Welcome to Project Start-Up, a six-part series on how a team of entrepreneurs take their bright idea from the pilot stage to production – from building a winning business plan and securing financing to hiring senior execs and developing a marketing plan. Along the way, our experts will weigh in on what they’re doing right, what they’re doing wrong and what they should do next.
BROADCASTING SCHEDULE
| Episode 06: Managing Cash Flow/Invoicing | Now Playing |
| Episode 05: Manufacturing and Operations | Now Playing |
| Episode 04: Sales and Marketing | Now Playing |
| Episode 03: Human Resources | Now Playing |
| Episode 02: Raising Money | Now Playing |
| Episode 01: The Business Plan | Now Playing |
It may seem unlucky that Innovequity’s founders Ben Bertrand and Mark Holtom launched their company in an economic climate that can best be compared to a credit ice age. But their timing could have been much worse. Their overhead costs remain very low, reducing the burden on the company’s cash flow.
Cash flow is often called a company’s lifeblood, and for good reason: managed poorly, it can bring down the healthiest business. For Bertrand and Holtom, the cash flow fun won’t really start until they sell the first Geometric Construction Unit. They plan to ask the customer to pay up front for the machine and overhead costs; their profits will come from royalties. “We will take a percentage of the savings the tool gives the home builder,” Holtom says. “Our actual profit will come on a per-square-foot charge.”
The arrangement makes the deal more palatable to homebuilders, but it also lengthens the amount of time the company must operate without a significant cash infusion. That calls for careful planning.
The Expert Panel
Our experts weigh in on Innovequity’s cash flow plan
Behind the Scenes
Innovequity’s CEO Mark Holtom on tightening their belts
Cash Flow Projections
A primer on long-term and short-term strategies
Links
Our roundup of useful links for start-ups from around the web
Money Zine
Money Zine calls cash flow “arguably the single most important indicator of a company’s financial well-being.” Its online primer guides you through creating a basic cash flow statement.
Small Business Notes
This resource for entrepreneurs has a good primer on cash flow, along with a worksheet, tips on how to make cash flow projections and how to improve cash flow.
Ca$hflow 101 Game
The Rich Dad, Poor Dad pundit explains his “Cash Flow Quadrant.”
Short term – weekly or monthly
Purpose:
- To determine short-term cash position.
- To plan the amount of cash that can be put in a short-term investment account (money markets for instance).
- To estimate working capital requirements.
Long term: Annually
Purpose:
- To show how much cash will be needed to run the business in the coming year.
- To determine where the cash will come from.
- To determine seasonal variations in cash flow.
- To estimate annual borrowing requirements, ability to make repayments.
- Supporting information for loan application.
Long term: Three to five years
Purpose:
- To support strategic planning.
- To determine equity needs.
- To estimate borrowing requirements.
- Supporting information for raising equity capital.
What is your current cash flow situation?
Mark Holtom: With the economic slowdown, investors took their chequebooks and ran. That pushed back our plans, because this is a company that needs investment. The government has helped, but navigating the municipal, provincial and federal grant proposal guidelines – and even knowing where to go and where to look – is a real skill. There are people whose full-time career is writing grant proposals. The more I learn about it, the more I understand the phrase, “Your network is your net worth.”
How are you managing in the meantime?
Ben and I have decided not to take salaries from the company to ensure there will be money there for “oopsy-daisies.” We know that things are going to happen; nothing goes according to plan.
How did you work out the business model?
We know that the original sale price of the machine will need to provide money for us to build the machine and cover our overhead cost. We will charge the cost of building the machine, plus 10 or 15 per cent. Our actual profit will come on the per-square-foot charge. We’re taking a percentage of the savings that the tool gives customers. If they’re realizing a $20-per-square-foot savings, we’re going to take $6.
Are you worried this will be tough to quantify?
Yes, people have told us: “Word of caution – with those cost savings models, it’s tough to quantify everything.” The customer is going to fight tooth and nail to say they aren’t saving much; we’re going to fight to say it is. But even at $6, we’re at less than a third of their savings, so our financial projections say we’ll be fine if we make less than that.
What will you do if people balk at royalties?
The Finning model says we’ll give you a lower price on the royalties, but we want a maintenance contract. We want to do something like that, balance it out between the two. That’s our plan. What the industry accepts – we’ll see. With the housing downturn, we also know we will have to have minimums in place, because if they’re not building, they’re not paying as much.
Johanna Hoffmann, managing principle, Oomph Group Inc., Toronto
On the Idea: They’re running lean and mean, and that’s key for cash flow. Their overhead expenses are not high at this point, and they also have a financial cushion that will carry them through 2010.
Red Flags: The whole thing swings on this machine. Innovequity’s managers acknowledge that the prototype may require adaption for each site. If it requires a significant redesign, they’re going to be eating their cushion of cash.
Next Steps: They need to continue to be conservative until the machine realizes the savings projected and clients see it operating in the field. Until then, they should really not spend any money beyond the core, which is getting it built, transported and installed on the site. Until the first client is thrilled and one builder after another is coming in the door, mouths dropping open and asking, “How can we buy one?” they should minimize every expense.
Bill Erichson, owner and educator, Pacific Training Innovations, Vancouver
On the Idea: The business model relies on a royalty-based system rather than a sale-of-product system. This means that Innovequity’s profits and cash receipts are deferred. They are effectively both the manufacturer and financier of the first two units.
Red Flags: There are two critical issues in any cash flow forecast for a business start-up: the starting cash position (capitalization) and the time it takes to become cash self-sufficient (burn time). Innovequity has serious problems on both accounts. The business model has stretched the burn time for this company to an extent that there is a greater need to finance this business.
Next Steps: Develop a monthly cash flow and carefully manage it. As royalties accrue, the company could sell this annuity for a lump sum to reduce debt and further develop the business. Remember, there are two ways to go broke in business. No profit is the slow, painful way; no cash flow is the fast, painful way.
Cindy Priebe, CMA, vice-president, corporate services, CMA Alberta, Calgary and Edmonton
On the Idea: The company appears to have conservative sales projections. Furthermore, they have considered the manufacturing warranty as well as the risk of downtime for their customer should the machine break down.
Red Flags: Although pro forma balance sheet and income statements are necessary, I’d recommend a cash flow statement, because entrepreneurs often underestimate the timing of cash flows. Innovequity may run short of cash, leading to an inability to fund future purchases, such as inventory to manage repairs. They should perform a sensitivity analysis to cash flows to project best and worst case scenarios, in case the cash they expect through sales or royalties for instance is not collected. The company acknowledges the potential for debate with the customer on cost savings. If a customer feels they do not realize the cost savings that translate into royalty payments, they may hold payments to negotiate a better rate.
Next Steps: The company should prepare a pro forma statement of cash flow along with a sensitivity analysis to determine the impact on cash flows if their estimates on collections or sales do not come to fruition.
When Innovequity’s founders, Ben Bertrand and Mark Holtom, built the GCU prototype, they had a dream arrangement: access to well-equipped manufacturing and research facilities at Northern Alberta Institute of Technology (NAIT). But with the first orders on the horizon, they need to decide how they’ll manufacture the GCUs on a larger scale – and they need to do it economically and efficiently, or watch their profits disappear. Oh, and there’s one more challenge: they don’t want to do it themselves.
“Obviously we know we’re handing away a portion of the profit to a manufacturer, but that’s part of life,” says Holtom. “We have to consider the capital cost for us, risk versus reward, and recognize that there is still profit.” That leaves Innovequity with an age-old debate: to sign a contract with a Canadian manufacturer willing to take on extra business or seek a bargain overseas.
The Expert Panel
Our panel of experts weigh in on whether Innovequity should outsource their operations to China or India and why they represent the future of manufacturing in Canada
Behind the Scenes
Don’t get into bed with wishy-washy investors! This and other hard lessons the Innovequity duo learned
Video: Pick Up Sticks 
A peek at how Innovequity’s Geometric Construction System works
Links
Our round-up of useful links for start-ups from around the web
Why not set up your own manufacturing shop?
If we get large enough we may do that, but at a maximum, we’re seeing 30 [Geometric Construction Systems or GCUs] in Western Canada. So we’re probably looking at someone building a maximum of six to 10 systems a year. If the market pulls us somewhere else and our volume rises, we’ll look at it again.
What are your manufacturing requirements?
Quite a few of the components are off the shelf. For example, our nail guns can come from any hardware store like Home Depot. We did that on purpose: if you have custom parts, when something breaks you have to make another custom part or stockpile those parts and keep an inventory. Anytime you can put that responsibility on someone else’s shoulders, the better. That said, the fabrication of the steel and the programming must be custom.
What is your first choice?
We want to stay Canadian. Currently we’ve been working with a company called Option Industries for the fabrication of steel components and McGregor & Davis Engineering on wiring the prototype, and sticking with them is a large possibility, but it’s not nailed out. Manitoba is our second choice, going overseas is third. Manitoba, through our research, is a manufacturing hub. They also have the distribution chain, even to the U.S. But then again, do companies there have the expertise? We also have to see if we can replace some customized components with off-the-shelf models; that will be a process in itself.
Why are you hesitant about overseas?
These GCUs will be going into factories. There may need to be customization for each machine in each facility, and even three in the same facility might need to be different. I think it will be difficult to provide that customization if the manufacturing is done overseas. I think our intellectual property being stolen is a larger issue, along with quality control.
What will your largest challenge be?
Finding maintenance people. The service piece is a large component. These machines will take a beating since they’re in a construction zone. We know we’ll have to keep our maintenance staff on payroll.
Business Development Bank of Canada
For everything from ratio calculators to figure out inventory flow to study guides on globalization for small businesses. Check out the production planning advice, too.
Entrepreneur’s Guide to Operations
Whether you need to track inventory or set up an invoicing system, this American guide is an equally useful primer for new Canadian entrepreneurs.
Canadian Manufacturers and Exporters
This national service has local chapters, including a branch in Alberta. Along with training and networking opportunities, a micro-site called Innovation Insights provides case studies on Canadian companies who have improved their ROI.
Duncan McNeill Centre for Innovation
A supportive environment for developing business ideas into profitable enterprises.
novaNait
Part of the Duncan McNeill Centre for Innovation, NovaNait assists with industry-relevant applied research projects.