By Cliff Ennico
“I am an inventor who just got a U.S. patent for a wonderful new mechanical device that will revolutionize a particular industry.
“I am in the process of forming a company with three partners to manufacture and sell this device. My first partner has a manufacturing company that is capable of producing up to 1,000 units a year. My second partner is a financial expert who has arranged a line of credit against our accounts receivable. My third partner is a retired local entrepreneur who is helping us put together our business plan and who will be approaching industry trade associations to get the word out about our device.
“We are all very excited about this device because a number of states have passed laws requiring companies in this industry to use a device like ours, and we have a patent on this technology which will limit competition. If we do our marketing right, we may end up owning this market.
“What are some of the issues we will need to deal with in putting together our business plan?”
You have a lot to think about, that’s for sure. Here are some things I’m pretty sure you haven’t thought about:
The Target Customer. Are we talking about large or small customers here?
If you target large customers, there’s a chance they will need to order a large quantity of units for delivery in a short period of time, which may overwhelm your manufacturer’s abilities to deliver. They are also likely to demand extensive customization of the product to suit their existing equipment, which will add to your production costs and create a situation in which no two customers receive exactly the same product.
If you target small customers, there’s a chance they will not be able to afford your product because their profit margins are extremely tight.
Manufacturing Cost. I assume your manufacturing partner is located somewhere in the United States. If I’m right about that, there’s a good chance his cost structure will be too expensive to give you a generous profit on each unit sold.
Although I’m as patriotic as the next person, I think you should consider manufacturing somewhere in Asia (India, Malaysia and Vietnam are popular choices now given the political tensions with China). Keep your unit production costs as low as possible. That way you will make a healthy profit whether you are selling to large or small customers.
Pricing Structure. I don’t know what your manufacturing costs will be, but if you are not charging a hefty price for this device and earning at least a 100 percent to 200 percent gross margin on each unit sold, you will not make much money with a production run of only 1,000 units each year.
Give some thought to what your market will bear in terms of price. For example, if it costs you more than $5,000 to make each unit, it isn’t likely that a smallbusiness customer will pay $10,000 to $15,000 for each device. This will limit your market to large companies.
Competition. Just because you have a patent on your device doesn’t mean you have the whole market to yourself. If your patent is weak, it may be easy for competitors to copy your technology without legal liability. Even if your patent is a strong one, there may be other, more cost-effective ways for your customers to comply with the new laws. Whenever laws change requiring companies to invest in equipment, there’s usually a “gold rush” of suppliers looking to fulfill that need in different ways. Make sure you’ve got the best, and cheapest, mousetrap available.
Financing. The financing arrangement you describe is called “factoring” — a company (called a “factor”) purchases your accounts receivable at a discount to the invoice price, and then you pay the full invoice amount to the factor when you collect. This is often a very expensive way to finance your operations, and you should look at cheaper alternatives.
Your Management Team. The retired entrepreneur worries me a bit. While many senior citizens are extremely active and energetic, there’s a better-than-average chance that this person will be forced to reduce his demanding role or retire from the company due to death or illness in the next few years. I would spend a little time grooming a successor for this individual. Also, since you will have to buy back his shares in the company when he dies, becomes disabled or retires, don’t give him so many shares that it will become prohibitively expensive to do so.
Insurance. You should budget for a products liability insurance policy to protect you if your device is defective. Also, give some thought to who will install and service your product. You can hire your own service personnel, or create a certification program by which local people can install and service your device as authorized technicians. Your insurance company will prefer the latter, as that way, you are covered by the technician’s insurance if he makes a mistake.
Cliff Ennico (email@example.com) is a syndicated columnist, author and former host of the PBS television series “Money Hunt.”
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