Red Rocket was recently asked to judge a startup competition. As I was filling in the questionnaire which evaluated the startups, I noticed that the questions being asked were really revolving around four topics all starting with the letter M: market, model, management and momentum. I thought that was an elegant way for all of us to think about evaluating startups, and I will share my thoughts on each of these topics below.
The market assessment comes down to a look at the startup’s industry and competition. From an industry perspective, the larger the industry and the faster it is growing the better. Investors would rather invest in $100BN markets than $100MM markets, to build as large a business as possible. As an example, a business selling travel to passengers around the world would garner more interest than a business selling whitewater rafting trips in Colorado.
From a competitive standpoint, the less competition the better, especially if that competition is already well-funded pointing their fresh venture capital marketing bullets in our direction. So, where you can, first movers or early movers are preferred, as opposed to the tenth startup entering a crowded space. So, look for white space opportunities where you can stand out and shine amongst the crowd.
The model assessment comes down to two things: the overall business model and the unit economic model. In terms of the business model, how does the company plan to make money? Is it ecommerce selling online merchandise? Or, advertising sales in a content publishing model? And, most importantly, how large can the revenues get in the next five years, and what does that mean to the ROI on my investment.
The unit economics comes down to two things: the lifetime value of a customer’s revenues compared to the cost of acquiring that customer in the first place. So, as an example, If you are Starbucks, and your average ticket is $10 per transaction, and a customer buys one cup of coffee a week, that is a year one revenue potential of $520. And, if we lose customers at a rate of 20% a year, over five years that is a lifetime value of $1,560 in revenues. As a general rule of thumb, I prefer not to spend more than 10% of my lifetime revenues on an initial cost of acquisition. So, in this case, if the initial marketing cost per customer is under $156, the startup is going to be in in pretty good shape for attracting capital.
The management assessment has several variables. How experienced are the founders in this industry? How experienced are they in building startups? How experienced are they as working as a team together? How credible are they? What is their personality fit with the investors, given the amount of time they are going to be spending together? For a more comprehensive list, take a read of this post I wrote on How Investors Define a Backable Management Team.
If I had to pick one thing investors gravitate towards more than anything is the speed of customer adoption. If customers and revenues are scaling quickly, that is a pretty solid proof of concept that instills confidence and excites an investor to write a check. Frankly, if you had all of the other three M’s, and this one was missing, it would be very challenging for you to raise capital. As I have said in the past, focus less on the product and focus more on the proof of concept marketing around that product, and you will be in great shape.
So, whether you are a startup seeking capital, or an angel investor looking to invest capital into a startup, make sure all four M’s of evaluating potential startup success have been checked.
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