by Ron Stites
Executive Director, CC4ICC
COVID-19 has destroyed many small businesses. This is a huge blow to the US economy since small business provides a disproportionate share of US job and innovation. The situation is even worse for minority business owners and leaders. Small business has historically been one of the most effective means for minorities to accumulate wealth. Hence, small business failures hit our minority communities especially hard.
Setting aside for the moment the unprecedented human cost of the COVID-19 crisis, from a long-term economic viewpoint, the pandemic can be viewed as a temporary accelerator of normal small business “churn.” For many decades small businesses have started and failed at a surprisingly constant rate of about a 20% success rate over a 10-year period. This “rule of thumb” has persisted through the post-war boom years of the ‘50s, the hippy ’60’s, the “stagflation” ‘70’s, the roaring ‘80’s, the dot com bust of the ‘90’s and the financial crisis of the ‘00’s.
During downturns, many small businesses go out of business, but many new ones are also started. Furthermore, a surprising number of good small businesses adjust to circumstances and flourish while (and sometimes because of) the downturn. The COVID-19 crisis has seen some surprising winners – especially those already positioned to take advantage of accelerated dependence on the Internet.
This has long been the case with small business. I once worked for a Dr. Walt Langston who had founded a small scientific testing laboratory. He was always hoping for a recession because the big companies cut back on in-house testing to “save money.” They contracted the work to his labs. During good times, the bigger companies fattened up their staffs and pulled the testing work back in-house to “save money.”
Through all the ups and downs, that rule of thumb has persisted. Why? I believe there are several factors including:
- Good small businesses are nimble enough to adjust and often find a way to flourish in changing circumstances.
- Many small businesses are started that don’t have much of a chance of success in good times or bad.
- Many small businesses are life expectancy constrained by the effective working life of the founding entrepreneur.
These factors are mostly about entrepreneurs rather than business ideas. work together to create a constant “churn” of small businesses. Entrepreneurs are a surprisingly resilient and persistent lot. They may go broke today but are planning to reopen tomorrow. The absolute numbers of that “churn” change based on economic conditions, but the percentages remain cannily the same. If we want to increase the efficiency of business capital, we need to move the needle on quality rather than quantity.
So, what is a “good” small business? More importantly, how would one pick a “winner” before that business has demonstrated “success?” This is the big question. Most investors make almost no effort to try to do this. They try to find the business that already has sales and buy a chunk of that business (the “Shark Tank Model”). Some will give a little support to the business to improve success rates, but most just buy a small piece of a bunch of companies and hope for the best. They depend on their “winnings” of a few to outweigh their “losings” of the many. That is a strategy that demands high returns on a few to offset the losses on the many. No wonder they “demand” 3X return in five years.
At CC4ICC we look at several key factors. We require all candidate companies to fill out exhaustive questionnaires before we will engage with them. We ask the usual questions about their history, technology and financial performance. We would like to know if they have gotten any traction, but our primary purpose is finding out if management understands their business and their customers. It is amazing to discover how many small businesses are not businesses at all but are some type of “hobby” or “technology” that the owner/founder “loves” and wants to promote.
We insist on seeing a business plan that demonstrates that the owner/leader understands what needs they are fulfilling for their potential customers and why those customers would be willing to pay for their product or service. If this is missing, then the owner either doesn’t have a business or doesn’t understand what his/her business is. In the first case we walk away. In the second case we will dig deeper and try to determine if the owner is willing to “discover” what business they are in and adjust their plans to make that business successful.
If we can get past that first hurdle, we will dig deeper to see what the small business needs to grow. We also try to assess the ability and willingness of the owner and the management team to work on known deficiencies. We have walked away from several businesses that had some traction but appeared to be unwilling to consider doing anything different. These folks are unteachable and, frankly, a giant pain in the butt.
Throughout this whole process we keep in mind the “rule of thumb” that 80% of who we are talking to are not going to be around for long. We don’t want to be working with them. We try to push the rule a bit further and take on less than 10% of the folks we talk to. That means we have to talk to a lot of folks. That is why we have automated the process and are working to perfect an AI evaluation program. We want to work with the winners. It is way more fun and way more profitable.
When we find what we think are the winners, we are happy to help them improve their business and get them ready to raise money to make their dream a reality. There is still a lot of work to do, but in most cases, businesses that know what they are doing and are willing to work at it can find the mix of equity, debt and grants to fund the growth of their business.
If you think that you are among the winners, feel free to contact us by email (see below) or visit us at: https://www.cc4icc.com/consulting-1 . There you can find a list of our services and a form to request more information.
You can also contact me at: [email protected] or visit our website at: www.cc4icc.com.
Ron Stites is an inventor and serial entrepreneur. His specialties are start-ups and early capitalization – especially with high-tech and “deep-tech” businesses. His is a founder of the Colorado Center for Innovation in Community Capital (CC4ICC) as well as several other businesses serving various facets of business improvement, growth and technology development.