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March 14, 2017

Tough Fixes Not in a Startup’s Playbook

Acknowledging Problems and Then Fixing Them Quickly Is Essential

Tough Fixes Not in a Startup’s Playbook

Problems rarely resolve themselves, and entrepreneurs at small companies need to be vigilant in addressing them for the sake of the business. [© afxhome/Fotolia]

  • Five years ago, in a column entitled, “Simple Fixes that Entrepreneurs May Resist”, I described what I had discovered in my consulting practice to be “the most frequent but readily correctable problems that CEOs from small companies face” but too often resist taking appropriate action. In too many such cases the company operates very inefficiently, is no longer able to raise capital, and/or goes out of business.

    There were four such problems: (1) being overly concerned about dilution and refusing funding; (2) continually delaying completion of a business plan even though it was essential for raising capital; (3) refusing to terminate an “irreplaceable” employee, deemed to be a problem solver but who in fact is a problem creator; and (4) loss of focus trying simultaneously to commercialize distinctly different technologies.

    The following four problems, which I have also observed, are not as common, and as a result most entrepreneurs have spent little or no time thinking about how to fix them, but when such problems arise they have to be fixed ASAP.

  • Problem 1— Sorry, the Seed Capital Will Fund Plan B

    Very occasionally, a new company develops an apparently solid business plan, presents it to its seed investors, obtains funding, and soon after realizes its plan is flawed or its business environment has dramatically changed. It either has to return unused funds or devise a new business plan acceptable to the investors. I have witnessed this a couple of times, and in both cases, the new company was able to develop an acceptable Plan B.

    For example, one newly formed company raised seed capital to merge with a small, privately held company that had been in the diagnostics business for some years. Even though the new company developed a business plan to justify the rationale for the seed capital, one of the cofounders was somewhat skeptical as to why the diagnostics company was willing to merge with the new entity. This cofounder kept searching for reasons until finding out soon after the new company received its funds, that the diagnostics company, which had never been audited, had significant accounting issues that had not been revealed in its previously disclosed financial statements.

    Fortunately, two of the new company’s cofounders had considerable research experience that was applicable to developing a new biotherapeutic. However, they had been willing to participate in the diagnostics venture because they thought that their biotherapeutic-related research was too early stage to justify raising capital even from seed investors. Now their biotherapeutic project was the only game in town, providing they could justify it to the new company’s seed investors. Working around the clock, the cofounders actually came up with a solid business plan built around the biotherapeutic project that was met with approval by the seed investors. Indeed, the new company subsequently raised significant sums of capital in several rounds of venture capital financing.

  • Problem 2— Exiting a Business Line Sooner than Later

    Sometimes a company has begun to market a product that it believes will satisfy a particular business need, but its analysis that provided the rationale for introducing the product was either flawed or the business environment has rapidly changed for the worse. For example, a research biologicals company developed a product line that it thought could attract a significant share of the existing market. What it did not realize was that a competitor had just developed a very inexpensive way of producing these products, and the competitor lowered its prices to a level that undercut the company that was trying to enter this marketplace. Yet, because of the capital it had spent on R&D, the latter company built up inventory, invested in marketing, and kept throwing good money after bad.

    In contrast, a chemical instrumentation company not in the biomedical marketplace decided to customize one of its products for biomedical applications following an analysis that indicated a substantial potential market for the product. Unfortunately, unbeknownst to the company, several biomedical instrumentation companies were already developing such a product. When the chemical instrumentation company was finally ready to launch its biomedical product, it then discovered that competitors’ products, which were well-designed, were now being marketed in a space that the competitors were already in, which gave them a distinct advantage over the chemical instrumentation company. As a result, the chemical instrumentation company decided to limit its financial exposure to the R&D expenses that it had already incurred for the new product and withdrew from manufacturing and marketing it.

  • Problem 3— Dealing with Product Recall

    There is only one effective way to deal with product recall. You have to be forthright in acknowledging the product’s defects or its outright failure and proactive in providing for product replacement or financial reimbursement. The following example pertains to a company I ran in the 1970s. At the time we were the largest commercial supplier of cultured human lymphoid cells. We were constantly striving to improve our cost effectiveness. At some point that backfired, when the only mouse lymphoid cell line that we carried contaminated all of our human lymphoid cell cultures via aerosols.

    As I have detailed elsewhere (Fundamentals of Human Lymphoid Cell Culture. New York: Marcel Dekker, 1980), we quickly obtained evidence to account for this disaster and overhauled our cell culture production methodology accordingly. The next step was to contact all of our customers who had received contaminated cell cultures. Our head of sales telephoned each such customer and after discussing the situation with them, encouraged them to speak with a member of our management team for a fuller technical explanation. Every one of the affected customers was willing for us to refill their previous purchase orders with uncontaminated cells, and in no case did we lose a single customer. Indeed, they all appreciated that we were forthright and proactive in dealing with this nightmare.

  • Problem 4— Downsizing Sooner than Later

    Downsizing is obviously something no entrepreneur wants to do. Moreover, most entrepreneurs assume that downsizing only happens when a business has met with adversity, such as failure of a major R&D undertaking or obsolescence of a product line. However, downsizing should be considered as part of a strategy to convert losses to profits, as described in the following example.

    After several raises of investment capital, a privately owned biotech company with fewer than 50 employees was manufacturing and marketing research products but was still reporting losses. Trying to raise more capital in order to grow much larger, the company received the same message from potential investors; first demonstrate profitability. The CEO and the COO, both of whom were the company’s cofounders, took this advice to heart. Between the two of them, they had direct experience not only in managing but also in carrying out R&D, manufacturing, and sales and marketing. Within a month they devised what they thought would be a more cost effective way of operating the company.

    First, they reduced R&D staffing on long-term projects; secondly, they reconfigured manufacturing, making it less labor intensive but capable of producing greater volume; and finally, recognizing that 70% of sales were repeat business, and two-thirds of new sales were obtained by only one-third of the sales force, they laid off half of the sales force. In total, they reduced the workforce by 40%. The following fiscal year the company was profitable for the first time, and the year after that, the company was able to attract venture capital while growing its revenues 25% and remaining profitable.

    In summary, in order to solve each of these four problems, speed is of the essence.

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