This is why investors need to ask about unit economics
You may have noticed that last Wednesday you did not receive your typical weekly edition of Small Bets. This is because, after 3+ years of avoiding it, I finally got Covid. And you guys – newsflash! Covid is terrible. I was totally useless for about a week.
So, what does one do when one is totally useless? Well, mostly I slept. And whined.
But eventually I started to feel well enough to watch some YouTube videos. And one of the videos I watched was the recording of last month's Angel Squad Summit. Maybe not as exciting as Season 3 of The Great, but certainly more educational.
Anyways. The Summit was split into three parts:
- how to evaluate a startup pitch
- a real founder pitches investors
- feedback from investors about that pitch
Through my fever-fuzzy brain, I noticed something pretty fascinating during the Q&A portion of the pitch. One of the investors on the panel – Elizabeth Yin, GP at Hustle Fund – asked Brett, the startup founder, about his unit economics.
The founder of the company that pitched is named Brett Rounsaville. His company, Hiya Shopping, aims to deliver a seamless shopping experience to consumers completely through text.
Here's how it works: users get a text from Hiya about a product that's available for purchase. If they like the product and want to buy it, they simply reply "yes" to the text message. The item is then delivered to the user's house within a few days. Payment information is collected at signup, so the user doesn't have to go through a checkout process each time.
And since the Hiya team purposefully under-buys each item, they always sell out. This creates more demand, which forces users to act quickly if they want the item. There's a lot more to the company, and Brett is super talented at pitching. Highly recommend watching the pitch starting at 22:43.
One thing I love about listening in on Elizabeth Yin's pitch meetings is hearing her questions to founders. She's not shy about asking questions that make some founders... a little squirmy. (Notably, Brett never got squirmy in this conversation.)
In this interview, around minute 41:40, Elizabeth starts asking Brett a series of questions around pricing.
- What's the average cost of the items you're selling?
- How much of the revenue you earn per item goes to Hiya, and how much goes to other players in process?
Then Elizabeth actually does the math. Right in front of the founder.
Based on the breakdown of the company's costs, which were provided by the founder, Elizabeth determines that the company makes roughly $10-$15 on each $50 item they sell. This is before marketing costs, and also doesn't account for Hiya's additional revenue streams.
So, why is this interesting?
Some of you are probably thinking... what's your point here? Why is this line of questioning worth an entire newsletter? Well, here's why.
When you're new to investing, it might feel a bit uncomfortable to dig into the unit economics of the business you're evaluating. This is especially true when the founder is charming, when you love the idea of the business, or when the tech is really cool. Sometimes we get so excited about the possibility of what can go right that we forget to ask the tough questions.
But remember: 90% of startups fail. And some of them fail because the unit economics of the business don't work. The profit margins are too small, the CAC is too high, and – too often – this is evident from the very beginning.
This is why we have to ask the unit economics questions. And why we have to do the math. Asking the unit economics questions shows us the founder knows their metrics. And doing the math tells us how easy or difficult it'll be for the founder to reach profitability at scale.
In the case of Hiya, founder Brett had already started thinking about unit economics. That's why he's built multiple revenue streams into the business.
But even so – as Elizabeth is doing the math in front of Brett, you can see the wheels spinning in his head. He sees that the why behind the company isn't all that matters. The how is equally important if he's going to raise his round.
The other reason this is interesting
The other thing Elizabeth did during Angel Squad Summit was give Brett some advice. She suggested that he consider removing the shipping costs altogether by having customers pick up their items from a local pick-up spot.
That suggestion wasn't the interesting part, though (no offense, Elizabeth). What fascinated me was Brett's reaction to that suggestion. Investors who aren't on the cap table often offer advice to companies during a pitch. And a founder's reaction says a lot about what it's like to work with them.
"How dare this person tell me how to run my business? She barely knows anything about it – I know what I'm doing, and she doesn't." might be written all over their faces.
These are founders who aren't coachable. Who don't accept suggestions from other people. Who aren't willing to accept that they're not the smartest person in the room.
But when a founder reacts more positively, it's a sign that she/he is coachable. Even if they don't take your advice – which frankly might be terrible – a founder who considers other people's ideas is open to finding ways to improve.
And that's a big green flag.
By the way
If you wanna watch the Angel Squad summit, you can do that right here.