A Startup Founder Brings a Knife to a Gunfight — why this needs to change
New ventures often require outside capital as fuel for growth. This is why, long before they create their next new venture, experienced founders and co-founders begin framing a potential venture in terms that make sense to investors. Entrepreneurs and investors play a kind of game (a serious game) in which new ventures are evaluated in terms of opportunity and risk.
The standard startup pitch deck reflects this. Each slide in the deck — problem, solution, market, business and revenue model, team, unfair advantage, competition, go-to-market plan — reflects the dialogue between entrepreneurs and investors as the opportunity and risks of this new venture are given careful consideration. But in the course of this game or process, entrepreneurs and investors take very different approaches. One aspect of their respective approaches stands out as notably divergent: due diligence.
If you are not an investor or have not raised capital as an entrepreneur you may be wondering what “due diligence” is, how it works and why it’s important. (As a starting point Wikipedia offers this.)
Experienced investors make their investments only after completing a process of due diligence. A typical due diligence checklist for a startup investor includes questions about every aspect of the business, including the organization and entity; financial matters and information; assets (physical, personal & intellectual property); real estate; team and talent; licenses and permits; contracts; taxes; and more. An investor will invest only after a thorough review of each these factors.
What about entrepreneurs? Do they perform their own entrepreneurial due diligence? Sadly, no. They do this rarely, if at all. Try this. Do a Google search on “entrepreneurs” and “due diligence.” Every example returned by the search will explain how entrepreneurs should approach investor due diligence. The point here is this: entrepreneurs have traditionally and almost uniformly failed to think about their own need for a due diligence process with respect to the opportunities they consider. I will say more about this in a moment.
In their approach to the opportunity and risk of in any new venture, entrepreneurs bring a knife to a gunfight. It’s not nothing. But it’s not enough.
Why Founders Need a Due Diligence Process
The absence of any systematic approach to founder/venture due diligence is unfortunate because those who bring capital to a new venture are not the only investors in the venture. Founders themselves are investors. And arguably a founder’s investment — of time, focus and often their own capital — carries with it far greater significance, cost and potential risk than those who merely supply the money.
Have you heard the business fable about the respective contributions of the chicken and the pig to a breakfast of ham and eggs? “The difference between involvement and commitment is like ham and eggs. The chicken is involved; the pig is committed.”
The investor is the chicken; the founder is the pig.
Founders will invest their time and attention in a new venture over the next 3 years, 5 years, or even 10+ years. Viewed in these terms, a founder’s investment is about much more than money. The opportunity cost is enormous. And while investors mitigate their risk of investment through diversification — spreading risk across a number of investments within a portfolio — founders rarely have this option. Investors expect founders to be, like the pig, fully committed.
It makes sense then to think that a founder due diligence process could help founders make better decisions as they think about where they might invest the next chapter of their lives.
How Would This Work & Why Now?
Investors understand information asymmetry. They look at hundreds of deals for each investment they will make. They routinely engage in the process by which new ventures are funded than the first-time entrepreneurs who seek capital. If this is your first rodeo as an entrepreneur, you might read Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, a book written by Brad Feld and Jason Mendelson, now in its third edition. Buy the book. Read it. And after you do this, you will be far smarter about venture deals than you were before. But know this: you still won’t be in a better position than your lawyer or your venture capital investors. Information asymmetry isn’t the only problem entrepreneurs need to address.
Why Do Founders Lack An Established Due Diligence Process?
Entrepreneurs face a related problem that might be called process asymmetry. People and organizations develop a process when important or complex tasks occur again and again. To make just 10 investments, a typical venture capital firm would review as many as 1,200 companies. This kind of volume and repetition fosters learning, improved decision making and better outcomes.Those who do something hundreds of times or do it over and over again tend to develop superior skills. This can be seen in other areas. Surgeons who perform a specific procedure and do this with enough frequency tend to become particularly skilled and highly valued.
Investors do what they do — evaluate investment opportunities and make new investments — as a repeated and ongoing aspect of the business. For this reason, they have developed a set of models and processes that are designed to improve their decision making and their anticipated outcomes — including IRR and ROI — and investors’ due diligence processes have been designed with this in mind.
In contrast, even the most prolific serial entrepreneurs start new ventures rarely. And some serial entrepreneurs run a venture for ten years or more. This means most entrepreneurs do not think about the process of starting a new venture in the same way as investors. They do not have the benefit of learning that comes through consistent repetition over time.
This is why it may make sense to work with a larger group of serial entrepreneurs in a way that benefits from their collective experience. As a serial entrepreneur, you may be exploring your third new venture. While you could benefit from a person who has started five or six ventures, you would benefit still more from the understanding of hundreds or even thousands of serial entrepreneurs who have undertaken this journey during the past three years.
Lessons Learned — So Far
In just a few years of our existence, we have learned a few things. Here are just a few examples.
- “Founder-venture-fit” should be “a thing” — analogous to product-market-fit. When founders consider new opportunities, the first and most important gate or filter to apply is “founder-venture-fit” (FVF). FVF is especially valuable because if FVF can be ruled out, none of the other time consuming aspects of an opportunity need be considered — not solution, market, team, unfair advantage, business model, capital requirements. None of it. If you know beyond any doubt that you will never start a biotech venture, you would never waste your time considering the opportunity.
- While many serial entrepreneurs understand customer development, lean startup, business model generation, fundraising and other parts of the post-venture-creation process, they lack any clear, coherent model for approaching new venture generation.
- Idea-driven ventures remain the dominant approach taken by most entrepreneurs, including serial entrepreneurs, and these are frequently solutions looking for a problem or problems wrapped in the solution most familiar to the founder/entrepreneur.
Founders often think of their journey as defined by the imagined investor presentation they will create. A founder’s pitch deck describes the new venture in terms that help entrepreneurs and investors communicate about opportunity and risk by calling attention to each of the useful touchstones by which the opportunity / risk to be undertaken by the founder can be assessed by an investor — problem, solution, market, team, business/revenue model, unfair advantage, competition, traction, capital requirements.
Of course this is just the starting point for the conversation, and of course the deck itself is nothing more than a list of highlights – based on the learnings of the founder/entrepreneur. But the deck itself has value to the extent it offers the entrepreneur a guide to understanding the journey from problem to new venture creation. This deck — and its creation — is currently the closest thing most startup founders have to a repeatable process. But it is not nearly enough.
The big guns that entrepreneurs need will only be available when creating a new venture is supported by an effective process that identifies the best opportunities for each entrepreneur and the best approach to make an opportunity real while systematically identifying and addressing risks.
If you are a serial entrepreneur who plans to start a new venture in the coming year and this sounds interesting to you, consider requesting an invitation to participate in our next 10.10.10 program. If you know an entrepreneur who could benefit from this post, please pass it along. And to learn more about the program itself, click here.