The question I’m most frequently asked (and most frequently ask myself) is how to validate and size business opportunities. Is a particular start-up or concept the next Google or doomed for failure?
I’m rather lucky. I’ve been able to spend the past year or so acting as entrepreneur, angel investor and early stage VC at various times. I think one’s process depends on whether you’re an investor building a portfolio of bets, or an early employee or founder with a portfolio of one.
First the similarities …
Evaluating businesses at its most fundamental level is really an exercise in understanding, measuring and trying to minimize risk. I’ve often said that entrepreneurship is like having 10 playing cards all face down, with the goal to turn as many over as quickly and cheaply as possible. It doesn’t matter if you’re an investor, entrepreneur or thinking of joining a young company.
In all cases, one must assess the ability to raise investment from quality investors. Capital is the venture’s fuel and the fuel has to be high quality and most importantly, you don’t want it to run out. Additionally, it’s important to feel that you’re being rewarded for the risk – the equity received should correspond to the level of risk in the venture. This can be hard to quantify, but there are some rules of thumb that experienced entrepreneurs and VCs use. Trading off some amount of equity for lower risk is generally a good idea given that the nature of start-ups is inherently risky.
Market size is also important, but can be elusive. Simply put, the venture should be attacking a hard and large problem. All ventures are hard, so if you’re going to invest money or “sweat equity,” you better be going after a significant opportunity and not an incremental innovation. I gain comfort by talking with folks in the target industry and making sure their eyes light up when I talk about what I’m doing.
People. So much of the success of a start-up comes down to the team. Does the team have a track record of success? Does everyone bring different skill sets? Does the team have good chemistry?
And the differences …
Time. My experience having founded 2 companies is that it can take many months (or more) to validate a business plan. An investor or employee can make a decision in a week with only a few calls, but the entrepreneur should make at least ten times as many calls. The entrepreneur needs to become an expert in the field in which he/she is thinking of entering.
As an investor, you can rely to some extent on other’s research. As an entrepreneur, you have to do all of your own research. You should hear directly from end customers. You also need to candidly assess whether your previous experience and your own skill set enables you to be uniquely valuable to the venture. In essence, you should feel as though joining the company improves its probability of success.
Finally, there’s the big intangible difference between investing and operating. As the operator, you have to wake up every morning and spend all day working on a single cause. To be successful, you have to believe in the mission. Without passion, it’s not worth it. Like much of life, wait for your spot. But when you find it, jump in with both feet.