Into the Den
How to convince investors that your company is worth backing
Years ago, before I entered the world of business, I used to love watching Dragon’s Den (the same as Shark Tank in the US), a show where budding entrepreneurs pitched their business ideas to 5 successful business people in an attempt to gain investment for their company.
I have always been very interested in creating and growing businesses, solving problems, and making money, so I used to love watching the show and seeing entrepreneurs try to sell themselves and their businesses to potential investors.
However, having now spent years assessing the attractiveness of companies as well as helping them to grow, watching Dragon’s Den frustrates the hell out of me! It frustrates me because time and time again, entrepreneurs are not able to objectively assess whether or not their business is any good and, if it is a good business, often fail to communicate this to the investors.
Communicating to potential investors that your start-up idea or fledgling business is worth investing in fundamentally boils down to proving 3 things.
1. There are lots of potential customers with this problem / need
First and foremost, every business or product is (or at least it should be) about solving a problem. What is the problem that you are trying to solve for people? How important is the problem to people? Why? Does the problem cost them time, money, effort, or something else? Ultimately, as an investor, what I want to know and believe is that there are potential customers out there who have a problem that they really care about.
Then, you have got to be able to prove that there are lots of these potential customers. This means that you need to be able to say more than “lots of people have this problem”, you need to provide evidence. Who in particular has this problem? What type of person / business? How many of them are there? Where are they?
Notice that we are not yet talking about the value of this addressable market; this comes later in point #3. The value of the market, particularly if it is a new market that you have created or very niche, can be heavily influenced by the business model chosen to serve it e.g. subscriptions vs one-off purchases. What is important here is that the demand exists.
Plus, separating out the volume of customers from the value removes the common temptation for entrepreneurs to just find a market number that is broadly applicable and really big. This can be a quick way to undermine any credibility in yourself in front of investors. For example, if you’ve launched a new premium, healthy vegetable crisp brand, you may be tempted to tell potential investors “the crisp market is worth billions!”. Do that and you look like you’re either trying to trick the investors, or that you don’t know what you are talking about. Your crisps are for a very specific segment; those people who enjoy crisps but are health conscious and willing to pay extra for a healthier alternative. This segment will be worth much less than the whole.
It’s relatively simple: focus on the problem, why it is important to people, and how many people there are out there who want it solved.
2. Our product successfully solves this problem / meets their need in a differentiated way that the customer cares about
Now that your potential investors are comfortable that you have identified lots of customers who have an important problem to be solved, the next thing you need to prove to them is that your product / service successfully solves this problem in a differentiated way that the customers care about
This statement has 3 parts, so let’s break it down:
Firstly, does your product successfully solve the problem? If the problem was financial, does your solution actually save the customer money? If it was time or effort, is your solution actually quicker and / or easier for the customer? Whatever the core of the problem was you need to demonstrate that your product has solved the heart of the problem. The best evidence for this is to hear it from real customers, either through quotes / testimonials or in person.
Secondly, does your product solve the problem in a differentiated way? That is, how different is your solution to other alternative solutions for the customer?
And finally, do customers care about the way in which your product is differentiated? There is no point in saying, for example, “my product is faster than any other” when customers don’t care about how fast it is and are more interested in, say the cost or quality.
If your product doesn’t tick these 3 boxes, then you need to go back to the drawing board, and you certainly won’t be able to convince investors to back you.
3. We can provide our solution to the customers’ problem in a profitable way
If you have successfully demonstrated that there are lots of customers with an important problem and that you have a solution for that problem that customers like, then the 3rd and final thing you need to do is to demonstrate that you can deliver your solution to customers in a way that makes profit.
Here is where most of my cringes come from when watching Dragon’s Den. It’s when someone goes on the show who has clearly created a genius solution to a problem and therefore has unwavering confidence in the fact that their business is going to be worth millions. And because they are so convinced in the inevitable success of their business, they have naively invested daft amounts of their own money into the business even though it isn’t generating any profit and with little evidence that it ever will.
To be clear, just because a business isn’t making money now does not mean it cannot be successful in the future; almost every business has to go through an initial period of unprofitability. But there has got to be a clear path for how you get the business from where it is now, to a profitable version of itself in the future.
In its simplest form, you need to clearly lay out the assumptions you have to believe for your company to be profitable. It might go something like this:
# customers × average # transactions × average price per transaction [Revenue]
Minus
Average cost per product × # products sold [Variable Costs]
Minus
Average cost per customer × # customers [Variable costs]
Minus
Overheads [Fixed Costs]
Equals
Profit £££
Clearly in proper due diligence an investor would go much deeper into the business plan, but the fundamentals are the same, and for a Dragon’s Den style pitch you need to be able to communicate this in a simple way.
1. How many customers do you need, and at what value?
- Your assumption for # of customers needs to be sensible given the potential pool of customers you presented in point #1
- The average customer value consists of how many purchases you expect each customer to make each year, and at what price
- Price, or average value, needs to be sensible given the characteristics of the customers you have identified and the scale of the problem you are solving for them
2. At this volume of orders, what is your average cost per unit (or equivalent) of producing the product? And therefore, what is the overall cost associated?
3. Also, what is your average cost to acquire and serve each customer? And therefore, what is the cost associated?
- Don’t forget this! Once your customer has your product, there are often still costs associated with serving them, particularly if it is a service or tech product. This can be various forms of customer support, logistics / returns etc.
- Also think about how much you will likely have to spend on marketing and sales in order to acquire each customer
4. What fixed costs or overheads will you have at that scale?
- E.g. Rent, bills, loans, salaries, utilities, product development etc.
Remember, you need to evidence these assumptions as much as you can in order to give the investors as much confidence as possible that there is a clear way to deliver your product to customers in a profitable way.
So that’s it in a nutshell. If you can prove these 3 things then your chance of securing investment will improve significantly. And if you can’t? Then perhaps you need to reassess your business before you sink any more time and money into it. Otherwise facing a dragon could be the least of your worries…
