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Three decisions that will sink you new business

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By Phil Chichoni

Promising new businesses get sunk by some seemingly simple decisions that most entrepreneurs don’t seriously think about in the excitement of building the next huge-dollar business.

The most common decisions are the ones that sink the majority of start-ups, according to a US academic. These decisions will also likely affect your business even in Zimbabwe.

Noah Wasserman, a professor at Harvard Business School, is the author of The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls that Can Sink a Startup.

His research is based on the experiences of 10,000 company founders, with stories from entrepreneurs such as Evan Williams of Twitter and Tim Westergren of Pandora.

“There’s a craving… to anticipate things that in the past would have taken a serial entrepreneur with the pattern recognition to see that decision X will lead to outcome Y,” Wasserman said.

Wasserman identifies three frequent causes of start-up failure:

1. People problems

According to Wasserman, most start-ups fail as a result of people problems, such as picking the wrong co-founder.

“The most common decision is to start with someone you know socially,” he said.

“But that’s the least stable of all teams, because you’ll likely be co-founding with someone who’s more similar to you than they should be.”

“You could [also] be far less likely to handle the tension-filled discussions and tackle the elephant in the room until these issues blow up in your face.”

An IT entrepreneur I spoke to recently agreed that it was a mistake to start a business with his best friend he had worked with at a local bank for eight years. “You run the risk of ruining the friendship. And because you’re friends, you tend to have a lot of similar interests… [Co-founders] need to be different from you,” he said.

The challenge is making sure you work well together when the pressures of building a business pile up. Because you likely have the same skills and experiences, there is no variety of ideas when it comes to solving problems or mapping strategies.

2. Equity splits and control

Wasserman said 73% of the company founders included in his research divided the equity within a month of founding, which, according to him, is too early.

“This is when uncertainties for the venture are at their highest, when you don’t really know what your business strategy will ultimately be or the roles you’ll ultimately be playing,” he said.

“Yet founders are splitting equity then and setting it in stone, and it causes major tensions later.”

I experienced this problem when I started a distribution company with my brother back in 2007. The main issue arose from the valuation of our contributions;  one  contributed cash but was not working full time in the company while the other contributed expertise and labour working full time. Issues of salaries and authorization of payments for business expenses caused the most tension.

It can be difficult to value contributions to new businesses. Entrepreneurs should set the terms and conditions of their legal and working relationship with their partners as early as possible-  before too much expense and time has been invested.

You could start with a 50/50 split in the new joint venture and have a mechanism to ‘buy’ more equity from the other partner. It is however important to agree on things like salaries, borrowings, cash withdrawals and powers of authorizing important decisions.

3. Funds from friends and family

Wasserman said while most founders take money from friends and family, “you’re playing with fire”, which means “you have to build some firewalls”.

He suggested writing a “prenup” and discussing worst-case scenarios upfront.

“And thinking hard, as founder, that if Aunt Sally is the only one willing to invest in your business, maybe that’s telling you something,” Wasserman said.

I would advise you to be very careful when taking money from friends and family. It can jeopardise all kinds of relations. If you’re good enough, and your idea is good enough, there will be an investor out there who wants to give you some money to make it happen.

If you can’t raise investment from private investors, perhaps something isn’t quite right with your business plan. A workaround is to try and do both – raise private investment and ask your family or friends to match it.

The big weakness is that family will probably give you money without scrutinising the business plan as much as they should. When the business fails to perform as expected and you are slow in paying back, they will be disappointed and may even get angry. Sometimes we fail to explain that all businesses carry risks and projections don’t usually yield as planned.

If you haven’t read my book The Entrepreneur’s Guide to Starting a Business in Zimbabwe, download it here.

Email your thoughts to chichonip@smebusinesslink.com.

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