Understanding the risks | Enriching information with insight pays off for entrepreneurs
Early-stage venture capital analysis is a many layered thing, with equal parts art (judgment) and science (data and analytics). Analytics can be taught, where judgment is developed from experience, whether the hard lessons of failure or the nuggets gleaned from success.
Lots of venture capital analytics go into a “yes” or “no” decision: market-product needs assessment; competitive positioning and differentiation; financial and financing analysis; and management analysis. Venture capital investors consider each analysis independently and then try to assess elements concurrently. The tables below reflect one such merger of analytical elements.
Simply put: VCs assess the size and dynamics of a market an entrepreneur would like to pursue. The market analysis asks: How large is the market, how fast is it growing and what is the competitive environment? The product analysis asks: How unique is the product or service, how much does it solve a problem for customers willing to pay or advertisers willing to subsidize? The combination of product-market analysis translates to the potential profitability of a venture.
A high gross margin business, such as software, generates more cash for each sale and so offers greater value than a commodity or low gross margin business, such as food retailers and natural resource businesses. So, the sweet spot in the table above is the quadrant (upper right) where the highest volume of high value products can be sold.
This assumes, of course, that the company has the capital and management capacity to deliver said volumes. If a target market requires too great an investment within too short a time period, it may not be attractive to investors. For example, if a company needs to build a large manufacturing plant at a cost of tens or hundreds of millions of dollars, the venture economics may not work. Accordingly, a second perspective — combined with that above which examines the capital requirement viewed against the time to market — provides a more complete analysis.
Operating ten-year limited partnerships, venture capitalists’ time constraint impels them to pick cash-efficient growth opportunities that can get big (sales) and valuable (good gross margins) within their target holding period of four to eight years, no mean feat. But such is the nature of this particular flavor of capital.
From objective to subjective
Data and analytics are comforting for their relative certainty. Judgment, by contrast, relates to assessment of a host of unknowns. First, seeing the present: assessing the cognitive, social and emotional intelligence of management, investors and directors. Then, projecting the future: a three- to eight-year outcome based on opportunities, assets and human capital powered by financial capital. Third, managing change: assessing reasons for non-performance and gauging proper response to outsized performance.
The tools and outcomes of judgment vary from individual to individual. My experience — peppered with successes, failures, biases — will inform my sense of a host of subjective issues around management, the future and what to do in good and bad situations. If I’ve had a tough experience in a new media play with an entrepreneur out of Google, I may be slow to jump in bed with the Yahoo refugee offering me his big-company suite of experience and networks.
Countless are the entrepreneurs who lead with the data and neglect the subjective elements that, more often than not, are the real drivers of success. These softer issues permeate the entire venture capital lifecycle, from determining whether to bet on a team and opportunity to dealing with the countless decisions that lack data.
To aspiring and practicing entrepreneurs looking to lock in some capital from professional fund managers, think through the hard and soft aspects of your product, team and opportunity. The more you think like us, the better your odds are of walking out of a VC meeting with more than some good advice.
Michael Gurau, managing member of Clear Venture Management, can be reached at mg@clearvcs.com. Read more of Michael’s columns at www.mainebiz.biz.
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