Q: I’m an entrepreneur with what I think is a great idea for a startup. But how do I know if it really makes sense to pursue?
A: The good news is there are concrete financial benchmarks that can help answer this. Nearly every industry has ratios that define the likelihood of success.
1) Begin by searching association publications and investment research specific to your enterprise. Be sure to examine the profitability metrics posted on your trade’s association websites, and study comprehensive industry overviews from reputable sources that present relevant models and statistics.
My early entrepreneurial career began in food, so here are a few examples from when I was starting my own restaurant business:
Projected revenue divided by startup costs needs to be better than 1.8%.
Fixed costs, which are recurring costs that don’t vary like rent and management salaries, divided by sales should hover around 8-12%. Of course the lower the better on that. The more sales dollars per year, the higher you can afford to be on the percentage.
Adjust this based on your market and business category, but fixed costs should not exceed a certain percent of sales. You can figure out that percentage by consulting credible resources from your industry.
Thoroughly analyze variable costs. The big two in restaurants are food and paper costs combined, and labor. You want to hold these at 60-62% of revenue. If your fixed costs run lower, the 60-62% can edge a little higher.
Some restaurant segments, like pizza, have costs specific to them. Pizza concepts generally run 2% lower on food and paper, but there’s an offset because of the very high outlay to acquire customers using direct marketing, like door hangers and mailers.
To project sales, multiply your predicted customer count by anticipated ticket average, less dollars spent to get people through the door. Be conservative on these estimates to insulate against unwanted cash drain.
2) Decide whether your idea is a financial performer by focusing on measureable factors. You can buy comprehensive industry research that publishes data on your competitive landscape. For instance, the National Restaurant Association has data available for a membership fee.
3) Not only should you review that data, you could hire an accountant who specializes in your field to crunch those numbers and produce a model P&L.
But buying industry data can be expensive.
4) Here’s a no-cost option. Ask those who own businesses like yours to share their P&Ls. Obviously not every business owner is going to be generous like that, particularly if you’re seen as competition. You might have better luck if you drive across town and ask business owners who aren’t going to be in your trade area. If you can get this information, it will be invaluable.
5) Avoid the market share game. Chose what you see as a growing segment for your startup. Going back to the restaurant example, if you open a traditional burger joint you’re in a more mature segment because there are lots of traditional burger places. You have to steal market share from those guys, like McDonalds, if they’re in your trade area. As you can imagine, that’s hard to do. But, if your startup is in a growing segment, for example craft burgers, you can probably count on shifting demand, or even new demand. That can be true even in a down economy.
So, find a new way to offer that burger.
When I was getting my own small business off the ground, if I hadn’t taken my own advice here and figured out if the numbers made sense, it would have been one of the biggest guesses I would ever make.
What’s your entrepreneur question? Email me at RESblog@consumercp.com.