Chapter ObjectivesTo explain the challenge of new-venture start-upsTo review common pitfalls in the selection of new-venture ideasTo present critical factors involved in new-venture developmentTo examine why new ventures failTo study certain factors that underlie venture successTo analyze the evaluation process methods: profile analysis, feasibility criteria approach, and comprehensive feasibility methodTo outline the specific activities involved in a comprehensive feasibility evaluation

The Challenge of New-Venture Start-UpsNew Venture Formation600,000 new firms have emerged in the United States every year since the mid-1990s.Ideas for Potential New BusinessesThe U.S. Patent Office currently reviews more than 375,000 patent applications per year.

Components of New-Venture MotivationThe need for approvalThe need for independenceThe need for personal developmentWelfare (philanthropic) considerationsPerception of wealthTax reduction and indirect benefitsFollowing role models

Reasons for Starting a Venture

Figure9.1The Elements Affecting New-Venture Performance Source: Arnold C. Cooper, Challenges in Predicting New Firm Performance, Journal of Business Venturing (May 1993): 243. Reprinted with permission.

Pitfalls in Selecting New VenturesLack of objective evaluationNo real insight into the marketInadequate understanding of technical requirementsPoor financial understandingLack of venture uniquenessIgnorance of legal issues

Phases in New-Venture Start-upsPrestart-up PhaseBegins with an idea for the venture and ends when the doors are opened for business.Start-up PhaseCommences with the initiation of sales activity and the delivery of products and services and ends when the business is firmly established and beyond short-term threats to survival.Poststart-up PhaseLasts until the venture is terminated or the surviving organizational entity is no longer controlled by an entrepreneur.

Critical Factors for New-Venture DevelopmentUniqueness of ventureInvestment sizeExpected sales growthLifestyle venturesSmall profitable venturesHigh-growth venturesProduct availabilityCustomer availability

Table9.1A New-Venture Idea Checklist Source: Karl H. Vesper, New Venture Strategies, copyright 1990, 172. Adapted by permission of Prentice-Hall, Inc., Englewood Cliffs, New Jersey.Basic Feasibility of the Venture1. Can the product or service work?2. Is it legal? Competitive Advantages of the Venture1. What specific competitive advantages will the product or service offer?2. What are the competitive advantages of the companies already in business?3. How are the competitors likely to respond?4. How will the initial competitive advantage be maintained? Buyer Decisions in the Venture1. Who are the customers likely to be?2. How much will each customer buy, and how many customers are there?3. Where are these customers located, and how will they be serviced? Marketing of the Goods and Services1. How much will be spent on advertising and selling?2. What share of market will the company capture? By when?3. Who will perform the selling functions?4. How will prices be set? How will they compare with the competitions prices?5. How important is location, and how will it be determined?6. What distribution channels will be usedwholesale, retail, agents, direct mail?7. What are the sales targets? By when should they be met?8. Can any orders be obtained before starting the business? How many? For what total amount?

Table9.1A New-Venture Idea Checklist (contd) Source: Karl H. Vesper, New Venture Strategies, copyright 1990, 172. Adapted by permission of Prentice-Hall, Inc., Englewood Cliffs, New Jersey.Production of the Goods and Services1. Will the company make or buy what it sells? Or will it use a combination of these two strategies?2. Are sources of supplies available at reasonable prices?3. How long will delivery take?4. Have adequate lease arrangements for premises been made?5. Will the needed equipment be available on time?6. Do any special problems with plant setup, clearances, or insurance exist? How will they be resolved?7. How will quality be controlled?8. How will returns and servicing be handled?9. How will pilferage, waste, spoilage, and scrap be controlled?

Staffing Decisions in the Venture1. How will competence in each area of the business be ensured?2. Who will have to be hired? By when? How will they be found and recruited?3. Will a banker, lawyer, accountant, or other advisers be needed?4. How will replacements be obtained if key people leave?5. Will special benefit plans have to be arranged?

Control of the Venture1. What records will be needed? When?2. Will any special controls be required? What are they? Who will be responsible for them?

Table9.1A New-Venture Idea Checklist (contd) Source: Karl H. Vesper, New Venture Strategies, copyright 1990, 172. Adapted by permission of Prentice-Hall, Inc., Englewood Cliffs, New Jersey.Financing the Venture1. How much will be needed for development of the product or service?2. How much will be needed for setting up operations?3. How much will be needed for working capital?4. Where will the money come from? What if more is needed?5. Which assumptions in the financial forecasts are most uncertain?6. What will be the return on equity, or sales, and how does it compare with the rest of the industry?7. When and how will investors get their money back?8. What will be needed from the bank, and what is the banks response?

Why New Ventures FailProduct/Market ProblemsFinancial DifficultiesManagerial Problems

Causes for FailureProduct/Market ProblemsPoor timingProduct design problemsInappropriate distribution strategyUnclear business definitionOverreliance on one customerFinancial DifficultiesInitial undercapitalizationAssuming debt too earlyVenture capital relationship problemsManagerial ProblemsConcept of a team approachHuman resource problems

Table9.2Types and Classes of First-Year Problems Source: David E. Terpstra and Philip D. Olson, Entrepreneurial Start-up and Growth: A Classification of Problems, Entrepreneurship Theory and Practice (spring 1993): 19. Obtaining external financingObtaining financing for growthOther or general financing problemsInternal financial managementInadequate working capitalCash-flow problemsOther or general financial management problemsSales/marketingLow salesDependence on one or few clients/customersMarketing or distribution channelsPromotion/public relations/advertisingOther or general marketing problemsProduct developmentDeveloping products/servicesOther or general product development problemsProduction/operations managementEstablishing or maintaining quality controlRaw materials/resources/suppliesOther or general production/operations management problemsGeneral managementLack of management experienceOnly one person/no timeManaging/controlling growthAdministrative problemsOther or general management problemsHuman resource managementRecruitment/selectionTurnover/retentionSatisfaction/moraleEmployee developmentOther or general human resource management problemsEconomic environmentPoor economy/recessionOther or general economic environment problemsRegulatory environmentInsurance

Figure9.2Internal and External Problems Experienced by Entrepreneurs Source: H. Robert Dodge, Sam Fullerton, and John E. Robbins, Stage of Organization Life Cycle and Competition as Mediators of Problem Perception for Small Businesses, Strategic Management Journal 15 (1994): 129. Reprinted by permission of John Wiley & Sons, Ltd.

Table9.3Determinants of New-Venture Failures E = External factorI = Internal factorSource: Andrew L. Zacharakis, G. Dale Meyer, and Julio DeCastro, Differing Perceptions of New Venture Failure: A Matched Exploratory Study of Venture Capitalists and Entrepreneurs, Journal of Small Business Management (July 1999): 8.

EntrepreneurRankVenture CapitalistRankILack of management skill1ILack of management skill1IPoor management strategy2IPoor management strategy2ILack of capitalization3ILack of capitalization3ILack of vision4EPoor external market conditions4IPoor product design5IPoor product design5IKey personnel incompetent6IPoor product timing6

New Venture Failure Prediction Model Role of profitability and cash flowsRole of debtCombination of bothRole of initial sizeRole of velocity of capitalRole of control

Table9.4The Failure Process of a Newly Founded Firm Extremely high indebtedness (poor static solidity) and small sizeToo slow velocity of capital, too fast growth, too poor profitability (as compared to the budget), or some combination of theseUnexpected lack of revenue financing (poor dynamic liquidity)Poor static liquidity and debt service ability (dynamic solidity)Source: Erkki K. Laitinen, Prediction of Failure of a Newly Founded Firm, Journal of Business Venturing (July 1992): 326328. Reprinted with permission.

The Evaluation ProcessProfile AnalysisInvolves identifying and investigating the financial, marketing, organizational, and human resource variables that influence the businesss potential before the new idea is put into practice.The Feasibility Criteria ApproachInvolves the use of a criteria selection list from which entrepreneurs can gain insights into the viability of their venture.Comprehensive Feasibility ApproachIncorporates external factors in addition to those included in the criteria questions.

Feasibility Criteria ApproachAssessing the viability of a venture:Is it proprietary?Are the initial production costs realistic?Are the initial marketing costs realistic?Does the product have potential for very high margins?Is the time required to get to market and to reach the break-even point realistic?Is the potential market large?Is the product the first of a growing family?Does an initial customer exist?Are the development costs and calendar times realistic?Is this a growing industry?Can the product and the need for it be understood by the financial community?

Figure9.3Key Areas for Assessing the Feasibility of a New Venture

Table9.5Specific Activities of Feasibility Analyses Source: Hans Schollhammer and Arthur H. Kuriloff, Entrepreneurship and Small Business Management (New York: John Wiley & Sons, 1979): 56. Copyright 1979 by John Wiley & Sons, Inc. Reprinted by permission of John Wiley & Sons, Inc.

Technical FeasibilityAnalysisMarket FeasibilityAnalysisFinancial FeasibilityAnalysisOrganizationalCapabilities AnalysisCompetitiveAnalysisCrucial technical specificationsDesignDurabilityReliabilityProduct safetyStandardizationEngineering requirementsMachinesToolsInstrumentsWork flowProduct developmentBlueprintsModelsPrototypesProduct testingLab testingField testingPlant locationDesirable characteristics of plant site (proximity to suppliers, customers), environmental regulationsMarket potentialIdentification of potential customers and their dominant characteristics (e.g., age, income level, buying habits)Potential market share (as affected by competitive situation)Potential sales volumeSales price projectionsMarket testingSelection of testActual market testAnalysis of marketMarketing planning issuesPreferred channels of distribution, impact of promotional efforts, required distribution points (warehouses), packaging considerations, price differentiationRequired financial resourcesFixed assetsCurrent assetsNecessary working capitalAvailable financial resourcesRequired borrowingPotential sources for fundsCosts of borrowingRepayment conditionsOperation cost analysisFixed costsVariable costsProjected profitabilityPersonnel requirementsRequired skill levels and other personal characteristics of potential employeesManagerial requirementsDetermination of individual responsibilitiesDetermination of required organizational relationshipsPotential organizational developmentCompetitive analysisExisting competitorsSize, financial resources, market entrenchmentPotential reaction of competitors to newcomer by means of price cutting, aggressive advertising, introduction of new products, and other actions

Key Terms and Conceptscomprehensive feasibility approachcritical factorscustomer availabilityexternal problemsfailure prediction modelfeasibility criteria approachgrowth of salesgrowth stage

high-growth ventureinternal problemslifestyle venturemarketabilityproduct availabilitysmall profitable venturestart-up problemstechnical feasibilityuniqueness