January 9, 2013
Entrepreneurship is the dream of many people. There is often the moment of brilliance when the product idea suddenly pops into their minds. Then, they embark upon their venture with high hopes and exuberant enthusiasm. But what comes next? There are a few common paths among entrepreneurs. Some start building a working prototype of the product that they can show to potential customers or investors. Others simply start searching for investors. If entrepreneurs are asked what their biggest challenge is, they will almost always say funding. Statistically speaking, only one percent of proposals presented to venture capitalists or angel investors receive funding. Investors consider most of these proposals to be junk, to not be worth the paper they are written on or the disk space they are taking up.
Why Most Start-Up Proposals Are Considered Junk
The biggest reason is a huge misunderstanding between what investors want and what entrepreneurs have to offer. Funding is a sales process. The investor is merely a customer. The start-up is the investor’s product and, like any customer, they are looking for one with the right features and benefits. Investors are interested in making a return on their investment – they are looking to buy into the start-up low and sell the start-up to others at a higher price. It’s simple. Yet, entrepreneurs want to focus the investor on the end product of the company, the widget they manufacture or the service they offer to customers. That’s not the product the investors are buying.
So if investors are looking for that perfect start-up – and we all know from being consumers ourselves that we never find the perfect one – what are the features and benefits investors actually want?
What’s Your Product?
Every entrepreneur knows what product they intend to make, but it’s amazing how many can’t convey the product to others. Many investor meetings spend a lot of time focused on the product because investors simply can’t figure out what the entrepreneur is doing. This leaves the entrepreneur with the impression that the product has more importance in the decision to invest than it actually does. Investors need to understand the product and why it exists because it frames the rest of the conversation. Investors want entrepreneurs to explain this quickly and concisely – at a high level – so investors can get to what they really want to discuss, which is the business of the product. A common request from investors is to give them an example of a use case because they are struggling to get a grip on the product idea. As part of the use case, investors want to hear how the product creates a WOW! factor with the customers, which is how it compares with what is currently available.
Where’s Your Proof of Concept?
Investors are fond of asking entrepreneurs for proof of concept. Most entrepreneurs come from a technical or skilled background in product development. When they hear the words “proof of concept”, they immediately think of a product prototype. The entrepreneurs are often bewildered by this request because they believe that they have already shown this. But what investors actually mean is proof of concept in the business sense. That’s product, customers, and revenue, not just a prototype of the product. Entrepreneurs should expect to get far more queries from investors about the customers and revenue than anything else. One of the first questions any investor will ask is how many of the customers are paying ones. Non-paying customers or products offered for free don’t prove much of anything. One of the biggest lessons from the dot-com era is that there is unlimited demand for free, and investors still remember. When investors have lost money in a related market or with a similar approach before, it’s much more difficult to get them to fund another start-up by simply claiming to make it work this time.
According to Erin McKean, founder of Wordnik, “The most important lesson for an entrepreneur to learn is focus — entrepreneurs by nature want to solve a hundred problems at once, but it’s important to pick one problem and test out your solution quickly. Something I found surprising is that most women who do startups have significant domain expertise and then jump into a situation where there are no experts, because they’re doing something new! So it’s important to let go of conventional wisdom in order to be as open as possible to new ways of doing things. Everyone in a startup is making it up as they go along, that’s why they’re so fun and so terrifying – and so potentially valuable.”
Part 2 looks at who’s involved in the venture and how investors see them through their eyes. Read it here.
Part 3 concludes the series and delves more into investors’ view, their fears and desires.