How to Find Economic Opportunities
One of the first aspects of starting your own business is determining if
it will be economically viable for your needs. Here are some key issues you must explore.
1. Profits after tax: High and durable gross margins usually
translate into strong and durable after-tax profits. Attractive opportunities have a potential for durable profits
of at least 10-15%, and often 15-20% or more. Those generating after-tax profits of less than 5% are quite fragile.
2. Time to break-even and positive cash flow: Break-even and
positive cash flow for attractive companies are possible within two years. Once the time to break-even positive
cash flow is greater than three years, the attractiveness of the opportunity diminishes.
3. ROI potential: Very attractive opportunities have the potential
to yield a return of investment of 25% or more per year. Given the risk typically involved, a return on investment
potential of less than 15-20% per year is unattractive.
4. Capital requirements: Ventures that can be funded and have
capital requirements that are low to moderate are attractive. Realistically, most higher potential businesses need
significant amounts of cash, several hundred thousand dollars and up, to get started. Some higher potential ventures,
such as those in the service sector, have lower capital requirements than do high-tech manufacturing firms with
continual large research and development costs.
5. Internal rate of return potential: Is the risk reward relationship
attractive enough? The response to this question can be quite personal, but the most attractive opportunities often
have a very substantial upside of 5 to 10 times the original investment in 5 to 10 years. A 25% or more annual
compound rate of return is considered very healthy.
6. Free cash flow characteristics: Free cash flow is a way of
understanding a number of crucial financial dimensions of any business; the robustness of its economics; its capital
requirements; its capacity to service eternal debt and equity claims; and its capacity to sustain growth. Unlevered
free cash flow(F) can be defined as earnings before interest but after taxes(E) plus amortization(A) and depreciation(D)
less spontaneous working capital requirements(C) less capital expenditures(X). Or F=(E+A+D)-(C-X).
7. Gross margins: The potential for high and durable gross margins
(the unit selling price less all direct and variable costs) is important. Gross margins exceeding 40-50% provide
a tremendous cushion that allows for more error and more flexibility. Gross margins of less than 20% are unattractive.