By their nature startups are attempting to predict the future. From reading goat entrails to crystal balls founders have been trying to predict the future for centuries. What makes us better at this today? How can entrepreneurs assure investors that their picture of the future is accurate?
Basically you can’t! What you can do is show how you will reduce risk. There are basically three types of risk with a startup:
- Technology risk
- Management risk
- Market risk
As production managers used to tell me, you can meet quality standards, meet schedule or meet budget – choose two out of three!
Unfortunately, investors will demand three out of three. So whether you are building a pitch deck or just having a conversation over coffee with an angel, keep these three risk factors in mind.
Obviously the best way to reduce this risk factor is to have a successful product in the market. But to have a successful product in the market usually requires investment to build it. So you are in a Catch-22 situation. The second best way is to have a prototype that your prospective investors can drive themselves and get to aha! before they crash it! The third method is to build a demo. That demo itself is an attempt to predict the future, the future of your product. But if your demo show, rather than tell prospective investors that your technology will solve a painful problem for a large, and preferably growing, set of customers you will have reduced technology risk. Finally, and most commonly, entrepreneurs who can’t show, tell. And that’s where your pitch deck comes in. Keep reduction of technology risk in mind when you build your deck.
Investors have tended to gravitate to founders who have done it before. Even tried if they tried before and failed. The saying used to go in Hollywood that a director who had a picture that failed was a lot more likely to get financing for a new movie than a
would-be director who never directed a picture in their life. (Which is where shorts come in.) If you are a first-time founder the best way to show you are reducing management risk is that you have startup experience – you’ve learned from other people’s mistakes! That may be helpful but what’s more compelling is your team. The majority of founders of tech companies are engineers and they tend to bring on other engineers as co-founders. That’s a dual problem: first, who will be CTO? and second, who will sell the product? For there are only two jobs in a startup: building the product and selling it. Far to few engineering founders look for teammates with sales and business development experience. The more fleshed out your team across the key functional areas, the less risk of management failure. Here’s where advisors and early investors lend credibility to the venture and its management team. Most VCs look first and hardest at the team, and the CEO is about 70% of the team!
Founders have the least control of the market and the market is where a majority of startups tend to fail: they build products no one wants, or not enough customers want, to build a sustainable business. It’s fine to start with a niche but be sure you have a roadmap to expand to adjacent markets or investors will consider your market too small. If you are tackling education or health care investors have seen how much capital and how long it takes these very slow moving, late adopters to change how they do things, so have pilot test or other hard evidence that all three parties to a sale want your product: end users, financial decision makers, and influencers. In other words know the adoption pattern and sales cycle of your market, and take those factors into account when attempting to project your revenues.
Well there are entire books about reducing startup risk. One book that I highly recommend reading, though it has nothing to do with startups or investors is Douglas Hofstadler’s Gödel, Escher, Bach: An Eternal Golden Braid. But there is one take away that I advise founders to pay attention to when attempting to predict the future of their ventures:
Hofstadter’s Law: It always takes longer than you expect, even when you take into account Hofstadter’s Law.
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There one other type of risk that needs to be taken into consideration in at least two types of companies: fintech and health care. That is regulatory risk. While governments tend to move slowly and ponderously, their regulations can have unexpected and profound impact on not just early stage companies, but any company in a highly regulated market.