Mini-Review: Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and the Government Bailout Will Make Things Worse


Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas E. Woods Jr.

My rating: 5 of 5 stars
Meltdown is a evidence-based, academically credible, and brutally honest analysis of the causes and effects of economic depression faced in the United States since the early 1900’s. Thomas Woods’ almost adversarial opinion of the Federal Reserve is approached via many different approaches and data sources, as is his affinity of Austrian business cycle theory. (As opposed to Keynesian economics primarily seen in the U.S.)

For those with interest in macroeconomic theory or the effects of government intervention on both business and individual finance, this is absolutely required reading. Those with politically libertarian leanings will also find many of the facts presented within outright shocking. I personally finished the electronic version of this book with over 10 pages of highlights, and plan to continue following Woods’ work.

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10 Joys Of Small Business Ownership

Don’t fret about those woes! For on a daily basis…

  1. You are building something greater than the sum of its parts.
  2. You set the mission, vision and values.
  3. You define the right people, right roles, and right rules.
  4. You will push constantly to explore and learn to think outside your comfort zone.
  5. You will often fall, but consistently stand up stronger… usually.
  6. You will grow leaps and bounds professionally and personally.
  7. You will come to understand the wisdom of those you admire, and fear.
  8. You are pursuing your dreams and will pity those that lack the courage to pursue theirs.
  9. You have no limit to your possible successes.
  10. You are the driver of your destiny.

I’d also like to emphasise that none of these items are directly focusued on the immense financial wealth of which we all hope. Over time wealth may or may not come, but the common factor amongst all great entrepreneurs is the primary importance of personal satisfaction regardless of monetary riches. At times–and during all stages of business–progress can require a certain amount of financial masochism and sacrifice, yes, but always should you be proud of what you’ve done, where you’re headed, and excited for the treasures of the next day.

The Financial State of Arizona

moneyThe Arizona Joint Legistlative Budget Committee (JLBC) released two documents yesterday quantifying the effects of U.S. economic fear, uncertainty and doubt as it applies to Arizona’s 2009 budget, and proposals for 2010. The big question on U.S. minds is, “How will all this affect my business?” By most accounts the answer is not positive.

The JLBC’s February 12, 2009 budget update puts “January revenues 21.5%…below [fiscal year] 2008”, for a cumulative 2-year decline of 35.9%. “January results [are] significantly worse than expected”, says slide 4 of the report. These numbers directly translate to additional lump-sum budget cuts for state-funded programs, including the Arizona University System.

Layoffs in the private sector worsen the situation via a direct reduction in state sales and employment taxes. In a 2010 appropriations hearing presentation also released yesterday, the committee discussed specific cuts to a page-long list of Arizona institutions. A 2010 option for reducing the Arizona University System budget calls for a $160.6 million lump-sum reduction. “ABOR and university system received a combined $141.5 million lump sum reduction [in 2009].” Such changes would affect Arizona’s Arizona State University, University of Arizona and Northern Arizona University despite higher projected enrollment numbers and tuition increases across the board. Arizona State leads in projected enrollment increases at 4% in 2010, with 15% at the East campus. Arizona University System tuition prices have increase an average of 8.5% annually since 2004.

The effect? All employees and families of the state of Arizona are nervous to find out, as “[c]urrent forecasts can indicate the direction of the economy, not its precise landing point”, to quote the 2009 update report. The nightly news will likely continue to cover layoffs, salary cuts and sob stories for Arizona not-for-profits for the foreseeable future, and it seems unlikely that a “quick fix” will restore budgets to previous levels as existing layoffs and budget decisions cannot be quickly recovered.

Please tell me I’m wrong.

The Three Types of Start-Ups

At OpenRain Elite Web Software we’ve seen all the popular combinations of startup business models when evaluating new projects. Here is a breakdown of the three most common startup models based on financial structure, the pros and cons of each, and recommendations on which one to choose for your new venture.

 

1) The Pop-Start

The pop-start–short for “popular startup”–is the stereotypical venture capital (VC) or Angel backed venture wherein an initial product prototype is created with a small angel fund, pitched to investors once (barely) operational, and subsequently funded for $1M+ in a second, third etc. round to fund growth to a profitable status. As each round is collected, additional personnel are generally hired immediately to kick off additional production development in a (hopefully correct) high-velocity direction.

Pros

  • Should you raise enough in your initial rounds and find the right people, you’ll be able to keep the company operational in the early growth stages without incessant worry on keeping positive cash flow, which, depending on the idea, may not be possible.
  • Fast growth once the big investment dollars roll in.
  • A minimum of personal risk since only the initial angel round will likely come from close ties. 

Cons

  • Tons of investor pitches and marketing/sales-speak on vaporware which will drive technical people insane.
  • Legal issues from the get-go. Expect difficult negotiations with second round investors and costly legal fees.
  • You’ll have to put up cash for airfare, lodging, marketing materials, legal fees etc. up front for possibly dozens of remote meetings. The costs add up fast.
  • Large amounts of constant pressure from investors.

This is for you if…

  • Your idea requires a substantial capital investment to get off the ground, such as $100K in federal licensing costs or $500K in manufacturing equipment for a first line of production product. You legitimately need this funding to get off the ground, and the amount is too large to put up yourself.
  • Your exit strategy is getting bought out by Google for $100B.
  • You can afford the risk of working on this full time, with little (or no) compensation up front and no gaurantees on a second round of funding.

 

2) The Weekend Warrior

The proliferation of online services for company creation has allowed many dreamers to create legitimate legal business shells in free time for hundreds of dollars. The weekend warrior start-ups are those who believe in the idea, but cannot financially afford to quit day jobs.

Pros

  • Low risk. If the company fails, you still have your day job.
  • Low cost. You still have the income from your day job, so eating small operational costs should be easy. If you’re supporting a large family on a single income, this may be your best option.

Cons

  • Making progress is painfully slow since it’s an “in my spare time” project.
  • People will not take your business as seriously since you are not committing your livelihood to it.
  • The logistics of getting things done off-hours can be challenging, such as finding the time for calls during business hours without interfering with your day job.  

This is for you if…

  • You can only commit yourself to working nights and weekends.
  • You cannot accept large financial risk.
  • You do not require large capital investments to reach financially sustainable operation.
  • You can accept the fact that progress and growth will be slow.

 

3) The Self Serve

Self Serve businesses are full-time owner operated organizations which grow based on their own performance, rather than external investment. They are self-funded, full-time ventures which put the responsibility of success squarely on the owner(s) since there is often no formal governing board. OpenRain’s web development business started this way, and continues to be entirely self funded.

Pros

  • No pressure from investors.
  • Full-time personal investment gives you time to put operations in order.
  • Will be taken seriously by potential clients/customers.

Cons

  • Self-funded. This can be mitigated by limiting personal credit exposure, but there’s no getting around the fact that initial operating costs will need to come out-of-pocket, and losses may personally bite you regardless of the precautions you take.
  • Personal pressure to constantly generate income since your personal income will be determined by the performance of the company.

This is for you if…

  • External funding is not appropriate or necessary for your idea.
  • You (and you business partners) are comfortable operating the entirety of a business amongst yourselves, our are able to invest in quality people to fill in the holes as soon as possible. Technical work, finances, marketing, sales, human resources, operations and 8000 other miscellaneous tasks will crop up needing someone’s attention. And that someone is you.

Sustainable Living

One purpose of my visit to New Mexico last weekend was to see what a self-sustaining single-family habitat in the Southwestern United States would.. or at least could.. look like. Several observations of which those of the region should already be keenly aware…

  • We use entirely too much water. Luxuries such as golf courses in 110 degree (Fahrenheit) heat consume an absurd amount of resources. The Governator officially declared California to be in a drought earlier this year, and Arizona… well… it’s a desert. Maybe we should lay off on the palm trees and grass, hmm? Fighting this hard against the Earth’s ecological tendencies for the sake of luxury is bound to produce the highly inefficient modes of living to which we’ve become accustomed.
  • Solar water heaters and photovoltaic collectors will be huge. Output effecientcy levels are increasing, they are approaching blue-colar affordability due to technological improvements and rebate programs, and fall in line with the ideal of consuming local resources.
  • We eat poorly, and also consume a tremendous volume of costly non-native food. Foods simply lend themselves better to certain regions and we need to be more explorative of regional food options.
  • Gas sucks. We all know it so I won’t go into it 🙁

This is a snapshot of my own macro-economic sustainability opinions, which change rapidly with the times and fall somewhere between ecological conservatism and hard-nosed financial feasibility.

Sustainable American living activists need to focus on three primary goals: (1) significant cultural change in all socioecominic classes, (2) improving sustainability technologies to produce incentives for #1, and (3) figuring out how to reduce the human footprint in economic context to make #1 and #2 plausible. Specific ideas I would like to see pursued..

  1. Focus aggrocultural subsidies away from small rural farms and onto medium-sized, community-run suburban farming initiatives which share equipment and resources. The notion of the independent, middle-American mom ‘n’ pop farm in Smallville will always be romantic, but you cannot ignore the economies of scale. We need to look at the production possibilities curve of farm size vs. output, factor in waste of transportation costs and pesticidal effects, and find a compromise which will allow significantly-sized local farms to produce native or near-native vegitation within a 20-mile radius of urban areas, while not requiring the populous to return to an aggregarian state or douse everything in chemicals. (Not that chemicals are inherently bad: just unnecessary and wasteful in many cases.)
  2. Incentivize large-scale adoption of solar water heaters by artificially raising the cost of traditional indoor tank water heaters and using the difference for solar subsidies. It’s ridiculous to spend energy heating a tank full of water in an empty air conditioned home when you could just put a damn tank outside in the sun for 10 minutes and have magnitudes more hot water for free. Sense make that does.
  3. Incentivize large-scale adoption of household solar arrays by using artificial energy costs to subsidize payments to households selling energy back to the grid via bi-directional meters.
  4. Plausible sustainability change requires working with the existing system. You can blame The Man all you want, but the world is not going to abruptly adopt better principles overnight. Changes need to come gradually–in a way people can slowly accept and adapt to–in incentives facilitated by the government, demand from the people, and interest of the industry.
  5. Ceteris paribus, chose local products and services to keep money in the region and reduce waste.
  6. Recycling costs cities too much. Trashing stuff costs citizens too little. Residents should force the issue with their municipality and compost the sanitary organic waste.
  7. The food industry needs to stop wrapping every last item in a silly little shrink-wrapped cardboard box and sell everything OEM-hard-drive-style. That is, make one box for the display, but sell the product in an extremely minimalist biodegradable packaging. This will be (1) easier on consumers since there’s less trash to deal with, (2) better for the environment, and (3) cheaper for everyone. You can put as many bright colors and wacky content on the display as you want, as well as print on the biodegradable packaging.

Financial Primer For Self-Funded Startups, Part 1

You’ve considered starting your own business–ExampleTech–and have pondered the initial investment, opportunity costs and personal risks. Here’s a brief financial primer on what you need to understand before taking the big leap, and key issues you’ll need to grok for after ExampleTech begins operations.

My big leap is OpenRain, for which I manage financial planning and performance amongst a bagillion other things, so I frequently receive questions on the financial aspects of forming and operating a company. This failure-based example assumes ExampleTech uses accrual accounting as opposed to cash-basis accounting.

Understanding Your Initial Investment 

When you start the company books, the first type of financial statement you’ll need to understand is the balance sheet. The balance sheet is a snapshot of the company’s finances at a particular moment in time, and aggregates all the company accounts into one single formula which always remains true..

Assets = Liabilities + Equity 

Once you invest in the company, that money becomes a company asset, and is no longer yours. You are only given claim to this money by an equivalent amount of equity. The company is a living, breathing entity, and is considered to a be a distinct taxable entity by the Internal Revenue Service (IRS) if you have formed an LLC (ExampleTech, LLC), S or C corporation (ExampleTech, Inc.). Even if you choose to do business as a sole proprietor (John Doe “doing business as” ExampleTech), which is not a distinct taxable entity, you should mentally consider your initial personal investment gone forever! Don’t event think about mixing personal accounts with business. ExampleTech accounts belong to ExampleTech and are maintained separately from your personal finances. Period.  It’s company money now, not yours, so get over it. You’ve invested $10K in ExampleTech to get it off the ground.

$10K Assets (cash) = $0K Liabilities + $10K Equity (ownership)

Since, the company has purchased $6K of equipment using $1K in cash and $5K on a credit card with an $8K limit (this will be important later). The balance sheet now looks like this..

$15K Assets ($9K cash + $6K equipment) = $5K Liabilities (credit card) + $10K Equity (ownership)

Where did these numbers come from? We have $15K in assets because we started with $10K in raw cash, spent $1K of it and received $6K of equipment in return. The difference is on the credit card as a $5K liability. Some interesting observations…

  • You (John Doe) still have $10K of ownership equity even though the company only has $9K of cash in the bank. It would not be possible to cash out 100% of your initial investment without liquidating (converting to cash, a.k.a. selling) the equipment.
  • If you bought the equipment out of warrantee and it breaks on day 1, ExampleTech will be down the $6K in equipment assets but would still need to pay off the $5K credit card liabiltity. The loss would come out of cash and leave the balance sheet looking like this: $4K Assets (cash) = $0K Liabilites + $4K Equity (ownership). Oops. On the plus side, you would realize what the term “equity-funded venture” means.
  • All book equity is held directly by you, the owner. This is a tremendous advantage over private equity venture capital (VC)-based start-ups, because you are the only person who cares about the eventual return on equity (ROE) investment. By using short-term debt instead of long-term equity, your creditors couldn’t care less about ROE as long as you’re making payments on time, so ExampleTech’s decisions remain yours to make.

ExampleTech is now ready to operate, and opens its doors with a slick new job for ClientComm.

Understanding Cash Flow & Income

After 1 month of operation, ExampleTech has performed and delivered $8K of services to ClientComm. Only $3K in credit card expenditures was need to complete the job. ClientComm has been invoiced and “the check is in the mail”, which should arrive and clear within 2 weeks. ExampleTech is now moving on to a much bigger project for MegaComm. Here’s your current balance sheet..

$23K Assets ($6K equipment + $9K cash + $8K accounts receivable)
=
$8K Liabilities (credit card: $5K initial equipment + $3K ClientComm job)
+
$15K Equity (ownership)

Note that you’ve increase your equity 50%, which is now $15K up from the $10K you started with. Woohoo! Here’s the ExampleTech income statement for the previous month..

Income
ClientComm: $8K

Expenses
Office equipment: $5K
ClientComm production expenses: $3K

Net income for period (last month): $8K (income) – $8K (expenses) = $0K

So in your first month you not only purchased reusable office equipment, but broke even! (That’s pretty awesome, go grab a beer!) Armed with $23K in assets and a renewed sense of self-confidence, you’ve signed MegaComm to a new deal worth $40K which will only cost $10K to deliver. You immediately start MegaComm production by writing a check for the $10K in materials and production costs.

..And you’re about to realize how you just screwed up.

To your surprise, you receive a call several days later that your check has bounced due to “insufficient funds”. What you forgot to consider is perhaps the most important aspect of financial management for the start-up phase of a self-funded new business: cash flow. Your cash flow statement for last month defines the raw dollars going in and out of ExampleTech during the given period, and looks something like this..

Cash at period start: $10K
Equipment investment: $1K
Net cash flow: -$1K
Cash at period end: $9K

Remember the $6K of equipment you purchased before you opened your doors? It’s only represented as $1K on the cash flow statement because $5K was put on credit, and creditors have not required ExtremeTech to pay out. The $3K shelled out for ClientComm production isn’t represented here at all because you chose to finance the entire amount with credit.
Thus, your bank only has $9K of raw cash even though your balance sheet showed you at $23K of assets, which also includes accounts receivable: money that has been counted as income on your income statement but has not yet been collected. Accounts receivable did not contribute to your cash flow statement since no money actually exchanged hands during the period, even though the job is completed! The cash flow statement will not reflect the ClientComm job until you..
  1. Cash the ClientComm check (which you really need), or
  2. Pay the credit card bill.
ExampleTech was cash flow negative last month despite having positive income, a non-intuitive but not infrequent business occurrence. Being cash flow negative isn’t in-and-of-itself a problem, but puts you in a short-term pickle because you don’t physically have enough cash for the materials, and your credit is already maxed out at $8K. You’re looking your next big client square in the face but don’t yet have the assets to pull it off, and you’ll be scrambling for the extra working capital to push forward rather than getting actual work done.

In Summary

Self-funding your company comes with the perks of directional freedom, less time pressure and fewer legal complications at the cost of pressure to stay cash flow positive from day 1. The self-funded company cannot grow–let alone survive–without an early, consistent trend of positive cash flow as we’ve just demonstrated. ExampleTech won’t have much wiggle room for strategic ventures and operational improvements until these numbers provide an ample financial buffer.

Next

We’ve glossed over quite a few important details such as taxes, loans, interest, accounts payable and, of course, paying yourself. So if you’ve found this information helpful and would like to see more content on the practical financial aspects of start-ups, let me know you’d like a Part 2 and the specific topics you’d like to know about!