The Startup Litmus Test
Back in school, you must have learned a simple test to determine if a liquid is acid or alkaline. When dipped in the liquid, blue litmus paper would turn red if the liquid is acidic and vice-a-versa. In the same way, by listening to few hundred pitches and working with few dozen of investors, I have developed few questions to determine if the startup is a sucky or a winning one.
Note: I have removed the founder factor on purpose to make sure that it’s based on the idea alone. Experienced founders have the tendency to pivot even a stupid idea to something workable within months into it (e.g. Instagram or Meerkat) but that’s another discussion for another day.
Nowadays I use this as a guiding principle to answer emails for feedback on whether someone’s startup idea is worth doing, or for help figuring out how to pick just one idea and focus on it.
Is the startup idea highly shareable?
The underlying question here is whether your startup is sexy enough to be shared or raved about by customers. Generally, any idea that can’t be marketed effectively through Facebook or Instagram (LinkedIn if you are a B2B company) is a bad bet. It naturally lacks the ability to make use of the network effect.
A simple test for this is to ask the founders to explain how their conversion happens from social or content marketing to a purchase? If the founders have a hard time explaining the strategy and the effectiveness of each channel, it is a bad investment.
Is there any blue ocean opportunities with the product?
The concept behind Blue Ocean Strategy is very self explanatory — “Blue Ocean” means untouched waters, or no competition whereas “Red Ocean” is a market in which competition is at each others throats, spilling blood (therefore “Red” Ocean) for sales from customers. It’s a sound strategy based on a book by two academics, Prof. W. Chan Kim and Renee Mauborgne but very hard to put in practice. To be clear, I am not saying Blue Ocean is a bad strategy, on the contrary, it’s a highly desired strategy. But it is very, very hard to do. To make things worse, any blue ocean discovered by a company will usually turn red rapidly (e.g. iPhone’s touch screen interface).
I believe companies discover new markets, products and technologies by accident. Hence, if any startup have successfully turned an insight into a key feature that verges on blue ocean (think Snapchat with self destructive pictures) — that’s a huge plus point.
A caveat here is that if I feel that it’s too out there that the market is not ready for it, it’s normally a bad sign. So, when a startup presents a blue ocean product, a proof of concept is necessary will normally be requested.
If you are a marketplace startup, do you know how to capture a huge demand side?
Lately, marketplace based startups are becoming more and more popular with lots of funding e.g. marketplace to find plumbers, hairstylists, doctors, etc. The key to making marketplace work is to solve the “chicken and egg” issue i.e. how are you planning to get your supply and demand side together on your platform?
I have a different opinion on this based on my experience working with few marketplace startups over the last year. Startups should always figure out their demand side first. As long as you have a strong demand side, the supply side will follow. The bees come to the honey, not the other way around.
Hence, any market place startup should be able to demonstrate a good ratio of supply to demand with the minimum of 1 service provider to 2.5 customers. If it’s any higher than this, it’s definitely a good bet provided the founders can keep the ratio up.
Are you an affiliate based business?
Affiliate businesses (you’ll earn 1–10% of the total sales by promoting someone else’s product) are the hardest to make a huge revenue. If the founders are not well experienced in fundraising, then affiliate businesses become highly undesirable.
This is mainly because the only exit that can happen is by a trade sale where someone buys the company to get access to the customer database. Until that happens, the founders must be fund raise continuously to grow the company. So, if the founders are new to fundraising, it’s best to avoid affiliate based businesses.
Is there a high possibility to pivot to an agency if their product doesn’t work?
Based on my past experience, startups that have a high possibility to survive by turning their product into an agency/customized service to a small number of customers are bad bets.
Why? because almost 99% of the time, the startup will pivot to an agency, especially if the founders are not highly technical. This happens when the startup is running low on cash and having trouble to raise their next round. More often than not, the founders will pivot into an agency to keep the lights on.
Agencies are hard to scale, need a bigger head count, require more cash to sustain growth compared to a product.
If you are are the ADHD type and need a way to eliminate some ideas or if you are an investor and looking for a way to identify good investments, make use of this litmus test. Additionally, the next time someone asks you for feedback on their idea and you are lazy to reply them, just send this article =)
Originally published at S19N By Sathyvelu Kunashegaran.