Last fall I wrote an article called “What if there were a Shark Tank for Creative Startups?” Of course, venture capitalists don’t invest in professional services companies—even the most lucrative firms don’t offer nearly the returns an investor needs. So if you’ve ever toyed with the idea of seeking investment for your company, don’t waste your time.
Being excluded from the world of venture capital, potential funding is not the only benefit we’re locked out of. We also lose out on the objectivity, experience, and insights of successful business people turned investors. And that’s too bad, because most creatives are already woefully unprepared for the realities of running a business.
When startup founders seek investment they get subjected to a long list of questions about their revenue, margins, runway, scalability, capacity, and marketing. These are questions most creative entrepreneurs would have a really hard time answering, and even if we could, the response from investors would not likely be very flattering!
Standing in for Shark Tank
Since we don’t have access to this helpful though painful form of scrutiny, we have to be able to evaluate these things ourselves. And so in the next few BizCraft for Creative’s articles, I’ll be doing a series that asks the kinds of questions that an investor would ask—translated for and applied to creative entrepreneurs.
What Does it Mean to Invest In Your Company?
To kick off this series let’s begin by considering investing in general. While you’re never likely to get Mark Cuban in your corner, you yourself are the primary investor in your business. And while 100x return on investment is not likely in your future, you should still want to run your creative business as profitably as possible.
When an investor offers their capital to a startup, they do it in exchange for equity. Equity is a percentage of ownership in a company. When you begin your creative practice you own 100% of the equity. Holding equity gives you the right to two main things, the right to the corresponding percentage of the profits generated by the company, and the corresponding number of “votes” for making decisions about the company.
Your Company is not You
Because creative entrepreneurs start off owning 100% equity, they often fail to differentiate between the entity, the LLC, the business, and themselves—at least until the corporate tax return has to be filed and you realize that you need an accountant to clean up the mess of mingled personal and business finances. (Hint, always set up separate checking, credit card, and savings accounts for your business. Don’t run your business from your personal accounts!)
Valuation of a Creative Practice
As a solo creative entrepreneur, you own 100% equity. But what is that equity worth? What is the valuation of your company? On day one, not very much. If you set up a checking account and deposit $100 of your personal money as an opening balance, your company’s valuation is $100. But as you begin work, sending invoices, and depositing payments, you’ll be increasing the value of your equity. Of course, when you draw money out of that account to pay for your Adobe Creative Cloud license and take a paycheck for yourself, you’ll be decreasing the value of your equity.
Breakeven Business Models Build Zero Equity
The only time your company’s equity grows in value is when you have money left over after paying out all your expenses. Sadly, many creative entrepreneurs run their businesses on a break-even basis. They might grow in terms of overall revenue, but they also add expenses that pretty much consume those revenues. The company itself doesn’t retain any profit.
You could have a firm with over $1,000,000 in revenue every year, but whose valuation is as low as the day it began. Sometimes owners of such firms get tired and want to sell, and only then do they face the reality that they never produced value or wealth—they just funneled money from one source to another as they engaged in creative work.
That’s a rude awakening and the owners in that situation often feel like they deserve more for their company because of their “sweat equity.” They poured out blood, sweat, and tears to build their business, they may have sacrificed their own compensation when things got tight as they built a firm with growing revenues.
But if the value of the equity never went up over all those years. All that “investment” of time, sacrifice, and effort simply never paid off. It never resulted in an increase in equity. The valuation of the company never went up.
Become A Smarter Investor of Your Sacrifices
And so from day one, it would behoove creative entrepreneurs to approach their businesses as if they were a Shark. Before you invest your time, and sacrifice your opportunity costs, or do the even riskier thing of absorbing debt to start your company, ask yourself the tough questions a Shark would ask.
And that’s what we’ll do over the next few weeks as we evaluate our businesses by asking tough questions—and undergo the scrutiny of the tank!