The Roadmap to Startup Success
A framework to help evaluate a startups plan.
Last time we continued the discussion on what makes a great venture investment by talking about the difference between Category Creators Vs. N+1 startups.
Even if you have a great team and a great idea, much of the risk in backing startups comes from the execution side - can this team actually take their great idea and make it a reality?
David Friedberg (The Production Board) talked about his framework for creating business value on 20VC. It’s a simple framework but I think it highlights the key building blocks for creating a sustaining business. Which ultimately is what we venture investors are looking to back. See below:
What I like about this framework is it helps you understand exactly what kind of execution risk you are underwriting depending on where you invest. If the company hasn’t yet built anything (technical competency) then you are taking product risk - can this team actually build what they want to sell?
Or if the team has an MVP / V1 of the product and is going to market for the first time, you are taking product/market fit risk. Do people actually want to buy this product?
How I use this framework to better understand risk
As a pre-seed investor, it’s impossible to know what will happen 12-18 months from now with any one of your prospective investments. But what you can do is build up your understanding of what the business might have to achieve to reach the next step in this framework
The first thing I do is pinpoint where on the chart the startup is today. Most companies we invest in are usually working through, or have just completed the technical competency stage.
Next, I start to work through the next 2-3 stages on the chart:
Product/Market Fit
Has the CEO outlined their plans to go to market?
Have I talked to any prospective customers?
Do people actually want to buy what this company is offering?
Positive Gross Margins
What is the proposed business model?
What drives COGS? Is this manageable?
Is a certain level of scale required to achieve positive gross margins? Can we get there?
Initial Sales & Marketing
How much competition is there in the space?
Is competition primarily legacy companies, or are there lots of startups getting funded for a similar thing (AI startups right now)?
What kind of sales model will the CEO need to deploy?
I know I speak often of how you can’t predict the future - and while this type of exercise seems to resemble just that I still find it useful. It forces me to go back to first principles and focus on the basic questions.
For example, Is there an obvious risk at the next stage that I’m not thinking about? Perhaps this startup has incredible technology - but there is no market for it. The mindset of “build it and they will come” begins to set in - which we have seen fail many times in the past.
Or maybe when evaluating the “positive gross margins” stage you start to realize that the economics of this marketplace business are all lopsided through heavy incentive programs. Where in reality consumers aren’t willing to pay the transaction fees that allow for positive gross margins.
Seeing these types of flaws early on can help you better identify risks. Perhaps as a result of the “positive gross margin” problem the company will require a bridge round, would you be willing to step up as an investor in that scenario?
The same could be said for our company with breakthrough technology, but no market. Would you bridge them through a pivot? Perhaps they move in a new direction that you didn’t underwrite at all - which of course happens, but if you saw it coming would you still say yes?
Closing thoughts
There are infinite frameworks and mental models out there for business & investing. But I wanted to zero-on on one that I think is very applicable to analyzing startups for investment. I’ll often draw this framework on the whiteboard and start to make notes of where the company is today and where they might run into trouble later on.
Relevant reads
The folks over at Ripple Ventures take a look at the Canadian DPI figures: Link
Benedict Evans discusses AI and the automation of work: Link