When evaluating startups or ventures, VCs usually focus on three major risks. Let’s take a look at each of these and how to hedge the as a startup, to ease the fundraising process:
- Market risk;
- Product risk;
- Founder risk;
This risk has to do with the actual market. It includes considerations such as:
- Is it big enough? (Current size of the market at the time of raising capital);
- Is it expanding? (Whether the market is expanding, and at what rate? What are the prospects for 5 years from now?);
This is the risk that your product might not beat other competing solutions in your designed market:
- Do you have anything proprietary or patentable? (That might defend or give an advantage vis-a-vis competitor solutions);
- What’s your actual competitive advantage? (What does the product do that others can’t? Does it perform something others don’t? Does it do the same dramatically faster or better?);
Founder risk has to do with whether the founders of this enterprise are actually capable of leading this endeavor. This includes:
- What experience do you have in the industry? Years of experience and associations with big names come in here (for example, has the founder of a cloud solution worked at Microsoft/Google’s cloud department?);
- Previous entrepreneur experience (how many companies created earlier and how did that work out);
- Experience of having worked together as a team (in past jobs or startups);
Bonus: Contextual Risk
As I’m typing this at the time of the coronavirus pandemic in March 2020, this raises the point of startups being able to hedge against a fourth risk (in this specific case, think “Coronavirus risk”). Under extreme or specific conditions, how will the startup fare?
- How will the current crisis/climate/restrictions affect our operations?
- Do we have product/operations/distribution that can navigate the current climate better than other ventures of the same sort?
The goal is to have a long answer to these risks as well, but also a short, summarized version, the “elevator pitch” of each, so you can summarize in an email, conversation or your executive summary.
Let’s take a look at a (fictional) example of summarizing these risks:
- Product risk: Our product provides a platform solution with higher scalability and speed than other comparable ones, proven by third-party tests.
- Market risk: The SaaS market is growing, and at a fast rhythm, with projections of being 300% bigger by 2025;
- Founder risk: Our two founders have extensive experience in cloud operations and software development, with total of 15 years aggregated experience in companies like Google, and CloudFlare. One of them was part of the team that scaled Google’s cloud services from 1B to 150B recurrent users;
- Context risk: We’re a SaaS platform and all our sales pipeline is online, so we are not threatened by the COVID-19 crisis, we actually benefit from it;
Knowing how you hedge against each of the three main risks goes a long way in raising venture capital, not mention actually planning how you’re protecting your startup/venture.