Startup Margin of Safety: When Value Investing Meets Entrepreneurship

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What if it doesn't work? That is the question that entrepreneurs must always be asking themselves. Starting a company is not about taking an idea and ramming it down the throats of consumers – it's about dancing with them. It's about setting a stake in the ground and letting your customers help you while you move it around to find that perfect spot. And when you have found it, that's where you plant the seed that grows into something great.

You know that your business model will change. You know that your product or service will change. You know that lots of things will change. So, in the early days, you always have to ask yourself what happens if it doesn't work.

In my retirement account, I own six stocks. Yes. Six. That's all. If I had a financial planner that person would probably think I am nuts. But I am a dedicated value investor, and I let cash pile up in my account until I find a really good deal.

The #1 rule of value investing is margin of safety. Why? Humans make many many errors, so if I find a stock selling at 10% below intrinsic value, I don't buy it. I may be off by 10%, or more. I try to find stocks that, even if my assumptions and calculations are off by 20%, the stock is still undervalued. That's my margin of safety. It's my room for error. It's my backup plan.

Value investing has influenced my entrepreneurial style. In particular, I like to think about startups with the idea of margin of safety in mind. That's why I always ask "what if it doesn't work?" I like to have a backup plan… or two. Startups have to be flexible and adaptable because there are always changes. Blind allegiance to an idea has led too many companies to the dustbin – companies that had a valuable offering but didn't structure a business model around the right value.

For a non-web business, margin of safety is usually a little easier to find. There are multiple ways to package and sell various products and services, and there are multiple points to insert yourself along the value chain.* For a web business, it's much more difficult because the number of available business models is more limited.

Andrew Carnegie once said "Concentrate; put all your eggs in one basket, and watch that basket." It's excellent advice, but risky if you don't have a margin of safety.

So as you go out and look for new opportunities, keep your margin of safety in mind. Ask yourself what you can do with your assets if the initial business model fails. Remember your own fallibility, but don't use that as a reason not to pursue your ideas. Use it as a reason to wait on the right idea – the one with a margin of safety.

*one good strategy for entrepreneurs is to take multiple parts of the value chain and offer them together for convenience