Although every investor has her preferred selection process when evaluating business opportunities, there is a common set of criteria reflecting the implicit consensus investment professionals have reached about those key indicators that better predict, on average, the success of a new business venture. Find out the top 10 things professional investors look for in a new business idea.
Krogger Highlights | 2015
In launching new ventures, lack of ideas is seldom the problem. The supply of concepts is unlimited and many business ideas, both good and bad, find their way to implementation every day around the globe. Many entrepreneurs and business managers we work with can generate literally hundreds of ideas – the issue, of course, is that only a handful of those will become a business, even less will survive in the long term and probably one (if any) will turn out to be a real breakthrough.
As many professional investors will tell you, often, it is not the idea per se, but the execution plan that makes the business a success.
Many successful companies started off with very different ideas than the one they ended up implementing. Take the case of flickr, the online photo management and share-application company now owned by Yahoo!, which started as a web-based multi-player online game called “Game Neverending”; or consider Mattel, which before becoming the global toy maker we all know, it started as a picture frames business many years ago. The truth is that there is no perfect idea – those that seemed good, turn out to be impractical, flops or ill-timed (remember Webvan?) and some arguably bad ideas make it to be great companies (no one thought a 24-hour news channel was a good idea when Ted Turner founded CNN). The execution plan is key indeed.
This doesn’t mean that subjecting new ideas to a rigorous analytical process before launching is less valuable. Yes, professional investors recognize that the variables ultimately determining the success and failure of a venture are too numerous to control, let alone predict, and therefore effectively identifying a potential winning idea becomes an incredibly difficult task – but the absence of a good mechanism to filter the myriad of proposals they receive every year, obviously does not solve the problem – it exacerbates it. Having a framework for entrepreneurs to assess an idea’s potential of becoming a successful business (or more precisely of not becoming a failure) that is line with investors’ criteria is more relevant than ever.
Although every investor has her preferred selection process when evaluating business opportunities, there is a common set of criteria reflecting the implicit consensus investment professionals have reached about those key indicators that better predict, on average, the success of a new business venture.
Based on our work with entrepreneurs, venture capital firms and angel investors, we have identified 10 of these indicators, as the ones people focus the most when first evaluating an idea.
1. There is a Need
This seems to be such an obvious point, but more often than what is thought, entrepreneurs forget to ask themselves if their new product or service indeed satisfies a market need.
Do people really need what they offer? Does the product or service solve a real problem or create identifiable value? What ‘pain’ is the idea tackling? What opportunity is it creating? – are all questions that need a clear and straightforward answer before going any further with a business idea.
Even if entrepreneurs have identified a need that their idea can satisfy, such need has to be relevant in the context of a business venture. Some problems are just not that ‘problematic’ to justify customers’ willingness to pay for the solution and many needs are so specific to each of us, that satisfying them is great from a personal perspective, but is unlikely that we can build a business out of it.
A winning business idea has a clear objective, solves a concrete problem and creates well-defined value in a way that matters to potential customers.
2. An Attractive Market
A large growing market is a key requirement for any potential investor when assessing a new business idea. The size of the market determines how large the opportunity is and a market that is growing offers much better prospects for the new company in the future. However, defining size and growth as the only determinants of market attractiveness could be misleading. In fact, opportunities abound in niche and even in shrinking markets. What is relevant then is not the absolute size and growth rate of a particular sector, but the new venture’s ability to command a significant share of it quickly and profitably.
Winning business ventures are able to demonstrate this ability. A large and growing market just increases their chances of success.
3. Competitive Advantage
A winning idea must possess defensible characteristics. Features that protect the idea itself or its execution plan and create barriers to entry for current and potential competitors. Without them, a new business idea could be easily replicated, customers lost to other players, profitability quickly disappear and the new venture might not survive for long.
Professional investors tend to favor ideas where there is solid intellectual property protection, exclusive agreements or licenses, strong brands, unique skills and resources or any other form of competitive advantage.
4. A Clear Business Model
Very simply, the business model tells the investor how the venture makes money. It defines the components, activities and logic that need to interact with each other, for the idea to work.
A winning business idea should be able to communicate unambiguously, the answer to four questions:
- What? – What does the business do? What does it sell? What does it solve? What does it offer? In a nutshell, why does the company exist (or should exist) at all?
- Who? – Who is the customer? Who values what the company offers? Who pays for the “What”?
- How? – How does the business provide the product or service to its target customers? In essence, what does the company actually need to do in order to provide the “What” to the “Who”?
- How much? - How does the venture make money? And how much of it can be realistically made? There is no point in having a business that doesn’t generate profits.
Naturally, the devil is in the details, but having a clear business model that ‘just makes sense’, goes a long way with potential investors.
5. Strong Management Team
If you ask a random sample of potential investors to rate the importance of a strong management team when launching a new business venture, we guarantee that nine out of ten will consider it the single most important criteria to evaluate the merits of an opportunity.
Professional investors are always looking for high-quality people who can demonstrate a track record of performance, integrity and leadership (in current or previous ventures), that are passionate about their idea and above all, that can work well as a team. Nothing is more disappointing (and unfortunately more common) than a great business idea failing because of a dysfunctional team.
Winning business ideas are unequivocally built upon credible, strong management teams.
6. Opportunities to Grow
Businesses that create multiple revenue streams are in general more attractive than those with limited scope to grow out of their core markets. Having at least a sense of where additional growth opportunities might come greatly improves the risk profile of any idea and could offer better returns to potential investors. More importantly, it dramatically increases the chances of creating a long-lasting business.
Winning business ideas are scalable and able to identify multiple opportunities to expand in a sustainable way.
7. Actionable Innovation
New ideas are exciting. The feeling of coming up with something never seen before is definitely contagious and many investors are naturally attracted to breakthrough ideas. However, for an idea to become a business, it needs to be actionable.
Some entrepreneurs are way ahead of their time. Their ideas are true candidates to revolutionize the way we live - but unless such ideas can be implemented (products can indeed be manufactured cost-effectively, consumers are willing to pay for them, etc.) they will remain just that: good ideas.
Successful start-ups possess a balanced degree of innovation – they come up with new concepts, do things differently, even create new markets, but they operate with full understanding of how the world works today, how their ideas can evolve within it and what needs to be done in practice to ‘bridge’ the current state of things with the future they envision. In other words, their innovation is actionable.
8. Exit Strategy
When assessing a business idea, professional investors are really evaluating its potential to generate returns on the initial investment. The required rate of return will be different for each investor. It will depend on the opportunity, the size and terms of the investment and the negotiation process with entrepreneurs. What does not change is investors’ need for a clearly articulated exit strategy – in other words, how will they extract these returns? How easy or difficult would be to crystalize their gains? And how long would it take for this to happen?
Those ventures with a clear path to ‘monetize’ shareholders’ participation in the business – via a trade sale, further rounds of financing or IPO – rank higher in the investor’s pecking order.
9. No Reputational Risk
Most professional investors are very sensitive to reputational risk and will never consider a business idea that compromises their integrity. This one is simple. Entrepreneurs should stick to ideas that are legal, ethical and in compliance with good business practices.
Sometimes is easy to forget that launching a business, raising money and operating a company is all about people. We naturally partner and work with those we like and respect and more often than not, our long-term relationships start with having ‘good chemistry’ between the parties. Well, professional investing is not different. Entrepreneurs could have a great business idea in an attractive market, with a strong management team and unique competitive advantages, but if they approach the wrong investor – if there is no fit between them, their business idea and the investor’s objectives – they simply won’t be able to bring the investor on-board, let alone raise any money from her.
Real investors bring to the table much more than cash – they are mentors, coaches, and ambassadors of the business. They provide contacts, business opportunities, and offer guidance when is most needed. They truly become partners in the new venture and this is why finding an investor that ‘gets the entrepreneur’ and gets their idea is incredibly important. And just as is the case with any relationship – there is no secret formula to get this one right. Sometimes you just hit it off, sometimes you have to work a bit harder to make things work and sometimes it was not meant to be and you need to move on.
This list of indicators is clearly not exhaustive and there is no guarantee that those ideas that possess them will be successful, but when it comes to professional investors and what they look for in new business ideas, taking these points into consideration will certainly set entrepreneurs apart.
Download the full Highlight here