Some of you may know that I recently launched a publication called Dissection (apologies for the https link not working at the moment).
I created Dissection as an outlet for my inner ‘analyst’. I enjoy the mechanics of businesses. I also created Dissection because I’m enjoying my own journey of learning how to craft narratives, build storylines, and keep someone’s attention.
Keeping attention these days is a rare skill.
With people being barraged with notifications and distractions pretty much 24/7, if you can keep someone’s attention for over 10 seconds – you’re better than most. There’s a reason Instagram stories are only 7 seconds! And there’s a reason Josh Fletcher
So this leads me onto why I created this post.
With Dissection, I’m going to launch a weekly series called “Crowdfunding Friday”. Wherein I’ll be writing about companies that are currently raising on crowdfunding platforms, or who have recently completed (or failed) to raise funding.
Over the past few years I’ve been in a fortunate position where I could invest a little cash via crowdfunding on platforms such as Seeders and Crowdcube, and I’ve learned some hard mistakes, as well as noted some default questions that I ask any company before I think about investing, even if it only ends up being £100.
As part of this introduction to Crowdfunding Fridays, I thought it would be a good idea to share some of the default questions that I ask, as well as a little of the mechanics and strategy that startups use behind the scenes to tilt the odds of success.
This post is best suited to the casual investor. Those of you who are investing vast sums of cash most likely have your own due diligence approach. Let me know if I’ve missed anything or if you have any recommendations. P.S. this is by no means exhaustive and only what sprung to mind today as I wrote this post!
1. Always ask for the underlying data that supports claims
First, remember it’s all a beauty parade. The whole pitch is orientated toward sales. The founders want to get you hooked. They want to appeal to your irrational self, so that you become emotionally attached and listen to your gut. And that’s a good thing. Sometimes the best investments turn out to be the ones that sound silly at first. Think back to all the blog posts founders of unicorns write – typically detailing their first pitches and the steady stream of noes they had because people thought the company sounded silly.
I digress, back to the main point…
There’ll be bold claims, for example, look at some recent advertising scandals:
- VW falsely advertised environmentally friendly diesel cars
- Activia yogurt said it had “special bacterial ingredients.”
- Lumos Labs said Luminosity could help prevent Dementia
Bold claims command attention (much like what I was talking about earlier in the fight for mindshare).
And quite right for the startups and companies to push the boundaries on this (within reason) – it’s a busy world out there, and if you don’t push, or compete, you may not live that long.
But you, as an investor, need to understand the data upon which the claims are made. You also need to understand how ludicrous the claims are, when compared to the data. Are the claims plausible? Is the data replicable? Was the data a time-boxed data series showing positive trend amongst a much larger dataset telling a different story?
Once you start to understand this, you can make better informed decisions.
If the startup refuses to give you the data, then I’d obviously start to think twice about investing.
2. Find out what the key metric is, and the challenges that metric faces
Last week I was chatting to a founder who is currently raising capital. In summary, she runs a subscription business, sending something to her customers each week.
I asked her about her “key metric”. e.g. the one that she views most pivotal to her startup’s success, at this moment in time. She responded with the cost to acquire a new user.
I drilled into this a little further (“five whys” ‘n all that).
It turns out that cost of acquisition was influenced more by the landing page than it was by Googles auction system for PPC ads. So the key metric wasn’t cost per click on Google – it was actually relatively stable. The larger variable was the landing page layout. When they A/B tested it, various layouts were much better than others.
All-in-all, this is a long way of saying – ask why. Keep asking why. Get the founder to think from first principles. Build the story and the narrative alongside them, start from the very basics and build layer upon layer, gradually getting more complicated. From there, doing it alongside the founder, you’d be surprised how many things will jump out – which the founder perhaps hasn’t thought of.
3. Always speak with the founder, or better yet, meet.
It’s crazy how much I hear of people investing in a company without meeting the founder.
Call me old fashioned, but I like to see how they present, what makes them tick and basically size them up in person.
Use the thousands of years of evolution to help you, we’re pretty good at building a picture of someone from first impressions – and in some areas, this can help assess whether the founder will be a good custodian of your hard earned cash in their mission to execute against their roadmap.
4. If needed, apply pressure on valuation
At the end of the day, this is the single most influential variable that can get you more of the company for the same amount of cash (and in essence de-risking the proposition).
It’s also the variable that hasn’t got an exact “scientific” basis.
If I was writing a post geared toward VCs I’d give them a hard time for giving entrepreneurs a hard time on valuations (if they’re largely in the right ballpark – as the economics of the end game needed for VCs means that squabbling over +/- £1m is neither here nor there). However, for Mr Joe Bloggs, the non-professional investor, it’s very much within your rights to question valuations.
Many of the pitches on crowd funding platforms have ludicrous valuations, and unless there’s someone there (e.g. you) to temper them they might not end up having a successful raise. Or if they do, the higher valuations will come back to haunt them later down the line – most likely leading to a corrective down-round. When someone doesn’t take their word for it.
Is the company pre-product, pre-revenue – apply a lot of pressure.
Is the company generating revenue? This should give you a base to take a more calculated approach. Make sure to dig into it.
Has the company previously raised? What was the last round done at, why was it done at that valuation, etc. Keep in mind you may think there’s a whole lot of careful thought that has went into it, but that may not be the case.
5. Understand that you’re investing in a very illiquid asset
Investing into a private company is a long term committment – you typically won’t see a return on your cash for 7 years (if not longer). It’s great to see platforms such as Seeders start to push an active secondary market, to allow for share sales. Once the secondary markets become more buoyant, it’ll provide the much needed liquidity, and increase the attractiveness of startups and private companies as an asset class.
6. Flat out ask what the biggest risks and challenges are
This is also a good way to ascertain the character of the founder.
Do they provide you with real tangible risks and challenges? Or do they fob you off with a bland catch-all.
If they can provide you with a detailed, specific challenge as well as how they are thinking about overcoming that challenge, it can tell you a lot about their thinking approach and give you more comfort that your decision to invest is correct.
7. If you’re investing a sizeable amount, talk with people who have dealt with the company – past employees, suppliers, etc.
If you’re putting in tens of thousands via a crowdfunding platform, reach out to people in the startup community. Ask customers, ask suppliers etc. That’ll give you more data points, which should help you with the next point.
8. Question the assumptions in the financial model
At the end of the day, a financial model is simply just that – a model. The model is structured in a certain way to show the key elements of a running business. Namely, costs and revenues.
With a model, a proficient founder should have a tab with assumptions.
Dig into these assumptions.
Much like point (1) find out what data supports them. Have they said their cost to acquire a user is £4 and their main acquisition channel is paid social? Ask to see their Google Adwords data. See how much they are paying per click, see how many of those clicks convert.
Taking the example above of acquiring a user at £4. It’s pretty standard that a “good” converting page will convert about 3% of the audience, that would mean you’d need to be paying £0.12 per click – pretty unheard of in PPC world (I think the minimum bid is in fact £0.50) – meaning their data and assumptions are false. This has a huge impact on the top line and cash flow planning.
Once you have your own forecast, you should be able to plug this into the financial model to see how long term profitability is impacted. Most startups’ successes are predicated upon a sustainable low cost acquisition channel and it’s crazy how many become unattractive once you start to look at the reality of acquisition costs.
P.S. did you know I have a newsletter? I try and send it out once a week, covering what I’m reading, what I’m up too and some other stuff 🙂