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The Perfect Business
Mapping your way to the perfect business
What if you were to discover the secret to the perfect business? What would you do with the knowledge?
When long-time friends Bob and Bill discovered the road map to the perfect business, they decided to put it to the test.
Searching for the perfect business had become a quest for them. It took the two many years to finally uncover the pieces of the puzzle. Here’s a look at their map to a successful business.
Bill worked for Family Partners, a group of high net worth families that invested in private companies. His partner in crime, Bob, worked as an investment advisor helping wealthy customers invest in the stock market.
“Imagine finding a business with a niche too small to attract competitors but with the ability to sustain a few large enough customers, who are willing to pay for a premium service that is a lot cheaper than having their own 24/7 standby maintenance crew,” said Bill, musing to two of his five friends that joined him at weekly poker nights.
The group gathered to discuss what was bothering them at work and let off some steam when their employers ignored their ideas. Sometimes, they imagined themselves as business owners and entrepreneurs, like over grown boys on a treasure hunt.
“In your dreams,” said Harry, the accountant. “All of my clients who have built successful businesses work crazy hours and never see their families. That is the price you have to pay.”
“You want to bet?” said Bill.
“What are you up to?” Harry asked.
“Alright,” Bill said, winking at Bob. “We’ll let you in on the secret.”
That got Harry to sit up and pay attention.
“It’s easy, really,” said Bob. “All you have to do is pay attention to what goes on around you.”
That night, Harry paid close attention to what everyone was saying.
The perfect problem
Jim and Tom, two of the other friends and poker players, had talked about shrinking their respective problems and looking at solutions they were working on together.
“My company has spent millions on reducing ink spread and paper jamming issues,” Jim said, talking about the big printing machines at ZPG. “Most of the stoppages are caused by problems with the bearings. One of the biggest costs is keeping a 24/7 standby crew for when the machines grind to a halt due to bearing failure.”
“That sounds very familiar,” said Tom, joining the discussion. “I’ve been working on a similar problem using software to predict equipment failure for a customer in the oil pipeline business. The customer is frustrated because it involves battles between different departments that keep blaming each other.”
“Are you two going to keep complaining or are we going to play?” asked Mike, who was a sales manager for Randall Web, a direct competitor of ZPG.
That put a brake on the conversation and brought everyone back to the game at hand.
The next week when Bill and Bob showed up at his place before everybody else did, Harry said, “I see what you mean.”
“Do you?” Bill asked, pleased with himself for guessing Harry’s acute sense of smelling out a business idea.
“You two were talking about Jim and Tom’s idea,” Harry continued, beaming with pride. “The minute Jim started venting about the machine bearings wearing out at his workplace and that he was working on finding the best solution, I knew there was an opportunity there. Plus, Tom jumping in to offer a software solution to predict the cycle of bearings was also a bit of a giveaway.”
“Very good, Harry,” said Bob.
“Do you think they’ll be able to make it a successful business?” Harry asked.
“Just wait and watch,” Bill said, winking as the others entered the garage.
The perfect solution
A couple weeks later, Tom explained he was working on developing software that anticipates the problems so the bearings can be fixed before an interruption happens.
“This is perfect!” said Jim, delighted at the thought that he had found a way to fix the problem at ZPG. “We should work together to come up with a solution for this niche market. I have the knowledge to create the ideal bearing oil, and you can develop the model that helps figure out when the machines are about to run into problems.”
Tom considered the proposition for a moment, one eyebrow raised, his expression when thinking things over.
“I guess so,” he said, raising his arm, which Jim immediately took into his hand, giving it a good shake.
“You’ve got yourself a business deal, partner!” exclaimed Jim.
Bill, Bob, and Harry looked at one another, their expressions saying, ‘What just happened?’
“I guess you guys are in business then,” said Mike, still not interested in the chitchat. “Now can we play?”
Bill and Bob met at lunch the next day to compare notes about what had happened the previous night.
“I’m making a list of what they’re going to do,” Bill said. “It will give me an idea of what novice entrepreneurs do right and wrong when starting a business.”
“Are you going to share it with them?” Bob asked.
“Only if they ask me for advice,” Bill replied. “I believe startups should always seek advice from professional experts, but I can only lead a horse to water, I can’t make it drink.”
“Fair enough,” Bob said.
The perfect investment
Poker nights had now become a mastermind session for Jim and Tom, who were surging ahead with their business, Fast Lube.
“Is that the name?” Harry asked.
“Yeah,” Jim said, “it’s great, isn’t it?”
“Ok,” Harry said, withholding further comment.
“We have Mike as our sales guy now,” Jim went on, undeterred.
“Wait,” Harry said, unable to resist commenting, “doesn’t he work for what would be Fast Lube’s competitor?”
“Yeah,” Mike said, without explaining his sudden interest, “but I’ll quit in a couple months when I have the first few big customers for Fast Lube. I would imagine Randall Web would be their first customer. After that, it’s smooth sailing.”
“And where are you getting the money to take the company off the ground?” Harry asked, now totally involved beyond rescue.
“I am using some of my own money from an inheritance and we’re going to look for investors,” Jim said, very proud of his idea, as if it were a discovery being made for the first time.
Bill quickly thought of the various investment options the three could benefit from.
Family friends and fools
The reason fools are grouped into this category is because of the risk associated with lending or investing in a seed venture. Generally, these individuals are not sophisticated investors; rather, they invest foolishly or by following whimsy. Many novice entrepreneurs think the bank will lend them money or angel investors and venture capitalists will be falling over themselves to invest in their idea. For most novice entrepreneurs, finding an appropriate/suitable investor is a journey from hell. It’s one that makes or breaks them. They either give up or in most cases find help only in family and friends. Research has indicated that each year between 35%–40% of startup ventures receive capital from friends and family.
Crowdfunding investments
The good news is that about half of the crowdfunding efforts by startups are successful; the bad news is that these campaigns are most successful when raising small amounts of money — usually less than $10,000.
Angel investments
Angel investors typically provide about $25,000 per investment and often invest through Angel networks to bring together several partners to collect about $200,000 to $300,000 in all. Angels are usually the first third-party investors into the project and sometimes they participate in additional rounds of funding. However, angels find they often have to wait for up to 15 years before their investments yield a good return. Bob’s father belonged to an Angel network that received about 20 applicants a month and only invited two startups to make presentations. Most members of the network invested in only one or two of the 20 startups they reviewed each year. Bob’s father was hooked because one of his investments went public within five years. That had made up for the more than 30 investments he subsequently made into companies that were yet to show a positive return or had already folded.
Venture capitalists
Both Bill and Bob had a good understanding of the world of venture capitalists, too. The two friends often attended conferences and chatted with folks in the big money world. These investors were usually looking at thousands of opportunities a year and investing several million dollars in each early stage company they selected. Even then, the venture capital firms seldom had a home run with more than one in 10 investments.
‘Both angels and venture funds will want to know: (1) what the company does, (2) where is it going, (3) how are they going to get there, (4) how much money is needed, and (5) what do they get in return for their money?’ thought Bob. ‘Angels and venture funds may not work for Jim, Tom, and Mike, as they don’t seem to have their numbers in order and they are not trying to become a giant company like Google, Facebook, or Amazon.’
Bank loans
‘Loans are bad news for startups but great for established businesses,’ thought Bill. Bankers charge interest rates of 3% to 8% for most loans and venture capitalists and angel investors look for returns that are 10 times the investment. A banker cannot afford to lose too many loans but angels and venture capitalist only need one in 10 investments to work to get the returns they seek. Bankers want guarantees and collateral to protect their loans, unlike angels and venture capitalists, which are focused on protecting their equity investment to participate in the upside. And research shows that about 75% of novice entrepreneurs expect to be successful but less than 50% of novice investors will still be running the same business in the few years after launching their venture.
Bill knew that business owners in established companies did not like debt, even if it meant they needed more equity to run the business. He’d seen that attitude in Family Partners. It took a lot of persuading on his part to show them that having some debt would help replace some of the equity they needed to leave in the business and improve their returns on it.
During COVID-19, when interest rates became very low, Family Partners helped their portfolio companies take on debt supported by the government, even if it didn’t feel necessary. This was to prepare for possible cashflow issues in the future, as banks did not like to lend money when interest rates were low.
He thought back on the one-pager he used to convince his clients that some debt is good debt.
Family
After many months of using his own money, and presenting to bankers, venture capitalists and angel investors, Jim eventually went the family route. His uncle was considering lending him some money to hire Mike to help Fast Lube secure customers. The uncle also wanted someone other than Jim or Tom to run the company before providing any loans. That’s why Jim announced he was thinking of hiring Mike to run the company, too.
Know your numbers
“But how much money do you need to get Fast Lube up and running?” Bill asked one poker night.
“Not sure,” said Jim. “I figure we need enough to cover salaries for Tom, myself, and Mike, plus office costs until we have our first paying customer.”
That was definitely not the answer Bob had expected or was looking for. In his experience one of the first things needed to get a business up and running was a strong understanding of the numbers involved in making it a success. Both he and Bill had expected Jim to pull out a spreadsheet to show what the numbers would be including what was needed from investors and what the expected return to the owners and the investors would be.
“I think you need to spend some time with Harry running some numbers because it does not strike me as though you have given this much thought,” said Bob.
Jim took the advice. A couple poker nights later, they came back with some numbers.
“According to the numbers, it looks like a nice business, but it is going to take longer and need more cash to get started than they had first thought,” said Harry.
“Why are investors not interested in Fast Lube?” asked Bill.
There was a long silence.
“They want more equity for the money,” mumbled Jim. “They want us to have a president in place and a numbers guy on the team. They don’t believe our margins. They want a fast-growing business that can go public. They want us to work around the clock for the business and for low salaries if we want equity.”
“When Jim’s uncle lent them some money, he insisted they register the loan so he has the same rights as a bank and he could appoint a receiver to take control of Fast Lube to protect his investment and even bankrupt the company,” said Harry.
“Yeah, you might need to crunch some more numbers then,” said Bill.
Perfect company size
“I would imagine Fast Lube as a small private company that does not have to grow much but throws off great cash surpluses for the owners to take out of the business each year and enjoy a great life and maybe only sell the business when they die,” said Bill, at one of his lunches with Bob.
“The big advantage for you, Bob, is you can buy and sell public company shares at any time,” Bill mused. “However, with a private company you can take a long-term view in growing the company, but selling a private company is more challenging.”
“If only Jim and Tom can get the right number of customers,” said Bob.
‘So what’s that magic number of customers for Fast Lube?’ both wondered.
Customers
The answer came at the next poker night.
“We have worked with Harry to figure out that potential customers spend about $3 million a year on lubricant oils, the standby crew, and replacement of machine parts,” Jim explained. “But Fast Lube can provide the service for $1 million a year.”
Harry then pitched the key numbers.
“Fast Lube really only needs 20 customers, which would be an easy number to manage, and each customer pays $1 million a year for hassle-free maintenance that gives Fast Lube revenues of $20 million a year.
“We have calculated that Fast Lube can operate with $4 million in direct costs providing a gross margin of 80% compared to other companies like Regeneron Pharma, MarketAxess, Microsoft and McDonalds that have margins varying from 89% down to 32%.
“We also only have overhead expenses of $4 million a year to support the $20 million in revenues that gives a 60% profit before tax compared to 33% to 37% for the other companies,” he concluded, as he handed around the financial sheet to Bill and Bob.
Employees
‘So what about the ideal number of employees,’ Bill and Bob pondered.
They figured the ideal business would grow until it had about three or four managers and no more than 35 employees in all. Bill had noticed that once their portfolio companies had more than 30 or 40 employees, the businesses became more and more difficult to manage, because larger businesses required cumbersome systems and procedures. If Fast Lube reached $20 million in revenues with 35 employees, then the revenue per employee would be higher than many famous public companies, such as Tesla, General Motors, and Walmart.
(Click on chart to view larger size)
Balance the emotional and the rational
Even though Mike had been promising it would be smooth sailing once they’d signed up their first customer, Bill and Bob knew that wasn’t how things worked. Businesses were made up of human beings and anytime a change was made to the operations of a business, it affected the human beings bearing the brunt of the work.
And the two friends knew that was always a consideration with upper management. Mike was discounting the emotionality behind a company’s decision to adopt Fast Lube. The customer would have to close an in-house maintenance department and lay off staff. This would be a tough decision irrespective of how it would benefit the company.
For Fast Lube to convince its 20 customers, they would have to fight on an emotional front, Bill said.
“Business owners sometimes make decisions based on emotions, rather than rationale,” he added.
“Emotions, such as…?” asked Bob.
“Despite being told repeatedly that there are no free lunches, entrepreneurs never stop looking for them,” Bill explained. “It takes them many years to learn that ‘cheap is expensive,’ especially when it comes to taking shortcuts and ignoring risks. Managers in large companies often avoid tough decisions — like reducing staff — and focusing on personal status, like protecting their department budget, versus growing the bottom line for the business.”
“You are concerned that potential customers will not want to cut maintenance staff to switch to using Fast Lube?” asked Bob.
“Exactly,” said Bill.
“Fast Lube will need to link what they offer to how it will impact the manager’s status, as well as the potential customer’s bottom line,” mused Bob.
“Yep,” said Bill, “and Fast Lube needs to look at the risk of the sales process taking longer and costing more than expected.”
Business basics
“And even if Jim and Tom get the okay from Randall Web, their first customer, they don’t have a vehicle to invoice the company,” said Harry.
“You mean you need to form Fast Lube as a company and then have them invoice Randall Web once they land the service?” asked Bill.
“Yes,” said Harry.
“I see,” Bill said, sighing.
Managing family life
Things were already stalling when Jim threw a wrench in the works by announcing his wife was suing for divorce and wanted half of his shares in Fast Lube as part of the settlement. That’s when he asked Harry to help work through the numbers to find a way to pay out his ex without giving up equity in Fast Lube. The business shareholders did not have an agreement to deal with divorce or any other downsides of being partners.
A few weeks later, Harry invited Bob and Bill to lunch. He wanted advice on how to deal with Fast Lube. During his work with Jim, he had spent time with Suzie, the bookkeeper at Fast Lube to pull together the numbers. That’s when he realized that since Jim’s wife had left him, he had started dating Suzie. That made what would be a straightforward business discussion really tricky.
To top it all off, Jim had not shared his new relationship status with Harry.
“So what is the problem?” asked Bill.
“There is money missing from the company,” said Harry.
“And you think Suzie took it?” Bill asked.
“Not sure,” said Harry. “Jim, Tom, Mike, and Suzie all have signing powers and any one can withdraw money from the bank account.
“It seems Mike is putting some of his casino night expenses through the company,” he continued. “And Jim is paying for Suzie’s condo through the company, which is also footing the bill for Tom’s fancy car. Plus, Suzie is not a trained bookkeeper and so the books are a mess and that makes it difficult to prove all this is going on.”
Managing money
“Wait, why so many signing authorities?” asked Bob. “Who are the shareholders of Fast Lube?”
“They have issued shares to Jim, Tom, and Mike but there’s still no shareholder agreement, so currently each owns a third of the company but Jim acts like it is his company,” said Harry.
“Holy smokes!” said Bob. “This certainly does sound like a mess.”
Shareholders and shareholder agreements (signing powers, etc.)
Two weeks later, Jim called Bill to ask for a chat. At the meeting, Jim shared what Harry had told him about the business. It was now running out of cash. The promised new customers were still not on board. Jim had asked his uncle for help only to be turned down. Jim’s dream company was disappearing before his eyes. He was left wondering who else he could approach to put money in Fast Lube and deal with Mike who was now a problem for both Tom and Jim — they no longer wanted Mike as president of Fast Lube.
“Why do you want to get rid of Mike?” asked Bill.
“Mike’s job was to run the company and get customers and he has not done either particularly well,” said Jim. “He has potential customers he is talking to but can’t get them to commit. He does not attend our weekly meetings. He always has an excuse. He is hardly ever in the office. We now have several staff, and he isn’t supervising any, so Tom and I end up running things by default.
“He is spending money without any accountability,” he continued, catching his breath. “When Suzie wants to go through the numbers, he always has an excuse except when it is his expenses, which he wants paid right away. He wanted to get rid of Suzie and get Harry to do the work. He is great but too expensive to do the bookkeeping. I have had enough.
“Mike is a great guy, but not suited for this job and a small company like Fast Lube,” Jim finished. “He must go.”
“I think you should talk to a lawyer, Jim,” said Bill. “You may well find that without a shareholder agreement there is no way you can force Mike to sell his shares. Also, what do your bylaws say about hiring and firing a president or secretary/treasurer of Fast Lube? Who controls the money in the company?”
“We can all sign cheques and draw money because we trust each other,” said Jim. “We have weekly meetings and then I make the key decisions, as this company is my baby.”
“I thought Mike was running the company?” said Bill.
“Yes, but it is my company so I can overrule decisions if they are not suitable,” said Jim.
“Jim, you are not the controlling shareholder,” said Bill. “For that, you need 51% or more of the shares or you need that authority spelt out in your shareholder agreement.”
“Well, I never thought of that,” said Jim. “We don’t have bylaws, we do everything on a handshake. And we never put together a shareholder agreement. They’re like prenups — who needs them?”
Experts and professionals are your best friends
“Harry, what are the numbers looking like?” asked Bill.
“Not that good, to be honest,” Harry said.
“What do you say, Bill?” Jim asked. “Do you and Bob have a way of saving my dream?”
“Well, we might have to bring in the big guns,” said Bob. “But I do believe I have some ideas that could help turn this thing around and make it into a perfect business.”
“Then do it, please,” said Jim.
It was at this point Bill and Bob knew they had to jump in to save the business.
Were you able to spot the hidden lessons in Fast Lube’s journey? Send us a quick note to tell us what you think were the prominent lessons and be part of a course on building a successful business.