Everyone makes bad investments once in a while. Sometimes you might ask yourself, how did we get into this situation, and boy I wish I’d done something different in hindsight. I now get asked a lot what I think a dealbreaker is for a venture investment. While there are a lot of metrics and commercial based aspects you can look at (see David Skok here or Brian Balfour here) there is also a lot of belief in the team, industry and opportunity.

Some simple “gut” questions I ask myself about a company before investing.

• If I wasn’t an investor would I work at this company?
  • If the problem isn’t painful for me, I could be a good investor in it, but to be a great one it should be something that I / my team can identify with personally and see where we can add personal value
• Do I feel like if I was going to lose all my money that I would question if the team would have done everything not to go out of business
  • Great founders are constantly evolving, they are always tampering, optimising and looking forward. If the business fails, it won’t be for lack of trying – if you have any doubt about this you shouldn’t back this team
• Would I invite the founder(s) to dinner with my family / friend(s)
  • This is a more qualitative one and the reverse of a job interview question. Many people will take a job which is a good opportunity and not worry about whether they like their co-workers. As an investor, you will be spending potentially 5-8 years of your life talking to the founders (and neither party can quit easily!). I’ve found it makes a lot more sense if you genuinely like each other.

A simple mental idea that I like to use when evaluating a company is what I call my “four quarters” rule. I find that this aids me to think about whether an investment is reasonable or not and is a good litmus test as part of a larger diligence strategy. Broadly there are four elements based on the quarter percentages adding up to 100%

25%: You should be confident the investment has a 25% or less chance that it will run out of cash without achieving its product aims or getting enough data to prove up an alternate model

What do I mean by that? There are risks in any investment but they shouldn’t put you in fundamental fear you won’t last the year. The investment should have reasonable runway i.e at least 12-18 months, have a reasonable problem to solve and enough chance to rejig / pivot if things don’t go as planned. You should be confident that management are spending enough time assessing whether things are working and have a defined strategy i.e if this hasn’t worked by X date we will need to reassess this model and make key strategic decisions about whether this is a viable solution in its current form. Implicit in this is the commercial market in which it operates and the pace of change in the area which need to be diligenced heavily and separately. A lot of startups are unprofitable, but nothing is harder to fund than something that hasn’t met its targets and hasn’t gotten at least 3-6 months data to prove that an alternate strategy is possible.

50% / 75%: You should be at least 50% confident the investment can achieve 75% of the current financial year forecast (or the next 12 months depending on how much is left in the current financial year)

Look at the vendor presentation / base case forecast. You should hopefully have, as a result of diligence investigations and spending time with the management team and customers at least better-than-not confidence that it can achieve 75% of the management plan for the current financial year absent a material adverse change. While this may seem a high level of confidence, the companies we have invested in that have done well have a very granular approach to their 6-12 month pipeline with identified prospects by name, probability weights and action plans on a per customer basis. There are obvious exceptions here but there is a reasonable chance that the company hasn’t planned well, it won’t sell well (and especially for enterprise SaaS). The best companies have laser focus on the next 6-12 months. If the company does not know what its next 6-12 months are, you should probably question the entire forecast.

75% / 50%: You should be materially confident (75% or more) the investment can achieve 50% of the business plan forecast (or the next 24-36 months depending on how much of a forecast period you have)

Again look at the vendor base case forecast. You should have pretty good confidence it can achieve 50% of the total vendor base case in the next 24-36 months (where reasonable). If the vendor base case has 100x growth in Y2 then discard that, obviously. But typically, if achieving 50% of the vendor 24 month target gives you pause, then this may be representative of broader commercial concerns you have about the business and require further rethinking of your thesis.

100%: Is the addressable market / use case you see at least 100% of what the company says it can be used for

We run a specific strategy of validation through our existing non-tech portfolio with the goal of adding material value / potential clients and synergies. If you can’t see a use case outside of the one that the company presents or you think it is much less, you may not be the right investor for the company. Investors should be able to show different potential paths and help the company grow in ways in which it could previously not access.

 

Anyway, those are some simple principles to keep in mind. But obviously not a substitute for a diligence process – happy hunting!

As anyone investing in technology knows, business is hard, technology is hard. Businesses that try to grow technology are therefore really hard. In fact, most of the investments that even experienced investors make will not return more than 1x the initial investment and could very well be nil returns.

In order to succeed in today’s competitive landscape a startup founder has to have a big dream and ambitious plans to get there. “Hustling” or “grinding” usually means getting it done when everyone else, including your friends and family, tell you that your idea is dumb or it could never work. Most of the time, ignoring feedback of this sort is a key personality trait for a successful founder however there is one simple rule that companies should not (but often do) ignore – YOU CAN’T SPEND MONEY YOU DON’T HAVE. You can’t also bank on network effects and word of mouth that you don’t have, but that’s for another post.

What does this mean in terms of your business plan?

• All the growth in the business plan can’t be based on phantom investment dollars that underpin lots of advertising
• You can’t have a business which progressively burns cash with no road to profitability that is based on raising more money to keep afloat
• You can’t justify a lack of growth / users / metrics / awareness for this year based on being in the middle of your capital raise
• You shouldn’t have an expectation that existing investors or friends and family will “bridge” you through a tough spot so that you can raise at a time when there are better metrics

These things seem self-evident, but unfortunately a lot of companies (even with well-meaning advisors) can get into trouble when the rubber hits the road, and what was previously a high-flying business in Month 3 with 6 months runway becomes a distressed business in Month 6 looking at declining prospects with declining runway. I was reading a book on marketing the other day which explains the compounding effect. Research shows that not only do the leading companies in a segment have an absolute edge (not surprising) over other companies in terms of market share and power but the impact on those smaller firms is significantly worse even on a relative basis when something happens (also not surprising).

Think of it this way, if your company is raising $1.2m on revenue of $3m and you are burning $800k a year (18 months runway) and you happen to hit $2m revenue instead – not only are you now burning a run rate $1.8m per year, assuming nothing else changes, but your runway is now shorter than 1 year even assuming the full raise. Meanwhile your chance of raising $1.2m also decreases because people will question a forecast which shows a 33% miss to the LTM financials.

Usually at this point one of two things happens:

• Either the company can only raise say a partial amount e.g 600k, and it raises that (which might be as little as 3 months money)
• There is an offer for $1.2m but at 50% less than the proposed valuation which the company then rejects and then asks existing shareholders for a bridge and hopes that they can raise in 3 months more time assuming that the revenue is nearer to a run rate of $3m

What went wrong here? The company’s plan was based on spending money it didn’t have and needed to raise as new capital. When sales didn’t materialise, it didn’t cut costs or re-evaluate its strategy it just tried to keep pushing through or “hustling”. This sometimes works, but unless your name is Elon or Jobs, it’s a high-risk strategy.

What could they have done instead? Y Combinator founder Paul Graham has a great article about are you “default dead” or “default alive”. Basically, is the default state of your company burning through all your cash unless you raise more or is there some path to profitability and a self-sustaining business. It is surprising how many companies don’t know the answer to this question and that the answer can’t be “default alive, assuming we raise this next round”. After all, you can’t control anything about your business, you can’t control your customers, or the market, or technology trends or growth. You can and should however be 100% responsible that you don’t run out of money. Putting aside the legal and directors’ duties involved, you are spending 110% of your waking hours building something great – why put it all at risk?

What else can you do to work out if your business is moving in the right direction? My last post talked about re-reading Geoffrey Moore’s Crossing the Chasm*. Chapter 4 talks about knowing your market. As an investor we are looking for great entrepreneurs that can specifically and firmly state what is their ‘target beachhead”. This means a) not pursuing every market at once to make a sale b) firmly describing what is core and non-core c) growing your presence, reputation and market and though leadership organically and by direct sales / face time to be the dominant player in your niche of the world (no matter how small). Doing this is a great mitigant to spending hundreds of thousands of dollars on “general” advertising and brandbuilding or building products and features you don’t need – which can be two of the largest costs at seed / early stage.

Chapter 6 talks about refining your market positioning message. An extension of the previous idea is you should be able to simply and effectively describe who you are, how you fit in with the other products and what you are for, and what they are for. If you don’t know the answers to all these questions, you can keep costs to a minimum until the time when you do or have a very good idea of what they are. Again if your name is Bezos you can try the “if you build it they will come” approach but it is a good idea to get out there, start interviewing your customers, your investors and your peers and making sure that your product addresses a big enough need – I’ve heard of companies that don’t do more than 24 hours of product development without testing it on a live and super passionate client. If you don’t know the answers to these questions, you can also be super critical / transparent about the effectiveness or non-effectiveness of cost base in the organisation.

In short, if you are in the middle of re-evaluating your 2018 business plan at the start of this year, I encourage you to really focus on what you can do with the cash you have in the bank today. Further capital is an accelerant of great business models, not a fixer of bad ones. You may sail pretty close to the wind cash wise (see AirBnB and the famous Obama cereal) but if you maintain cost control, focus and a (financial) mindset which is focused on not going out of business than you can take the next steps to building a product mindset which is ready to grow your startup.

 

*Anyway, again, if you are a SaaS or enterprise sales product, I highly recommend you read the entire book. If you aren’t, I still recommend you do – although some of the principles won’t be totally applicable.

 

Happy new year everyone!

One of my resolutions in 2018 was to start writing again. I don’t know if lots of people will read this blog but I started this with the aim of sharing some of the ideas from real investments and the variety of books, blogs and podcasts I read and hopefully helping at least one startup founder have an idea they can really use in their business. So my goal is to write once a week or fortnight, about things that interest me, and hopefully interest you too.

Anyway, our office reopens tomorrow for the start of business year 2018. The new year means the start of new resolutions and new goals. And nothing says start of the startup year than company strategy retreat days.

Company strategy days are a strange beast – too many ideas or too many people and nothing gets accomplished and all the ideas are too general. But make it too small, and you don’t get enough buy-in from key people who actually do customer-facing work in the organisation and you run the risk that you just affirm the current strategy because it’s the CEO’s baby and they are leading the session.

Examples of poor conclusions I have heard at strategy days:

“Wow, that was an unexpected year, wish we’d picked a different channel partner. Let’s try another one next year and see how that goes ”

“Metrics spreadsheet? Yeah we don’t have one of those”

“Yes, we definitely should sell more products. That would definitely be a great goal for us this year”

“I think our product is market leading – but the sales guys just aren’t selling. I guess it’s a tough market, what can you do”

“How about that Bitcoin! Let’s put all our money into Dogecoin instead”

So how do you make the most of the start of 2018? How do you ensure that you actually use this time to rethink your strategy and redefine your business? I’ve recently been re-reading Geoffrey Moore’s “Crossing the Chasm”. I recommend this to every enterprise software business I meet. I will continue to recommend this book – yes that’s right YOU should buy it, frame it and give it to all your sales staff.

This week’s blog post will go through two of the exercises in Crossing the Chasm that I have been seeing having real effects in developing competitive positioning and go-to-market strategy in our startups. Until then, see you next time – it’s exciting to be writing again!

JC