Successful CEOs are always looking for new opportunities to invest, either in their own company or new start-ups. Are you planning on investing in a new venture? Or perhaps you are looking for someone to invest in a new venture you are starting.
If the answer is yes to either one of these questions, you need to make sure you understand the 8 major questions to ask before you write a check or be prepared to answer if you want an investor to write you a check.
• Do many feel it?
Is there objective analysis to validate the market size? I get very concerned when
I hear “It is a billion dollar potential market and if we get just 2% of this market….”
• Is it well understood?
What market research from objective sources supports this?
• Is it painful?
How painful and what is being done now to address the pain? Why does this address it better, and is it really worth it for someone to change?
• How are you solving the problem? Secret sauce? Technology? Service?
This is so important because answering this question will help you address the question regarding what happens after you launch. How will competition respond?
• How is the problem being solved now? What are the alternative solutions?
How many inventors invent, then look for a problem to solve with their invention. They have it backwards. They need to identify the problem or the pain, then invent solutions. A solution that is looking for a problem is a very tough sell.
• Why is the market ready now? If you invented a device that measures body fat with a smartphone app and keeps reminding you how fat you are, is the market ready for this now?
• Can the team create and execute the plan? If the CEO is a scientist that has never started a company and has worked with a Fortune 100 company with a big research budget, or worse yet, runs the research department at a university or non-profit, then they are not prepared to run a company. They do not recognize the challenges of cash forecasting and managing the burn rate. They will quite often run out of money a lot faster than someone that has done this before. If they are hiring FTEs and moving into beautiful office space, they are spending money on the wrong things.
• Do they understand the space? What successful hands-on experience do they have
in this market? If none, then is there is a plan to objectively validate the insights before investing in the market?
• Can they lead and inspire change? More importantly, have they defined what the corporate culture needs to be to drive their vision? Do they have a vision? Can they articulate it in less than two sentences? Is it realistic, is it understandable and is it motivational?
• Are they start-up ready? Can they handle setbacks and operational inefficiency?
One thing for certain is the plan on paper will hit bumps, brick walls and naysayers. Is there a passion to navigate the mind field? Have they been challenged in the past and how did they navigate through the challenge to achieve their goal? Anyone that can read can discuss how to get something done. The real question is have they done it? Can they demonstrate what they have done based on what they know?
• What is your competitive advantage? Can you unlevel the playing field?
What unfair advantage can I create so that my competitors will have a difficult time competing? “Know-how” is good for a short period of time. Count on others to figure it out. First to market is not a sustaining strategy. Patents, if you have the resources and intention to defend them, are good barriers to entry, but competitive cost, high quality, and excellent customer service are all givens and are not barriers to entry.
Regulatory hurdles can also be effective barriers to entry. Secret sauce as long as it is delivering real value and not perceived value can sustain the growth.
• Is your solution unique and defensible? Are there barriers to entry by copycats?
Google, Facebook and LinkedIn have virtually no viable competitors. What is the strategy to protect your market? Is it sustainable? If you are successful you can expect others to try to mimic your value proposition and take your customers.
• Who do you compete with? Directly? Indirectly?
What value do their customers receive and what will it take to demonstrate you have a better solution that will deliver a higher value?
• How does the landscape change after you launch?
Create a picture of what you company will look like in three years. Use your team of
investors to help draw the picture so you get buy-in. Then backfill to the present and identify all the changes you will have to manage to get to achieve your picture three years out. Read “Double Double” by Cameron Herold and apply his concepts, especially when it comes to creating a culture and hiring the right team.
• Who are the players? If you’re going up against an 800 pound gorilla that dominates the market and keeps moving the goal post, why will you compete and win some of their customers? Who is the decision maker and what influences their decision to change to what you are providing?
• What is the market size? Be very leery of pie in the sky numbers. Financials based on market size are seldom achieved or achievable.
• Who are the customers? How do you acquire them? What does a customer cost?
• What are the distribution challenges? Direct sales reps, ecommerce, independent agents, stocking distributors, strategic alliances are all options. What is your distribution strategy?
• Is the timing right? Think RIM. Are you a former Blackberry user who resisted changing to the “smartphone” but now have made the change? Blackberry’s new entry is very late to market and the goal post keeps being moved every few months. Where will the goal post be when you launch and can you move them?
• Do you need a branding strategy? Spending precious resources on branding needs to be well thought out. I created a brand with very little marketing resources. We did it through technology, service and solving a big problem. The brand became a generic reference like Xerox copy. Or “Google” it on Bing.
• What is the sales cycle? How long will it take to convert a customer? Can the time be shortened?
• How do you make money? Are your margins realistic?
• How do revenue and expenses scale? Have you done this before? Does your forecast make sense and can you modify it up or down as the business start to launch?
• How much cash do you need? Do you have a cash flow analysis? How much revenue will you need to stop burning cash? When will this happen?
• How much runway do you have? In other words, will your cash burn rate take you to the next milestone and can you get more cash to get you to the milestones beyond?
• What is the target revenue per FTE? At some point you need to have a CFO and you will need metrics to look objectively at you business model. Revenue per FTE is one of the metrics experienced CEOs and investors track.
• What do you need to take the risk? Technology? Team? Market? Customers? Revenue?
If you need to raise more cash in the future or want to sell your company, what will the next investor want to see to justify the investment? What does your ROI look like? Look at it from an investor’s perspective not a business owner’s perspective. Talk to seasoned successful investors and ask them what they would need to see before providing a second round of investment in your company.
• What key assumptions do you need to prove? Customer acquisition? Cost? Pricing? Timing?
• Who will acquire the company? Strategic partner? Competitors? New investors?
If your three-year picture is to be acquired, then this is important. If it isn’t, then don’t spend a lot of time on this. Strategic partners will approach you if they see a fit or opportunity. If you approach them first, the price goes down and you become weakened in your negotiations. If your three year picture is to be acquired, do things to get the attention of potential strategic investors.
• Why would someone else want it? Technology? Team? Revenue? Customers?
Don’t spend time on this unless you are an investor and want to get out in three years. If the picture goes beyond three years, is there an opportunity to get out with a reasonable ROI in future investment rounds?
• When do you exit? Early? Mature? Threat? Partners?
Three years is a good rule of thumb. If you can’t get out in three years, the risk becomes much greater.
Many investments are made based on relationships and intuitiveness. Before you invest, you need to understand and validate objective issues. Remember, most new companies fail. Even the most sophisticated PE groups have significant numbers of companies they invest in that never provide a return. A very small (less than 5%) of start-ups successfully raise enough capital to get off the ground, so make sure that the budget to start the company is realistic. If the founders are taking large salaries, hiring a large staff, and spending heavily on brick and mortar be wary. For more on this topic, consider reading Martin Zwilling’s article: Entrepreneur: Challenge yourself before you invest.