Dodging the danger zone

Many people think start-ups are in most danger of collapse during their first year. However, data suggests that most get through the first 12 months.

In fact, they enter the danger zone in years two, three and four. Some of that is because of inadequate planning and the mistakes of the first year kicking in. Others blame it on fatigue.

The trend isn’t solely an Australian one. According to a recent World Economic Forum report, 69% of the world’s start-ups will have “snakes and ladders” growth, enjoying a strong start and then suffering a sharp decline between years two and five. It’s a dip that many fail to recover from.

According to the Australian Bureau of Statistics, of the 316,867 business that started in Australia during 2007-08, when the world’s economy appeared to be falling off a cliff, 71.5% were still operating in June 2009. It was the more established businesses that were hit hardest. 

Growing pains

The highest churn rates in 2008-2009 were for companies involved in administrative and support services, handling back office functions for business, and companies offering food and accommodation services.

The number of companies entering insolvency in March this year reached a near-record high of just under 1,500, according to the corporate regulator. Cautious consumers and rising rents are believed to be causing the problem.

Figures from the Australian Securities and Investments Commission show the number of company collapses reached 1,491 in March, versus 1,299 in February and 640 in January.

That is one of the highest ever figures released by ASIC since the late 1990s, and a significant rise on the figure of 1,313 in March 2010. According to ASIC, the number of companies entering external administration in March 2011 was 968 Australia-wide, up from 852 in February and 455 in January.

Angus Luffman, head of consumer risk at Veda Advantage, says the reasons for failure are clear.

“During the first few years of business operations, many start-ups are at risk of financial burn-out as a result of financial mismanagement, and from failing to adequately implement best-practice credit methods to minimise financial risk,’’ Luffman says.

Connect Furniture director Joe Bruzzaniti says the two most important variables for start-ups in the first years are fatigue and funding.

With his business now entering its third year, Bruzanniti says it is well capitalised so there are no funding issues. That, however, was all a key part of the planning.

“It’s all about doing a lot of research and preparing and having a detailed business plan,” Bruzzaniti says.

“You really should have all your assumptions about, for example, staffing, going out to market and price points and projections listed. You should have all those assumptions explicit, in bullet points and articulated. If it’s implicit, then people are making assumptions and it becomes wishful thinking.”

Keeping an eye on milestones

The key, he says, is to assess the plan as you go along and look carefully at milestones such as revenue and marketing.

“You really should have all the assumptions listed so that you can test them as you go along,’’ he says. “Are the price points correct, what do my forecasts look like, is the staffing right, is the market right?

“Those plans are built on a whole stack of assumptions. If you are tracking well against your plans, then I can’t see any problem. But if it’s incorrect, you have to assess how far out you are.”

“If you are deviating, why are you deviating, how serious is that deviation, can it be fixed and what are the implications? That all relates back to cash.”

What’s your market?

Adacel Technologies director Silvio Salom, a start-up veteran, says many start-ups do not know whether they have a market and that, he says, is the biggest danger.

“I started nearly half a dozen companies and it’s always tricky to know whether you have the right product or service,’’ Salom says.

“If you are starting from scratch, it takes you 12 to 18 months to get it right, depending on what type of business it is.”

Salom says one way of testing the market is to do pre-sales. “One business I started, what we did when we were trying to create the product was to create all the marketing material,” he says.

“We then went out and started pre-selling it. While we were pre-selling it, we learned a whole lot of things that allowed us to adjust the product.”

If the company can’t do pre-selling, Salom advises start-ups to do their market research and talk to potential customers.

He says all business plans need a margin for error. Nothing works out exactly as planned. It always takes longer than expected and the money might not be enough.

“You always under-estimate,’’ he says. “I use Pi on all my estimates. If you multiply it by 3.147, you get close to where it is.”

Start-ups are entering a world of uncertainty where nothing will work exactly to plan.

“You can be guaranteed it won’t,’’ Salom says. “You have to build in a margin of error. You plan is just a starting point.”