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.
1. MARKET
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.
2. MODEL
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.
3. MANAGEMENT
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.
4. MOMENTUM
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.
For future posts, please follow me on Twitter at: @georgedeeb.