And there was Enron, etc, etc.

• Don't try very hard.  After all, the libraries are full of biographies of famous people who became incredibly successful by dabbling in things on a part-time basis.

Yeah, right.

OK, I'll re-state the obvious, just in case. 

• Find a Market you can enter early, so you can ride the growth wave.

• Create some Magic that sets you apart from the ho-hum competition.

• Enlist a good batch of Mentors who can point out all the possible not-so-obvious pitfalls.

• And bring along enough Moxie to see you through the tough times that always come.

A taste of MOXIE

MOXIE - the soft drink of true entrepreneurs.

Here's the story of MOXIE - as told and demonstrated by the "MOXIE man" in Lisbon Falls, Maine.

You may want to try it yourself. It's available online at www.buymoxie.com .

How big is big?

Question from a reader: A big company wants to sell my flagship product under private label.  How can I be certain that I'm getting a fair deal?

Short answer - you probably can't.  But - it doesn't have to be a fair deal to be a good deal.  That is a useful distinction that is often overlooked.

I'm reminded of the good old story of Steve and Charlie haggling over the price of a fish.  (I love good old stories.)  "I'll give you $5", said Charlie.  "Not a penny less than $9," replied Steve.  "$6," said Charlie.  "$8," Steve replied.  And, of course, they settled on $7.  As they parted Charlie called out, "Ha, I would have paid $10."  Not to be outdone, Steve's response was, "Ha, yourself.  I would have let it go for $3."

So, how hungry was Charlie?  How badly did Steve need fast money?  How much pride was at stake?  Was it Steve's first sale of the day or his last?  Was the fish really fresh?  Aaagh.  In the face of so much uncertainty, how can we ever define fair?

Only one thing is totally clear from the story.  Once Charlie offered to pay $5, the price was never going lower.  If Steve had spoken first and offered to sell at $5, the price would never have gone higher.

The various surrounding circumstances are not clear in the fish story; but in your own story you have the opportunity, in fact a personal obligation, to ferret out as much information as possible about the marketplace and your prospective customer.  Why, for instance, the big company wants your product is a key determinant of deal goodness to them.  They may be adding it for strategic positioning, rather than for the direct profit it might generate.  If so, they will likely pay a premium.

The same logic holds on your side of the transaction.  If you're doing fine without the proposed deal, you are in a position to hold out for a higher price.  But if that drives the big guy to do a similar deal with your chief competitor, you might be in serious trouble later.  Hmmm.

It's easy to say that it's all about the money.  But others say that timing is everything.  Etc.  Etc.  And so on.

You may never know whether a deal is fair.  But there are plenty of ways to make reasonably certain that the deal is good, at least for you and your business.

I recommend Jim Camp's book on negotiating - Start with No.  Go to the web, or to a bookstore.  Look it over.  If it's a good deal, buy it, whether it's a fair deal or not.

NOTE:  If you have a question, just email it to me, Jim Flowers, jimflowers@startwithmoxie.com.