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How to Avoid the 6 Biggest Financial Mistakes Young Entrepreneurs Make – Inc.

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Money is like gasoline during a road trip. You don’t want to run out of gas on your trip, but you’re not doing a tour of gas stations.
~ Tim O’Reilly, founder and CEO O’Reilly Media

The Financial Role of the Entrepreneur

What is the core role of the entrepreneur?  To invent?  To innovate?  To take risks?  To change markets, industries, the world?

The role of the entrepreneur can be explained in part by any of these descriptions, but it still misses the core.  Why?  Because there is a financial role and responsibility of the entrepreneur that wraps around the products, services, and innovations they bring to the world.

The first financial role of the entrepreneur is to define and forge a pathway to cash flow positive for a new business.  If an organization can’t find its way to positive cash flow then it’s not sustainable and not a business.  Every year there are thousands of good ideas and inventions that never find their way to market because they aren’t part of a business that finds its way to a sustainable financial model.

Startup Financial Pathway

Startup Financial Pathway

Most, if not all, startups will have a period where expenses outweigh revenues.  It may be part of product development, product launch, market penetration, organization building, capital expenditure, or be a combination of each.  The burden of the entrepreneur is to find a means of getting through that startup phase to where the business is cash flow neutral.  The means could be bootstrapping, debt capital,  or equity capital or a combination of the three.

The second financial, and core, role of the entrepreneur is to build enterprise value.  The entrepreneur needs to focus on how to make the business worth more at the end of the year than it was at the beginning.

And from where does enterprise value arise? In the startup phase of a business, enterprise value (a financial measure) can come from non-financial sources.  For example:

  • A strong team devoted to starting the business
  • A successful prototype
  • A key partnership
  • Progress in research and development
  • Success in product trials
  • Execution of project
  • Overcoming regulatory hurdles

Long-term, enterprise value arises from the business’ ability to produce cash above and beyond operating expenses.  In agriculture we often think of the value of a business in terms of its asset value.  The value of a farm business is often thought of as the sum of its equipment and land.

Not all assets are created equal, however.  Those assets that have the ability or promise to produce more cash income per dollar of asset are the most valuable.

Why do financial analysts value businesses based on free cash flow?  Why do business valuation discussion drop acronyms such as EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)?  Because a business’ capacity to produce cash excesses represents its enterprise value over the long term.

A simple case in enterprise value is to compare two auto companies, GM and Tesla.

.                                             General Motors           Tesla Motors
Revenue                               $152.4 billion               $4.1 billion
EBITDA                                 $13.7 billion              -$294 million
Market Cap                            $48.1 billion               $33.6 billion

GM has almost 40 times more revenue than Tesla and makes billions in profits, yet the market values it only 40 percent higher than Tesla, a business yet to make a profit.  Why?  Because the market/investors think that Tesla’s long term ability to produce cash above expenses is very good.  The company only makes a fraction of the cars that GM does, but investors’ money is bet on a much bigger, financially successful future.  In a nutshell, investors have a strong faith in CEO Elon Musk‘s ability to continue to build enterprise value.

How do you describe the pathway of your business to cash flow positive?  How do you build enterprise value in your business over the long-term?