A METHODOLOGY FOR EVALUATION THE BUSINESS POTENTIAL OF PRE-REVENUE STARTUPS — PART TWO

Recently I was invited to give a guest lecture to the Young Venture Capital Forum of Israel — a professional association of VCs in Israel. They asked me to give a series of talks on how to assess the business/financial components of startups, from pre-revenue through late stage. With their permission, I am sharing highlights from the first lecture in the series: “Business and Financial Evaluation of Startups — Pre Revenue”.

This is intended for everybody, not just investors. The same methodology can be applied from the founder perspective to help them strategize the development of their company from the earliest stages.

Read Part One — Introduction here

Part Two — The Early Stage Startup Square

We are going to assume that the company in question has adequately researched their competitive landscape and marketplace; and, subsequently, has adequately described their use case and value proposition.

The next thing you, as investors, want to see is that the founders understand how their product fits in to their niche marketplace. The throwaway phrase for this is “product-market fit”, but I want to give you a different framework for understanding this concept, which I call the “Early Stage Startup Square”. It will help you map out the product market fit in a way that makes it easy to assess the bigger picture, and assess if the founders are prepared to enter the market in the future.

This is a heatmap of the niche marketplace of the startup.

Let’s explain what is going on here. The area above the horizontal axis is where the niche market is Robust. This means three things. First, and most importantly, demand for products in this niche has been proven and broadly exists. Secondly, technological standards/benchmarks are in place and commonly known. Finally, regulation (if needed) is codified and transparent.

Below the horizontal axis, demand in the marketplace is not guaranteed, or hasn’t been proven, and there are still question marks regarding technical standards and regulation.

Moving from left to right across the vertical axis; on the far left the marketplace is dominated by few players, maybe even just one. Incumbents rule the roost here and maintain a lot of influence and power. On the far right the market is filled with competitors and no effective market leaders.

When considering a startup for potential investment, and assuming you trust the information presented to you, the first thing to do is place the startup on the map above. Of course, there are going to be some outliers that cannot be assessed, but the overwhelming bulk of startups can be evaluated in this simple matrix.

One note for founders –

You should also think about your idea in these terms, as it will give you an early indication of what to expect when you enter the market, and how to plan accordingly.

Next time we will start getting to the interesting parts and digging in to the four quadrants and their significance on the future prospects of the startup.