How do you Finance a Project or Start-up?

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Target audience: Decision makers (CXOs/Directors) of firms & start-ups (sector agnostic), management consultants, business strategists, innovators, and curious people.

Reading time: 5-10 min.

Introduction: Given the COVID-19 pandemic’s first and second waves, the economic impact has eroded many businesses (especially hospitality sector) worldwide since early 2020. Many people who were happy with their contributions to their organisations were also laid off, due to reasons beyond their control.

To be successfully self-employed or an effective project manager, it is important to understand some basics about project planning.

Key Question: What points should one consider before starting a new project or start-up?

To answer this question, we divide the answer into a few simple discussion points.

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Firstly, for any product or service to be successful, it is important to understand the “What”, i.e. ‘What problem are you solving (Improve user experience, Enhance safety features, etc.)?’

At the same time, it is equally important to understand the “Why”, i.e. ‘Why do you plan to solve the problem (Is the problem/opportunity worth your time)?’

For example, you may want to design a web-based meeting service like Zoom/MS Teams/Google Meet which is ‘better and safer’ than these options. You should probably do a few surveys and interviews (Typeform, Qualtrics, etc.) to know the pain points of existing alternatives or Competitors. It would be wise to add weights in your surveys/interviews to help you focus on the key improvements (Pareto Principle). For instance, you should infer if ‘the problem is big enough to be solved or is it a small issue’ that the customer is willing to accept and adjust. An analogy would be – “Is the customer’s pain like a sore foot (heals itself with a few days rest) or is it like a ligament tear (needs immediate medical attention)?”

During your survey, it is imperative to make note of the Market Segment you plan to sell your service. This would help you answer the ‘What’ & ‘Why’ accurately. In other words – “Would firms in the medical sector (another B2B sector/B2C segment) in USA (another country) be willing to pay for your service or they prefer to use the services even with these flaws?”

This would help you provide a service that addresses the important issues (at least 75-80%), which becomes your USP (Unique Selling Point) or Differentiator.

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Secondly, you should create a plan to have a steady growth in your market share over time. For this task, you could consider using the PAM, TAM, SAM, SOM framework. In many cases, the PAM (Potential Addressable Market) may not be considered. The reason being – ‘Is it worth including all people/firms who could become potential customers in the future?’

TAM (Total Addressable Market) would be the total number of firms in the medical sector in the US (from our earlier example). SAM (Serviceable Available Market) would be the actual clients you can reach out to through your networks or distribution channels within the US. SOM (Serviceable & Obtainable Market) would be the percentage of market share you can obtain. This involves a guesstimate of the clients who value your service and would pay for it. There are many organisations that help you obtain secondary analysis at low costs like Statista, Census, OECD, etc.

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Thirdly, you should clearly identify the types of costs associated with the product/service they create – direct and indirect. To explain this further, let us continue with our previous example – the web meetings app. This can be termed as a  software service, as it is an enabler to help people connect virtually. This is unlike a software product which serves a specific purpose to the user (ERP software, attendance monitoring app, etc.).

The direct costs or COGS includes the materials and labour directly used to create the web meetings app. The time spent by each programmer is directly associated with the app development. Hence, it is included in the COGS calculations. As there are no physical products manufactured, there are no associated raw material costs.

The indirect costs or SG&A include all costs that enable the company to make products & services. These include the tools used to develop software – not exclusively for this meeting app (can be used to develop many apps). These could be – laptops, office supplies, marketing campaigns, accounting costs, employee benefits, insurance costs, utilities, etc. As machines (laptops, servers, etc.) are used to create software products, their depreciation costs can be included.

How should a new player estimate these costs?

A new player should discover a set of suitable public comparable companies (public comps) in the sector they would like to operate. This would help them plan their investments and expenses, with minor deviations (ideally up to ±10%) for each line item. The advantage of public comps over other comparable firms – all financial reports are certified by professional third-party auditors. These reports are available for everyone (for free) on their website. The securities & exchange websites in each country/region host these reports, which must comply to the securities laws – SEC in the US, FCA in the UK, ESMA in EU, SESC in Japan, SEBI in India, and SFC in Hong Kong.

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Fourthly, accounting for all the costs and managing expenses wisely in the early stage is key to make a project/start-up successful.

For a high-growth product/service, it would be sensible to treat this project/start-up as a profit centre. In a profit centre, access to capital is given to the executive in charge of this division or branch. This executive has two major goals (KPIs) – reduce costs and increase revenues.

The profits generated are vital to help a firm (multi division) survive in difficult times (economic shocks), and to invest in future projects. In case of a start-up, a profit centre approach would help executives manage their finances better (frugally, if required).

The costs discussed earlier (COGS & SG&A) should be carefully assessed to ensure profitability at early stages. An example would be – increase marketing costs (2x) for a high potential market segment/geographic area to boost sales (5x/10x). Similarly, eliminate some non-value-added tasks to reduce overall product/service costs.

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Finally, every new project/start-up requires courage to be bold and take risks. This involves financial planning, product/service iterations, and to find the right product-market fit.

In the example discussed earlier – the web meeting app, you should be able to project your financials for the first three years. This involves all expenses (direct & indirect) and the expected revenue (sales volume). These financial estimates would help investors and people you want on this project/start-up team to trust you. To accurately assess the growth of the project/start-up, you can re-evaluate these financials later – six months or one year from the start date.

The J-Curve for a project/start-up can involve many dark days when things do not go as planned. It is important to learn from the mistakes and re-iterate with required major/minor changes. An ideal method to re-iterate your product/service – one or two incremental/radical changes. This helps your team evaluate the impact of these changes thoroughly.

Some helpful books on this journey include (but not limited to) – Nail It Then Scale It, Sprint, The Lean Start-up, The Start-Up J Curve, Zero to One, etc.

Image credits (sequential order): Min An from Pexels, Bich Tran from Pexels

Conclusion: To sum up, a new project or start-up is about the vision to create something new & innovative that is not replicable by many people. This journey involves being agile to adapt your product/service to the market needs. It also involves teamwork – a set of believers who share your dream, follow your lead & passion. All the best to embark on a new journey!