Evaluating an early-stage startup's solution
Becoming a successful VC means getting good at a lot of different things:
- building dealflow
- managing the operations of the fund
But I think the most important thing might be: getting really good at evaluating companies. This is probably obvious, but being good at evaluating companies is a critical step toward building a world-class investment portfolio.
When the investment team at Hustle Fund evaluates a startup, we look at 5 things:
Evaluating each of these categories is an art form. Or maybe a science. Or maybe it's art-meets-science.
We've already talked about how to evaluate an early-stage startup team. You can read those articles here and here. Today we'll cover: how to evaluate solution. Yes, I'm skipping "problem" for now. Don't worry - we'll be back.
Ok, let's dive in.
Elements to look at
When you're looking at a company's solution, we recommend keeping in mind these 3 things:
2) the process of switching to a new solution
3) product roadmap
Differentiation is perhaps the most critical part of a startup's solution. If a startup isn't 10x different and 10x better than what's already out there, the team is going to have an extremely difficult time acquiring customers. When it comes to evaluating differentiation, it's critical to understand two things:
1. what other solutions are on the market?
2. what are other non obvious solutions?
Let's pretend we're looking at a startup that aims to help marketers better measure their marketing campaigns. Current SaaS solutions out there are things like: Hubspot, Funnel, Google Ads Manager, etc. But there are non-obvious solutions as well, like: hire a freelancer, assign a team member to track manually using Excel, etc.
Understanding all the options available to potential users will help you think critically about whether or not this is is a problem people will pay to solve... and how that will affect customer acquisition costs.
Cost of switching
There is a financial cost and a time cost to switch from one solution to another. If these costs are too high, or if there's too much friction to make the switch, the user probably won't make the effort. Here are some questions to ask the founder, particularly for B2B startups.
- are users likely to be locked into a contract with a different provider? What will it cost them to break that contract?
- how much time will it take to switch to the new platform?
- how much employee bandwidth is required to switch to the new platform?
- what's the cost to your team to help users make the switch? Will you offer a white-glove service? What will that cost you?
Answers to these questions will give you a better sense of how easily (or not) it'll be to actually close a new customer. If switching to a new platform has too much friction, the startup will have a very hard time onboarding new clients.
For early-stage companies, the product roadmap may be vastly under-developed. And probably this is ok.
That roadmap will become more clear as the founders get better insights into their customers' biggest pain points. But it's still important to ask about product roadmap for the next 6-12 months.
Now, there isn't one right answer to this question. But the founder's answer will tell you a lot about how they're thinking about the next phase of the company.
Are they focused on building an audience that they can then monetize?
Are they focused on simplifying the onboarding process so they can boost their revenue?
Are they building the product based on feedback from their beta users?
Or... red flag alert... are they not focused? Maybe their answer will tell you that the team isn't aligned at all, and they're all rowing in different directions.
Whatever the answer is, asking this question should tell you quite a bit about the founder's ability to focus on the most pressing issue facing the business right now.