You Asked: What Makes a Startup Unique? We Listened.
Answered by: Branden Fini, Sr. Associate, Providence Ventures.
Venture investors prioritize a variety of firm and market characteristics when evaluating an investment opportunity, but among the most important is the firm’s uniqueness. But it’s not enough to simply be different from your competition; this difference needs to convert into a competitive advantage that ultimately leads to quicker (and sustainable) market adoption. Here’s the framework through which we view differentiation. We generally evaluate differentiation in three ways. Note that this framework excludes other critical evaluation criteria, such as the management team and TAM.
What do you offer and why will people care?
The first, and most intuitive characteristic is the actual customer offering. I prefer decomposing the offering into component parts that drive the customer’s willingness to pay (“WTP”). The firm with the offering that drives the highest collective WTP tends to be the most interesting. For a software product, a “WTP driver” might be architecture flexibility, use case breadth, or existing integrations with legacy infrastructure software. For a services-heavy offering, a WTP driver could be offering breadth, geographical reach, or compatibility with existing services the customer is using. For any type of product, customer ROI is a critical driver.
Who are your customers and how will they pay?
A firm’s go-to-market (GTM) strategy could affect adoption as much as the actual product. The go-to-market strategy includes the selected customer market and the revenue model. In healthcare, these two choices can be very complicated. The customer (i.e. who’s actually paying) could be an employer, health system, private practice, insurance company, a medical device company, pharma company, or some intermediary (e.g. distributor, pharmacy, benefits manager). The revenue model may be a SaaS subscription fee, utilization-driven cost, shared savings, or involve insurance reimbursement — or a combination of all these.
How efficient is your business?
Looking at the operating model is an effective way of evaluating efficiency. We define “operating model” as processes directly involved with the production and delivery of the product. For software, the operating model isn’t as relevant (but still interesting), as there is no inventory and no physical delivery. Steady-state gross margins for software should be 80%+. For physical widgets and human capital-intensive services, however, the operating model is critical in determining unit economics, which tends to have higher variance in these categories (vs. software). A good way to evaluate a firm’s operating model is examining various cross-sections of the company’s contribution margin. Specifically, the contribution margin of its: products, geographies, and consumer segments. We view contribution margin as revenues net of all variable costs directly associated with the product or service, which includes product cost, shipping, and labor.
Once entrepreneurs can clearly articulate a startup’s differentiation, the next step is to find the right investor:
VCs are not always the answer. For early-stage, highly risky businesses, terms and conditions traditionally associated with venture capital may not be worth an amount of capital that can be also found with friends & family or family offices. For companies ready to take on venture capital, we generally prefer to see a balanced cap table with a complementary set of VCs. The investor base may include both strategic investors with proprietary knowledge of and access to relevant markets, and traditional investors, who have the financial wherewithal and sophistication needed to support the business and attract other investors. Regardless, entrepreneurs should select investors who are supportive. That support can come in many forms including customer introductions, active board participation, and general strategic advice. We recommend conducting reference checks on investors of interest, just as investors would do with entrepreneurs.
Final Word
Ultimately, all good investors back companies with strong business fundamentals, exceptional management teams, and favorable secular trends. Entrepreneurs should choose investors who will reinforce the company’s vision and complement the competencies of the management team. Listen to current, potential, and even former customers to continually increase your offering’s collective WTP, and ensure your GTM strategy and offering are mutually reinforcing — in a capital-efficient way.
Follow us at @ProvVentures for more insights about healthcare investing.
