This past weekend, my neighborhood hosted its annual “back to school” popsicle event where everyone gathers in a cul-de-sac to celebrate the kids starting a new school year. While the little ones run around with sticky fingers, the adults mingle and make smalltalk while pretending we’re not as excited about the popsicles as we actually are. In other words, it’s a nice way to ease into the hectic school season. In this case, however, it became work as I unexpectedly found myself having to give an impromptu lesson about the true costs of entrepreneurship.

I was chatting with a neighbor who’s a physician. We exchanged the usual pleasantries about the weather and the kids, but, before long, once my neighbor remembered I teach entrepreneurship, our conversation shifted to his idea for a new health tech startup.

It’s a concept he believes is a game-changing idea that leverages AI to deliver diagnostic services. I won’t share more than that in order to protect the confidentiality of our conversation. More importantly, within three minutes of talking to him, I knew the product didn’t even matter because of how he explained the business model. He told me the service would cost subscribers around $200 a month. “The best part,” he said with the enthusiasm of someone who’s clearly spent lots of time imagining the math, “is that it’ll only cost me about $20 a month to deliver the service thanks to AI. That’s a huge margin!”

I nodded as he spoke, but inside, my mind was running through a different kind of calculation — one I’ve seen countless entrepreneurs fail to make.

The Real Costs of Entrepreneurship

My neighbor’s excitement was understandable. Who wouldn’t be thrilled at the prospect of turning a $20 cost into $200 of revenue per customer? However, as any experienced entrepreneur knows, there’s a lot more to running a business than just the cost of goods sold.

I’ll break it down for you roughly the same way I broke it down for my neighbor.

When he was talking about his $20-per-customer cost, he was likely referring to the API fees associated with whatever AI tool he plans to use. That’s a direct cost, and sure, it’s an important number to know, but direct costs are just the tip of the iceberg.

What about customer acquisition costs (CAC)? After all, customers don’t magically appear once products are built. Whether it’s digital marketing, partnerships, sales teams, or even word-of-mouth campaigns, getting people to sign up for a $200 monthly subscription won’t be easy or cheap.

Then there’s customer support. Even with the best AI in the world, things will go wrong. Subscribers will have questions, technical issues will creep up, and, of course, even the best businesses get lots of complaints. This means my neighbor’s company will eventually need a support team — real people, not just chatbots — to handle the hundreds of issues he can’t even begin to imagine. As you’d expect, the people on that support team are going to want to be paid.

Speaking of paying employees, the costs of hiring people include a lot more than just salaries. To be a competitive employer he’s going to need to provide benefits ranging from a ping pong table in the office break room to 401k matching to fancy health insurance.

And health insurance isn’t even the only type of insurance he’ll have to fund. Since he’s trying to build a health tech startup, liability is a big concern. He’ll need things like professional liability insurance and cybersecurity insurance. Neither of those are cheap.

Then there’s the cost of compliance? Health tech is a heavily regulated industry. The company will have to navigate HIPAA regulations, data privacy laws, and medical device compliance, just to name a few. Each of these areas will require legal guidance, and we all know lawyers don’t work for free.

Office space, even in a remote-first world, still costs money. Maybe it’s not a physical office, but there’s software, tools, and infrastructure. There’s the accounting, payroll, HR — every part of building and sustaining a business has a cost associated with it.

And don’t forget about those office Christmas parties. They might sound trivial, but they’re part of the culture-building that’s essential for any company that wants to retain talent. Happy employees are productive employees, and keeping them happy often requires investments that don’t show up in the initial budget.

Sophisticated vs. Unsophisticated Entrepreneurs

As I listened to my neighbor share his startup idea, I found myself reflecting on the difference between sophisticated and unsophisticated entrepreneurs. Sophisticated entrepreneurs know that the real costs of running a business extend far beyond the direct costs of producing a product or delivering a service. They understand the hidden expenses — many of which are difficult to predict — that can eat away at those seemingly large margins.

But more than just understanding the costs, sophisticated entrepreneurs plan for them. They build financial models that account for customer acquisition, legal fees, support infrastructure, and all the other things that’ll ultimately cost the company money. They know a business isn’t just about making a product; it’s about building a sustainable operation.

In contrast, unsophisticated entrepreneurs get caught in the excitement of a big idea. They see the difference between direct costs and pricing and assume every sale will return a small fortune. But, when the unforeseen costs start piling up, they find themselves scrambling, often too late, to make the business work.

By the way, the lesson here isn’t just about understanding costs. It’s about understanding complexity. Building a business is complex. It’s messy. It’s not just about having a great idea or a low-cost product. It’s about managing thousands of different details, many of which have nothing to do with your core product but are essential to keeping the lights on.

Embracing the Complexity of Entrepreneurship

As my neighbor and I ended our conversation, I could see the excitement in his eyes beginning to fade. I felt a little guilty because, if I’m being honest, one of the best parts about entrepreneurship is imagining the wild successes.

But the more important lesson my neighbor needed to learn if he was going to be serious about his venture was a lesson about maturity. Sophisticated entrepreneurs understand that the excitement of a new idea needs to be balanced against the reality of execution. They know a business isn’t just an idea — it’s a system with many moving parts, all of which need to be managed, financed, and optimized. Those expenses get paid for by the margin between your cost and your revenue, which means the space between those two numbers is where the real work happens. It’s where businesses succeed or fail, and it’s where the difference between sophisticated and unsophisticated entrepreneurs becomes painfully clear.