As a serial entrepreneur, I learned a lot of lessons from things that didn’t work. These lessons later on shaped my ideas on what would be needed to build a successful startup company. When I became a VC, I realized that these same lessons could be applied to helping evaluate the many businesses that I was getting to see. Whilst the following criteria are by no means a guarantee of success, or the only criteria that you should think about, I do believe they can be very helpful.
So in no particular order, here is a list of six questions that I learned to ask to validate my own startup ideas, that now shape what I look for in an investment. I hope this list will help you validate your idea:
1. An extraordinary entrepreneur with unique insight
- Does the entrepreneur show the extraordinary drive, energy, passion, and commitment to take on the tough task of starting a company? And do they appear to have the ability to attract a first class team?
- Does the idea that you are working on come from an area that you know extremely well and where you have an unique insight?
- An entrepreneur working in an area where they have no knowledge or special insight rarely works.
- For B2B startups:
- Is there extreme pain being felt by an individual or group?
- Is that individual or group in a position to spend money to solve that pain?
- For B2C startups:
- Is there strong enough motivation for the consumer to really want to use your product/service?
- Market size: are there enough people with this pain/motivation to build a large business?
- Does this product/service adequately address the need (without introducing new problems in the process of adoption)?
- Is there long term sustainable differentiation and barriers to entry?
- The differentiation needs to be strong enough to beat any potential major competitors whose size, distribution, customer base, and credibility, would give them an immediate unfair advantage if they decided to compete, even with an inferior product.
4. Business Model
- Can you build a viable business model around the solution?
- Specifically most startups fail because it costs more to sell their product than they are able to make from the sale. So a big part of a viable business model is determining a cost effective way to sell the product. The other part of it is figuring out a great way to monetize each customer.
- For more details on this topic, see Business Models, and Why Startups Fail.
5. Management Team
- Do you have the beginnings of a great management team?
- It is well understood that a great management team plays a huge role in increasing the chances for success.
- A players attract other A players. B players attract C players. Therefore the starting team should ideally be all A players.
6. Capital Efficiency
- Can the company be built in a capital efficient way?
- With lower exit valuations, the one reliable way to ensure both the entrepreneur and VC will end up with a good return is to build the business using a small amount of capital.
Two of the most common issues that I encounter when hearing pitches from entrepreneurs stem from the same entrepreneurial trait: entrepreneurs are often by nature very passionate about their particular product or technology. In itself this is a good thing, but unfortunately that passion is often blinds them to some important issues:
- They don’t focus on how they are going to acquire customers in a cost effective way, as they believe that people will either beat a path to their door, or that their product will go viral as everyone will love it so much they will tell all their friends.
- They fail to look at whether the need their product aims to solve is important enough to get the customer to overcome inertia and purchase it.
I hate to admit it, but I have made both mistakes myself. In my fourth company Watermark Software, we introduced a document imaging product that was so cool that we got half a page coverage in the Sunday New York Times, and great reviews in all the leading publications. Even your grandmother would have thought the product was cool. However cool did not translate into purchase orders, and it took us another 18 months and two versions later to finally get the product focused on vertical customers in banking and insurance that processed lots of paper before our sales finally took off. This was a painful lesson that I won’t forget.
My hope is that other parts of this web site will help address the question of how to cost effectively acquire customers (see Building a Sales and Marketing Machine), and also help to think through how to balance the cost of acquiring customers with the ability to monetize those customers (see Business Models, and Why Startups Fail). I would love to help you avoid making the mistakes I made in the past.