Good Venture/Bad Venture

An Excel Tool and a Litmus Test

Anjali Oberoi & Mariam Furmanau | In a recent interview with The Workshop, Ariel Barbouth of Nuchas confided that a scarcely spoken challenge of entrepreneurship is to not be swayed from one’s goals by random opportunities that start raining in droves as soon as momentum picks up.

Good point. But then how do you recognize a real solid opportunity in the sea of glitter and deception? If you are familiar with the pace of entrepreneurship, you know that there is rarely time or money to conduct due diligence on every idea that presents itself to you. There are however simple schemes to sort the bad ones - typically the vast majority - from the better ones.

Is It Profitable?

For a start, let’s spell out the obvious: No numbers = No venture. If you cannot estimate a venture’s cash flow, you should not touch it with a stick. And if you can, the first thing you should do is run a basic IRR calculation.

In case you are not familiar with the concept of IRR (Internal Rate of Return), think of it this way: it is the interest rate on a hypothetical savings account that would be as profitable (or loss-making!) as the venture you are contemplating. If a venture’s IRR is negative, you lose money. If a venture’s IRR is positive but lower than the savings interest rate the bank is offering you, you’re better off placing your money in the bank. And if the venture’s IRR is greater than that… well, that’s when things get interesting.

To help you go about this task, we have built an Excel-based IRR calculator that you can download for free by clicking on the image below.

A warning: Do not get too excited if you calculate an IRR of say 3% to 4%. Technically, that would be above today’s average interest rate on savings accounts (~1.85%). But not by much. And remember, s*** always happens. You want to be comfortably above the bank’s interest rate to conclude that a venture seems financially sound.

Not only that, you should make sure that your IRR calculation was conservative, meaning that you factored in some contingency in cost estimates and moderated revenue estimates. If you find yourself tweaking your cash flow so you can inch your IRR into the comfort zone, you are letting your emotions govern the process, and should go back to the drawing board.

And Is It Feasible?

Estimating the IRR is not the full story. A good IRR simply says that if things go according to plan, in the long run, a venture should be profitable. That’s a big “if”. Many factors could still get in the way of your success, and your assessment of a venture idea should involve guessing and evaluating all feasibility challenges and risks.

For simplicity, we have compiled a list of four key affirmations that you could use as a litmus test. If you cannot comfortably state all of these affirmations, you should probably revise your plans:

1. I can describe and defend my venture idea with ease. The point here is cognitive. If you find yourself going into convoluted explanations before audiences struggling to understand your idea, you might not have fully grasped it yourself. Present your thoughts to people around you, and self-assess your ability to answer their questions concisely and to their satisfaction. The goal is not (necessarily) to convince people that your venture idea is profitable, but to make sure that it is clearly defined, and that, when the rubber hits the road, you will be an effective conductor.

2. I know the opportunity cost. When you launch a new venture, you make the choice to shift time and resources away from other potentially growing and profitable activities. Get a sense of what you would be missing out on and quantify it as far as possible. When you look at it this way, is your new venture still worth it?

3. I can access the resources to start and grow this venture. Lay out a technical plan and project as realistically as possible how you will mobilize the resources to implement it. Say for example, that you expect to need certain technical functions six months after launch. Do you already have staff that can fulfill these functions? If yes, will they have the bandwidth to fulfill these functions in due time? If no, are you aware of the challenges of recruiting for these functions?

4. My projected cash flow stays comfortably in the black. It is not enough to know that your venture is profitable in the long run. If your cash flow drops to negative for an extended period of time, your venture may not survive long enough to achieve those projected profits. Identify the periods when you expect your cash on hand to be at its lowest, and assess the risk that it might drop below zero. Can you make changes to your plan to mitigate that risk or do you have the resources to help float through those periods?

* Illustration by Dannae Alvarez