Great Ideas, Investors, and Money — Fail Spectacularly! (SM)

I had a meeting recently with a highly capable, respected expert. I hope to have the chance to do some business with him—he impresses me. We talked about developing an iPhone app together—perhaps built off the How to Self-Destruct platform—and/or SCORM-compliant CBT modules for the key lessons in Super Staying Power. Eventually, the conversation came around to money:

If we work together, who pays the hard costs and how do we split any revenues we earn?

Now, I don’t know how this particular story ends yet—it’s still unfolding—but it’s not the first time I’ve had this discussion. From my own experience on both sides of this conversation (as someone looking for funding and being approached to help others) and from many conversations with others, I know that the conversation is actually quite common. And usually, it goes like this:

“I have this idea. It’s brilliant. You should fund it, and I should own it because (1) it is my idea and (2) I’m already investing all these soft costs like my time. Everyone’ll get rich.”
“You know, it doesn’t quite work like that.”
“Did I mention it’s brilliant?”
“You did.”
“And that I have major soft cost investments?”
“Hm-mmm.”
“And?”
“It still doesn’t quite work like that.”
“Even with the soft-cost investment I’m making?”
“I think we’re done here.”

Before you march head-long into this less-than-ideal conversation—assuming you’re the one with the idea—there are some basic things you should know about business and money that will help you.

The information below will help you plan your business better, will make you a savvier negotiator, and will put you in a position to succeed and not just bang your head against the wall. This is not exhaustive, but it is important. It’s what I’ve taken away from 4 yrs at Wharton and 2 more years at Kellogg, direct negotiations for 4 entrepreneurial ventures I’ve been involved in, managing in a company that filed to go public and ultimately sold, as well as my consulting and coaching… hope it helps.

Money—A Window Into the Soul

Money is neither good nor evil; it is merely a reflection of the human nature that moves it. Just as human nature is capable of good, evil, virtue, sin, and everything in between, so to is money. How someone spends his or her money is reflective of who that person is.

Cash—Not the Same as Money

Cash is not money. Cash is the lifeblood of a business. No cash, no business. Illiquidity (lack of cash) = death, whereas a lack of money can often be survived. If you look at what drives bankruptcies, it’s less often the big, failed, money-losing product than the inability to pay loan obligations due to lack of cash. Cash will continue to be critical until you can pay your electric bill with an IOU.

So whereas how you spend your money (including credit) represents what’s in your heart, what you do with your cash represents the reality of your most basic needs.

This sets up an important disconnect in the investment conversation: You—idea person—will likely be thinking in terms of “money,” because you are so certain of the future revenues that you see yourself as just asking for credit against all the money you’re going to make. Meanwhile, the investor doesn’t share your enthusiasm for the future, and focuses on all the bills that have to get paid whether or not the revenue materializes. This means the investor is focusing on “cash.” Cash conversations are gritty and occasionally brutal… be prepared.

How Much Money You’ll Make! (Not.)

The money you collect from your customers is called “revenue.” Sometimes it’s referred to as “the top line,” because on a standard financial statement, it’s the first item listed. This can be a big number.

But, it costs money to make money! First of all, you have the direct costs of building and selling the product or service itself. For instance, with an iPhone app, someone has to pay to have the app developed. Freelance designers and developers cost money, and those costs get paid out of—hopefully—revenues. But there are other costs, too: The ad we take out to promote the product; the PR person we hire to let magazines and newspapers know about us… that costs money, too. And so does the “office”—real or virtual—that we have to provide to the design team to keep them working together. When you break it down on paper, it looks like this:

REVENUES
-Cost of goods sold
=Net revenues
-Sales & Marketing Costs
-Overhead (including salaries, rent, office equipment, and supplies)
=Earnings before Interest and Taxes (EBIT)
-Interest on loans
-Taxes
=Net Profit

It’s actually a bit more complicated than that, but that’s the gist of it. Notice that there are four separate income lines: Revenues, Net revenues, EBIT, and Net Profit. To confuse things further, these line items sometimes go by different, but similar, names.

Make sure, when you’re thinking about all the money you’re going to make, you don’t stop with the top line.

Good Ideas—Worthless

Good ideas are a dime a dozen. Have you ever had someone refuse to tell you their “brilliant idea” because they were afraid you’d steal it? Did you roll your eyes in disbelief—as if you have nothing better to do, and so little integrity, that you’re just waiting around to steal that person’s idea! Ha! Right then, you realized, not only were they being myopic about you, but they were being shortsighted about their own plans, too: by refusing to tell you about their idea, they prevented you from helping them!

But then, genius strikes and you think of your own “great idea,” and suddenly you forget all that and you want everyone you’ve ever met to sign an NDA before you say hello to them again.

If you’re idea is so fragile that anyone who hears it can run with it, then it’s not a good idea. Why? Because as soon as someone sees you making money with it, people are going to start copying you. If your idea doesn’t offer you an advantage beyond “I’m the only one who knows about it,” it’s not the right idea.

In my conversation with the expert, we’re each protected because neither of us can do what the other one does. I have a brand based on the books I’ve written, and he has an expertise. We can share trade secrets all day long.

Execution—Priceless

Your ability and willingness to work your butt off to make your idea successful is what gives it value. And rest assured, when you’re asking someone to fund a project, anything you say that suggests that you’re looking to short-cut the “hard work” part of the start up will be a major turn off. And I’m not talking about obvious things that people might say. Usually, you signal your laziness in very subtle ways… sometimes, simply overestimating your likelihood for success signals laziness because it indicates that you didn’t do your homework—and if you shortcutted your homework, chances are, you’ll shortcut a future part of the process, too.

Remember, your investor is watching everything you say and do—this is like a job interview that never ends.

Your Expectations—If You Have Them, They’re Too High

If you expect any type of success at all, you’re being optimistic. In my conversation with the expert, he wondered aloud if I wouldn’t be willing to invest a few thousand dollars in an iPhone app to ensure an additional 50,000 book sales.

Seriously? You bet I would!

Want to know why?

Because 50,000 books is an insane amount of books. Books do not sell themselves. Here’s a secret: You don’t just pay a bunch of money for marketing and suddenly have a best seller. You have to work. Here’s another secret: the same is going to be true for that iPhone app. The odds of us creating the next viral hit are slim. More likely, the iPhone app will have potential, and instead of having an app product that drives sales for my book product, I’ll have two products with potential that now both require time and energy to make successful. Which means now I have a divided focus… and I don’t want a divided focus. I’ve been there; it doesn’t work. Sales requires concentrated effort.

Math—Do It

Do you have any concept how much care and feeding is required to move 50,000 copies of something? Here’s some simple math: a wildly successful catalog (I think of the J. Crew catalogs I ordered from in college) might have a return rate of 2%. That is, for every 100 catalogs sent to people, 2 of those people order something. Using that 2% figure, that means that if I wanted to sell 50,000 copies of my book via a catalog, I’d have to put that catalog in 2.5 million people’s hands.

By way of context, Brooklyn has 2.5 million people.

When you build your expectations, do the math. Not “your” math, “the” math. “Your” math is what you do when you look at revenues of the top 5% of a field’s performers. “The” math is what you do when you look at bottom line profits of average performers.

Expect to be average. Look, I hope you hit a homerun. But odds are… you’ll be average.

Time Already Spent—Doesn’t Count

People don’t like hearing this, but you don’t get credit for time already spent. For instance, maybe you have a job at a small company, and you’d like an ownership stake. You’re going to have to earn that stake by buying in (with cash) or working extra—beyond your current level of effort. Why? Because you currently get rewarded for your efforts with a paycheck. That’s the deal you’ve struck for yourself. If you want equity, you’ll have to buy it, either with cash, or a reduced salary, or extra hours.

Similarly, with a new idea, you get rewarded for the value of that idea, not for the time spent on it.

To see what I mean, imagine this: I get paid to write two case studies for two different companies, one in Chicago, Illinois and one in Madrid, Spain. The Madrid case is going to take me much, much longer to do because no he hablado espanol mucho hace mil novecientos noventa y tres, cuando vivi en Madrid. But does that mean that I get to charge more the case I write in Spanish? Probably not. The case itself has inherent value, and that value drives what I get to charge, irrespective of the time it takes to write it.

So with the expert, if he wants more money because he has decades of expertise, or if I want more money because I have a decade of experience plus a retail product, too, it doesn’t matter. The only stuff either one of us will get money for is the inherent value of our ability to execute moving forward.

Opportunity—Wait for It

A new idea is like a new significant other: it fascinates you, captivates you, and blinds you to the world around you.

Got a great idea you want money to implement? Best as you can, fast forward mentally through the flirtatious honeymoon phase. Get to the part of the relationship where you and the idea are talking money.

It’s not as sexy, but if you can wait until you get through the infatuation phase before pursuing your idea, you’ll be in a much better position to succeed.