Approximately 500,000 new businesses debut every year in the USA, according to the Small Business Administration. One of the challenges of starting such a venture is the difficulty to obtain financing. If you weren’t lucky enough to get an angel investor, and have decided to pour in your own savings, tread carefully. The world of start-up investing is markedly different from IPO or franchise investments. As far as return on your investment (ROI) is concerned, a reasonable expectation can help you avoid taking on too much risk. Therefore, it is important to learn about Startup ROI basics and how to calculate them before you jump on-board.
First of all, as a thumb rule, startups need to pump in all the cash they can get, and therefore whatever income they generate is usually absorbed back into the business, at least through the nascent phase. As a result, returns might not be high for at least three to five years.
Finite Business Life-cycle
Secondly, you cannot assume that the business will last forever. For instance, a local salon may have a few good years before starting to lose its clientele to another competitor, ultimately going out of business. Moreover, in all probability, most businesses are unlikely to generate a fixed amount of profit every year. While innovative players are likely to grow their profits year after year, the mediocre might see the profits decline and eventually close down.
Experts recommend the ‘cash flow method’ for calculating business returns. By using a spreadsheet, such as Microsoft Excel or Google docs, you can easily calculate the total amount invested, the total money back and the net profit over a period of, say, 10 years. And then by using the Excel’s ‘Internal Rate of Return’ (IRR) function, you can easily figure out an annual return number.
Imagine a situation, in which an entrepreneur puts in $400k with the hope of getting back $100k every year. He is thus aiming at a 25 percent ROI. However, the situation may be such that after making the $100k return for four consecutive years the business starts declining and eventually shuts down in its seventh year. In such a case, the ROI is 14 percent, which although a reasonably good performance for a local venture, is not the expected 25 percent.
In the real world, it is next to impossible to calculate expected Startup ROI with high degrees of accuracy. One of the main reasons startups fail is because they pursue unrealistic ROI goals. Set a reasonable startup ROI target, and work toward it. If you are ready to take the plunge in this high-risk yet rewarding territory, we can draw out a technology roadmap for you, enabling you to leverage the right start-up tools and technologies for potentially higher returns. Contact us here.