...as we enjoy great advantages from the inventions of others,
we should be glad of an opportunity to serve others by any invention of ours;
and this we should do so Freely and Generously

Posted November 8th, 2008 at 8:39 pm by Trent

One of the more interesting aspects of entrepreneurship is identifying and understanding the underlying nature of different business models.  For this post Ill explain the nature of Capital Requirements vs different measurements of return.

In many instances, the perfect business model requires low amounts of capital and has high returns, or profits.  What will keep many business ideas from reaching fruition, especially for first time business builders, is the lack of capital.  The next thing to worry about is cash flow.  Finally, you will want to gauge the amount of return and evaluate this based on both a Return on Capital (measured in percent) and Absolute Returns (measured in currency), to make sure it is worth while pursuing.

Different business models have different capital requirements.  Services typically have much lower capital requirements than manufacturing or product driven businesses.  As such, if you have low amounts of personal equity (held assets like cash in the bank or property) and limited access to credit or loaned capital than the most viable start-up business is one that is driven by a service you provide.  These businesses can then generate cash flow to either scale the new business (add additional personnel or move the business to a commercial office) or fund the capital requirements of another business that you wish to endeavor.

Once you have identified a business with capital requirements that you can meet, than you will want to evaluate the business based on its returns.  Ultimately, a low return business will be very difficult to manage.  The lower the absolute returns, the harder you will have to work in order to make ends meet.  Most services have low margins, especially in established service sectors (like restaurants).  Product based business tend to have higher margins, but the higher capital requirements can make your Return on Capital much lower than services.

If you meet the capital requirements and the returns look good in an absolute sense, than you last need to understand your cash flows.  Many service oriented businesses can generate immediate cash flow, which makes running the business much easier.  If the horizon to your first revenue is long and your business turnover to revenue (the time it takes to secure a piece of work and then get cash flow from the work) is also long, than you will need additional capital up front to fund operations (know as Operating Capital).

In the end, a good idea isn’t good enough to make the idea be successful.  Ideally, to become an entrepreneur, many ideas need to be vetted and either discarded or pushed off until the timing is right.  In general terms, if you are starting your first business, getting into a scalable service-oriented business is the best.  As you labor in that first business, you can build up some equity that will fund your capital requirements for other businesses with higher capital requirements but higher absolute returns.  This dance between low capital requirements with lower absolute returns to higher capital requirements with higher absolute returns is the path to becoming a successful serial entrepreneur, especially in the current business environment where credit is scarce.

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