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Three things aspiring entrepreneurs must evaluate before starting up

The idea of launching a startup in India has gained momentum over the years, powered by factors such as funding, evolving technologies and an expanding domestic market. However, a majority of startups fail within the first few years of their initiation, leaving budding entrepreneurs in disarray.

Amid the uncertainty on the success of startups, there is always a question in the minds of budding entrepreneurs whether to launch a startup or carry on with a regular job. It is almost impossible to find the right answer as there are many factors that influence the success or failure of a startup.

Let’s assume that you are 40 years old and you are the primary breadwinner in the house. You are interested in launching a startup that apparently doesn’t require any external funding. The project can kick-start by investing less than 15% of your net worth. Though such a startup may be less scalable and offers a lower upside, it is easier to start.

Below are the three soft criteria which may give you an idea before starting up.

Coping with the failing startup

Only a few successful entrepreneurs talk about their success while many others who have tasted moderate success or have failed prefer to remain quiet. So, there is a bias in the stories we hear about entrepreneurial success. The reality is that a majority of startups will completely fail (see ‘Figure 1’ in the ‘Kauffman Firm Survey’ )Further, it may take around five years to figure out whether the startup has failed or not.

If the startup fails, you will probably go back to a job which may pay you lower than your previous job. The primary challenge with the startup failing is psychological (see ‘The Psychological Price of Entrepreneurship’)

So, do you think you will be able to cope with pressure if your startup is failing? 

Making less money

A very small number of startups are ‘very successful’. This unlikely scenario is like winning a lottery. So, we should ignore this scenario while deciding whether to start up.

Let’s assume that you are in the small minority of ‘moderately successful’ startups after five years. Such entrepreneurs probably earn half of what they would in a high-paying job. In such a scenario, most entrepreneurs won’t be able to save much. Therefore, they will add very little to their real net worth after adjusting for inflation. Only a few extraordinarily frugal entrepreneurs may continue to save and add to their real net worth.

Now, let’s assume that you are not one of those extraordinarily frugal entrepreneurs. To cope with the financial challenge, before you begin a startup, your net worth minus any investment in the startup (over the next five years), should be equal to at least 25 times your annual family expenses in your first year as an entrepreneur.

The term ‘net worth’ in this context refers to your and your spouse’s assets minus liabilities. To simplify the calculation, if you live in your own apartment then imagine that
you have sold your apartment and you pay the monthly rent on that apartment. If you would like to go into some of the assumptions in this calculation, then see ‘Living with Zero Real Returns’.

The metric of ’25 times’ is a high bar that most people cannot meet. If the metric is less than ’25 times’, then you could re-engineer your idea so that it requires a lower
investment and saves your net worth. If even after re-engineering, the metric is less than ‘25 times’, then starting up is likely to hurt your family’s standard of living after retirement.

Entrepreneurship is very risky when it comes to saving enough for retirement and your children’s higher education. Hence, your desire to be an entrepreneur should be strong enough to accept the fact that there could be a drastic reduction in your lifestyle.

Better than 50% chance of moderate success

Any weaknesses in your plan, which is the combination of the idea and the execution strengths, can crush the chances of success for your startup.

After making the blueprint, do you think your plan has more than 50% chance of ‘moderate success’? To help you answer that – do you have good reasons to believe that
your startup will be the best option for your target customers? In the worst case, will your startup share the best spot with your competitor?

If you are likely to be the second or third best option for your target customer, then the plan may not be worth the risk.

Conclusion

If you want to become an entrepreneur but do not fit in the soft criteria mentioned above, then there is still a way out. Luckily, entrepreneurship has many shades. Being a member of the founding team of a startup or an early employee in a startup could be a good move. That may help you meet the soft criteria over time.

As legendary boxer Mike Tyson said, “Everybody has a plan, until they get punched in the mouth.” All entrepreneurs will definitely get punched. You would certainly put yourself in a strong position if you meet the above mentioned framework before setting up a startup.

Avinash Luthria is founder and SEBI-registered investment adviser at Fiduciaries.in. He was previously a partner and a member of the founding team at private equity firm Gaja Capital.

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