Startups: The big problem with the business model

What is the purpose of every company — and consequently also for every start-up? In my opinion: Ultimately, the company should earn money. That sounds very easy. In practice, however, founders do not pay enough attention to this purpose.

Experience shows time and again how difficult it is for founders to implement a suitable business model. One with which at the end of the day the receipts exceed the expenses. Why is that?

“Implementing an idea” vs. “Starting a business”

When I think back to the company formations I was allowed to accompany, I think one problem is that some founders equate the implementation of an idea with starting a business. What do I mean by that?

Many founders once had an idea with which they associate the vague hope of possibly earning money. This hope remains vague because they only look at the idea as such and not at the future company that is needed to earn the money. In addition, they read everywhere on the internet and hear from many counselors that in order to earn money the idea should provide a solution to a problem or simplify or improve something. And it may even be that the idea does exactly that — providing a solution or improving or simplifying people’s lives. However, that alone — the idea alone that provides a solution to a problem or improves or simplifies someone’s live — is not enough. A company does not (only) exist to implement an idea. It exists because revenue is to be earned.

But that alone — earning money with the company — is still not enough in my opinion. Ultimately, the profit — that is, revenue minus expenses — must be high enough to make the effort of running a business worthwhile. And the effort includes everything — personnel management, marketing, sales, taxes, negotiations, etc.

And when is it worthwhile? For an entrepreneur, the answer should be clear: if you can live on it.

The big mistake

But right here again and again a mistake happens. Because this “can live on it” must be inspected more closely. When can one live from his company? Founders should think about this question at the very beginning, before they found the company. They will discover that to answer this question they have to have a close look at the business model and especially at the “plan to earn money”.

I’ll give an example, which of course has no claim to universal validity.

Let’s say, three founders want to start a software company. If each of the founders wants to live off the business, it quickly becomes clear that this business needs to generate decent profits. (Again, profits are what’s left of the revenue after deducting the costs or expenses!)

Suppose that every founder wants to go home with 3,000 euros (to make this example easier to handle we assume this amount of money is before tax — and I understand that this amount of money might not be the final goal for founders, taking into account their risk and their efforts…).

Then the company has to make at least 9,000 euros per month. That’s all? Of course not, because we have not yet considered the taxes and the expenses.

Let’s say that the founders spend 3,000 euros a month on their office and on auxiliaries and other materials (to keep this example as easy as possible we don´t take into account sales tax). Then the revenue must already be 12,000 euros per month.

If we take into account income taxes (let´s say 30%), then we end with approximately 16,000 Euros — per month. That is about 200,000 Euros in revenue per year. Not bad, right?

Ok, you might say. And where is the error that the founders make? They think about the idea. But they don´t think about a return from the idea that justifies the effort of founding and running a company.

How should founders deal with their business model instead?

I would like to emphasize at this point that this article is not about the comprehensive development of the business as such. Therefore it is not about the identification of customers, products, distribution channels or the like. I’m only concerned with the question: Are the profits that are made or that can be made enough and in addition for what must they be enough?

In my opinion, first it takes a lot of realism. Every founder has to ask himself whether his idea is really about making money and when he will be able to say: “For me it´s worth it!”. And if he answers honestly, it will only be worthwhile if he can make a normal living with the money he earns, under consideration of expenses and taxes.

But this is where the founders are not always honest. I want to give another example: One founder starts a company while studying. He is satisfied with 500 euros in profits per month. In addition, he has no plan (whatever the reason is) to make more profit. Let´s be honest: realistically one could barely pay the rent for an apartment with this amount of money!

To help founders identify the amount of money they should realistically earn, they should draw a comparison to an employment situation. What salary would a founder be satisfied with? And what premium should he have to add to compensate for the risk that he has to bear as an owner of a company.

When you start thinking about that, suddenly the 3,000 euros in my example above are no longer such a large amount, right?

Don´t start a company?

Of course now I hear a few people say: “Well, but realistically, I will not earn so much at the beginning compared to a salary. In fact, I will not earn anything for the first few months. Does that mean I should not start a company? “

This statement from a founder that I got a few weeks ago is of course a little bit too short-sighted. Because that’s not the point. It is quite normal that many companies have little or no profit or even revenue at the beginning. That is not bad as such.

It is bad, however, if in the further planning the founders have not even asked themselves the question whether their company will earn enough money at some point in time so they can make a living in a way that want to make it (sometimes this question is not even addressed because the founders deep inside have a bad feeling about what the answer might be….).

Conclusion

With this contribution I would like to argue for a slightly different view of business models. I recommend that closely after the development of an idea the founders should think about if and what revenue and profits are possible.

There exist good ideas, but unfortunately there is no money to earn from them. Nevertheless, some of these ideas are worth pursuing. But founders must not be disappointed if they cannot make a living from these ideas.

But if the goal of a founder is to generate enough income to earn a living with his company, he is well advised to check as soon as possible what is in it for him.

And he or she has to do this realistically, without lying to oneself.

If one comes to the conclusion that the profits will not enough — well at least this has saved him or her a lot of time and energy that can be used to pursue another business idea whose income might be in better proportion to the effort and the risk.

Thanks for reading! :)

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I am the co-founder of “Gründen@Würzburg”, the startup initiative of the German city of Würzburg. I had the honor to be the President of the G20 Young Entrepreneurs´ Alliance (YEA) Germany and the Chairman of the Steering Committee of the G20 YEA, an organisation that is the voice of more than 500.000 young entrepreneurs in the G20 countries (www.g20yea.com) .

A corporate lawyer by profession and equipped with my own law firm, I advises German and international clients (who want to do business in Germany) in corporate and commercial legal matters. By invitation of the European Commission, I have the pleasure to participant every year in the annual SME Assembly, the most important event for small and medium-size enterprizes. Additionally, I am a member of the B20 Task Forces and was from 2014 to 2017 the General Legal Counsel and also a member of the national board of JCI Germany (WJD — Wirtschaftsjunioren Deutschland), the biggest organization for young leaders and entrepreneurs in Germany. Last but not least I am one of the ambassadors for the “Großer Preis des Mittelstands”, the biggest and most prominent German award for companies of the German Mittelstand.

Former Chairman G20 Young Entrepreneurs' Alliance (YEA), Co-founder startup initiative “Gründen@Würzburg”, Startup Investor, Commercial Law Firm Owner