Israeli Ventures

BME Capital Management


Auditing a Technology-Based "Start-up"

Written By Dr. Gideon Tolkowsky




The Need for an Audit

Technology Start Up
The unfolding of business entrepreneurship is a process that combines strategy and opportunism. On one hand, the budding venture has, or should have, a vision and a well-defined strategy for pursuing it – which are normally embedded in its business plan. On the other hand, reality continuously poses some opportunities and annihilates other, thus demanding the business to constantly adapt. The latter, opportunistic force of nature is particularly potent in the case of start up companies, for 'positive' as well as 'negative' reasons. Positively, a start up is nimble and can easily change course in response to opportunities that come its way. Negatively, a start up is short in resources and lacks the staying power to test the validity of an existing plan for long, in the absence of supportive results. Consequently, the management of a start up is constantly in the midst of a tug-of-war between two conflicting forces: The desire and need to tenaciously sink its teeth in a goal and not let go, in spite of discouraging 'noise'; and the desire and need to adapt and nimbly exploit new opportunities. This 'tug-of-war' pronouncedly necessitates to, every once in a while, audit the budding venture's business plan and operations. The purpose would be to question the original plan and re-validate it or, alternatively, modify it; and to assess the coherence between plan and deeds. The need to audit is amplified by ever new challenges that the company faces as a result of its own growth, some of which may have not been adequately addressed in its original plan – be it for lack of experience or for circumstantial changes that have taken place since then. The purpose of this document is to propose a methodology for such audit.



The Core Business

Here, the basic question is: What business is the company in? Surprisingly, numerous technology-based start ups fail to pose this admittedly trivial question to themselves. For instance, if a company develops and sells an implantable insulin pump for diabetic patients, is it in the business of implantable drug delivery pumps? Or, implantable medical devices in general? Or, insulin pumps in general? Or, in the business of therapeutic devices for diabetics? Or, in the business of high-reliability, extended-operation, miniaturized pumps for medical and other applications? What business is the company in? Explicit posing of this question very often meets management's apprehension at the very question, alongside pronounced uncertainty in answering it. Notably, if the answer to this basic question is longer than one sentence, it probably reflects lack of clarity in the mind of management. The question of 'what business are we in?' must have a short answer, or else be admitted to presently have no answer at all. It is surprising how common it is to find start up companies that have no answer to this question, or have an answer that is not a result of well-thought-out weighing of several possible options. Lack of understanding of 'what business are we in?' is a common cause of failure among start up companies. They often end up spreading their resources too thin, and shooting in too many directions, only to discover – too late – that they have been far too myopic in defining their business.



 The Market

Which market is the company pursuing? This is a neighboring question to the previous one, but far from identical. To use the same, insulin pump example – one can be in the business of insulin pumps and address the hospital market, home-care market, private clinic market, etc. Obviously, the same distinction can be made regarding low-end versus high-end markets, or different geographical markets, or other criteria. The company must decide which market it is after, as this decision obviously has profound implications on all facets of its life.




  Intellectual Property 

Intellectual Property
Often, technology start ups tend to stick IP flags in the ground shortly after they begin operations, in order to establish safe passage through hostile competitive territory. Yet, with time, these flags (e.g., patents) become expensive to maintain, and consume a growing portion of the venture's very limited resources. It is then time to take a pause and evaluate the IP estate, namely: Which patents, or other IP assets, are really in the company's critical path? Which are no more than nice to have? And which have been filed/developed merely to satisfy the development team's everlasting craving for innovation and professional recognition? Similarly, re-evaluation of the business and the market the company is in may result in a new understanding of the desirable IP estate and critical path. Product Development Engineers often tend to use the term 'R&D' instead of 'product development'. This reflects their natural pursuit of R&D-ing as a goal by itself; which it is not, in a business environment. One purpose of auditing product development is to weed out R&D that is not in the critical path to market, and to ensure that all product development resources are indeed allocated to product development as such. Another purpose would be to define cut-off points for product development, beyond which the development should stop and sales should begin. Engineers always seek to improve their product. Yet, clearly, further technical improvement often has negative commercial added-value, be it due to delay in product introduction to market, or rise in production cost, over-complexity of operation, etc. And, obviously, an over Property extended development effort results in waste of precious resources, which is typically discovered and recognized by management too late. Engineers are very good at vehemently explaining why this or that additional product functionality is absolutely critical... and they are also good at being personally offended when forbidden to develop this or that additional functionality.


Marketing

A common error among technology-based startups is that they do little to no marketing until the product is (presumably) ready to be sold. Marketing, of course, should be carried out in parallel to product development and, in fact, should precede product development. One purpose of auditing a startup's marketing efforts is to ensure adequate balance in resource allocation between product development and marketing, in the face of the natural inclination of technology-oriented entrepreneurs to allocate too much to the former, at the expense of the latter.


Human Resources

Budding, resource strapped ventures tend to hire people who are fit to do their jobs under the company's current modus-operandi, instead of people who have the qualifications to take the company to its next phase, and the one after. This erroneous tendency often stems from hesitance to pay 'higher than absolutely necessary' salaries, as well as from an (understandable) blindness of inexperienced entrepreneurs to the full scope of challenges that await them around the corner. Auditing human resources may be used to enlighten management as to the need to hire employees that are seemingly over-qualified for the current modus-operandi but critical to the next stage, and beyond. In the same vein, the auditing process should be used to encourage management to grow out of its (typical) inclination to invest in high-caliber product developers and settle for mediocre marketing personnel.


Finance

Finance
Entrepreneurs always tend to under-estimate their future financial needs. One archetypal reason is that they are inclined to grossly under-budget marketing. Another reason would be over-optimism in product development timetable, while not taking into account Thomas Edison's statement that no machine works voluntarily; you have to make the darn thing work. A financial audit would carefully examine future financial needs. It ought to do so by posing tough questions to all senior managers in the company – CEO and VP level – with the aim of unearthing under-budgeting of, and unbalanced budgeting between company functions. Another purpose of a financial audit would be to discourage management from gearing up spending in the face of 'extra-early', or 'wishful thinking' signs of success; as well as to encourage it to cut down spending – more and sooner than it is inclined to – in the face of alarming signals from the marketplace.


Conclusion

While periodic, company-wide audit is desirable for any company, of any size and in any line of business, the need is particularly pronounced in technology-based start ups, for the following reasons: - Management typically consists of engineers who have little to no business experience and have not gone through the start up cycle before. - Technology markets are characterized by a high degree of uncertainly, which is all the more demanding on management's business skills. The burden of initiating a company audit is on the board of directors. The board may conduct the audit itself, and/or utilize external resources to do so.