Venture Capital

Look Closely at These 4 M's Before Investing in a Startup

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Recently, I was asked to judge a startup competition.  As I was filling in the evaluation questionnaire, I noticed that the questions being asked revolving around four topics all starting with the letter M: market, model, management and momentum. That is an elegant way for all of us to think about evaluating startups.

1. Market.

The market assessment comes down to a look at the startup’s industry and competition.  From an industry perspective, the larger the industry and the faster it is growing, the better. Investors would rather invest in $100BN markets than $100MM markets, to build as large a business as possible.  A business selling travel to passengers around the world will garner more interest than a business selling whitewater rafting trips in Colorado.

From a competitive standpoint, the less competition the better, especially if that competition is already well-funded and pointing their fresh venture-capital marketing bullets in our direction. First movers or early movers are preferred, as opposed to the tenth startup entering a crowded space. Look for white space opportunities where you can stand out and shine amongst the crowd.

Related: The Innovation Challenge Facing Startups in Crowded Industries

2. Model.

The model assessment comes down to two things: the overall business model and the unit economic model. In terms of the business model, how does the company plan to make money? Is it ecommerce selling online merchandise? Or, advertising sales in a content publishing model?  And, most importantly, how large can the revenues get in the next five years, and what does that mean to the ROI on my investment?

The unit economics comes down to two things: the lifetime value of a customer’s revenues compared to the cost of acquiring that customer in the first place. If you are Starbucks, and your average ticket is $10 per transaction, and a customer buys one cup of coffee a week, that is a year-one revenue potential of $520. If we lose customers at a rate of 20 percent a year, over five years that is a lifetime value of $1,560 in revenues.

As a rule of thumb, I prefer not to spend more than 10 percent of my lifetime revenues on an initial cost of acquisition. If the initial marketing cost per customer is under $156, the startup is going to be in in pretty good shape for attracting capital.

3. Management.

The management assessment has several variables. How experienced are the founders in this industry? How experienced are they in building startups? How experienced are they as working as a team together? How credible are they? What is their personality fit with the investors, given the amount of time they are going to be spending together?

Related: 3 Steps for Assembling a Startup Dream Team

4. Momentum.

If I had to pick one thing investors gravitate towards more than anything it is the speed of customer adoption. If customers and revenues are scaling quickly, that is a pretty solid proof of concept that instills confidence and excites an investor to write a check.  Frankly, if you had all of the other three M’s, and this one was missing, it would be very challenging for you to raise capital.  As I have said in the past, focus less on the product and focus more on the proof of concept marketing around that product, and you will be in great shape.

So, whether you are a startup seeking capital, or an angel investor looking to invest capital into a startup, make sure all four M’s of evaluating potential startup success have been checked.

Related: How to Find an Angel Investor