How to Spot a Bad Entrepreneur

The following is not a true story, even though it may resemble stories you have you heard. No names will be used, to protect the guilty (and the highly sensitive).

A kid decides to open a lemonade stand. He sets up shop at a busy corner, and he sells lemonade for $1.50, pocketing $1.00. His net profit is 67 percent, a very nice amount of money for the value he creates for his customers.

A serial entrepreneur (read: wants to get rich quick, not run a business) from San Francisco happens upon this kid and his delicious lemonade. Recognizing potential when he sees it, said entrepreneur offers to invest in the business to help the young kid scale up his budding enterprise. The kid agrees, accepts the investment, and brings the entrepreneur on as an advisor.

The kid suggests that they open a second lemonade stand on an adjacent street to pick up traffic his location misses. The entrepreneur explains to the kid that he is thinking too small, that when you have something that works, you need to find investors and scale the business as fast as possible, take it public, and exit a billionaire. The kid likes the sound of that, even though he doesn’t understand what any of it means.

A Modern Approach to Scale

The entrepreneur explains the plan. First, they need an investor deck. The business isn’t going to scale fast enough without the money necessary to exploit the lemonade market in the entirety of the United States now, and the rest of the world starting eighteen months from now. After they have the deck, the entrepreneur, the kid, his bicycle, and the lemonade stand will begin a roadshow to get the first $25,000,000 and start scaling the business. Once they have the money, they will begin to acquire additional cash in the form of debt, leveraging the company as collateral.

They open the second lemonade stand, but to speed the revenue growth, they hire an agency and begin marketing. The marketing firm suggests that to create buzz, they need t-shirts, wrist bands, and branded cups with the logo that also keep the lemonade cold. Now the cost structure for the cup of lemonade is just over $4.00, leaving the kid with a loss of $3.50 on every cup of lemonade he sells. The next ten lemonade stands open in quick succession, and the losses being to mount. The entrepreneur tells the kid that the problem is that they are not scaling fast enough, that they need to open more lemonade stands.

The entrepreneur and his advisors realize the constraint in opening stores faster is real estate, so he tells the kid they are going to need to secure long-term leases on property to ensure they have the best locations. The kid says he doesn’t know what this means, but now he is on the cover of magazines and featured in new stories as the lemonade wunderkind. Caught up in the hype of his success and his lemonade, he agrees to the long term leases.

The marketing budget is to property leases what matches are to a flame thrower. Soon, the kid and his advisor need another round of funding. They’re still losing money on every cup of lemonade, but their revenue is doubling every six months. As they are doing their second round of investments, one investor suggests that losing millions of dollars each year and being saddled with debt commitments that exceed their revenue by 3,700% each year might not be sustainable. The entrepreneur and his advisors quickly share a slide that shows the growth and the future profitability of the company. Money pours in.

The End Game

The kid says he is worried about what people are saying about the business. The entrepreneur tells him not to worry; he is getting a bonus, a new car, and a private jet. As the CEO, these are things he is entitled to as part of his role and his image. Besides, they are getting ready to take the company public, the company is valued at $4,000,000,000, even though it loses $400,000,000 a year and has a debt of $8,000,000,000.

A financial commentator makes the statement that kid was more profitable when he had a single lemonade stand. The kid rings the bell to start trading. The market responds to the opening by driving up the price of a share of the kid’s lemonade stand as institutional investors and people who want into the next big thing. The next day, the price drops by just over 50% as the short sellers start to attack the stock as being insanely over-valued.

If you can’t turn a profit, you are not running a good business, no matter the size. A large enterprise that loses money is not better than a smaller one that turns a profit. If a kid with a lemonade stand nets more money than you at the end of the year, the kid is a better entrepreneur. What you are trying to do is something different than entrepreneurship.

Filed under: Entrepreneurship

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