4 Risks to Consider When Trying to Get Funding
A few weeks ago I came across a new framework for thinking about “what makes a startup investable” that I found very useful so I thought I would share it.
The question of how to get funding and investment is one that comes up frequently if you spend any time around startups.
Hopefully, this gives you some food for thought when thinking about a startup’s funding prospects.
As a general rule, when sane people are investing, a key principle of their decision-making process involves evaluating the “risk-reward” profile of their investment.
For example, instead of investing in your startup, an investor can put money in the S & P, buy a rental property, etc.
They probably won’t generate a 100x return in the next 5 years, but they probably also won’t lose all their money.
If you look at this another way, a scatter plot that shows all of the likely outcomes in 5 years would be a group of dots clustered relatively closely together.
This means both the good outcomes and the bad outcomes aren’t usually that extreme. When it comes to a startup, the scatter plot looks a lot difference.
The most likely outcome is $0 followed in a distant second by anything resembling a positive outcome.
However, on occasion (and theoretically if picked properly) these investments yield a very high return.
So when someone is evaluating an investment based on a “startup” risk-reward profile ie one that needs the potential for a huge reward to be rationalized, these four risks can be a helpful checklist to think through.
This should give you a sense of the “risk-reward” profile of your business from (relatively) objective eyes.
Does your technology work? Can it be easily replicated? Is there anything novel or proprietary about your technology?
I don’t think it is always a requirement that your technology is proprietary and earth-shattering depending on the business you are in.
But it is always a requirement that you can make it work.
How big is the market you are in? Or the markets you can enter?
Even the best idea in the world that solves a big problem for 1000 people probably isn’t a very good investment.
It’s crazy how often I see people forget to think about this.
You could make the counterargument like in the Innovator’s Dilemma that you are going to create a new big market (like Nike did for running shoes in America), but good luck with that.
I’d also include questions around “product-market” fit in this category.
Even if the market is big, is there evidence that your product is the right solution?
Are you the right people to solve this problem? Do you have complementary skills and the ability to adapt quickly?
Things will inevitably go wrong so this one is very important.
More than anything, an investor is betting on the team at the earliest stages.
If I give you money, what are the odds other investors will give you money? And that it will be the amount of money you need to be successful?
Even if you are in great shape on the other 3 risks, but it doesn’t seem like you will be able to get the money you need to grow, the “financing risk” risk of investing in you would be very high.
I wouldn’t want to give you my money only for you to run out of it in 6 months because you were unable to get additional funding from others.
There is nothing revolutionary about any of these 4 risks. I just found the framework for organizing them into these four categories and thinking about the “investability” question of startups through this “risk mitigation” lense to be useful.
If you found any of this post helpful, I’d also recommend reading Competitive Strategy by Michael Porter.