Most technology start-ups fail. Yet the prospect of doom hardly discourages entrepreneurs, because the rewards are disproportionately great for those who do succeed. What sets the winners apart? They score well on the five key Ms: Market, Model, Moat, Management and Momentum. Although your original business plan may change over time, it is still an important starting point to attract talent, capital, partners and customers, which collectively provide a platform for growth, change and scale. Here is what investors, employees, business partners and board members look for in deciding whether to back a new venture.
Market: Assessing the size of your opportunity is critical, even though many entrepreneurs give this short shrift. They simply base their plans on top-down statistics and then hope to get X% of the overall market segment. When Dirt Devil introduced a new-generation, high-powered handheld vacuum cleaner in 1984, it was the first of its kind. But if the company had positioned Dirt Devil to take even a small share of the broader vacuum market, it would have been met with much skepticism. Instead, it created a new market segment: quick cleanup at home or in minivans. Consumers bought 23 million units in the first few years because the company pursued guerrilla tactics, such as selling through K-mart and Walmart. Dirt Devil carved out a nice "wedge" in a large established global market, selling 100 million vacuums a year.
Once you have a clear, distinctive offering, try to set reasonable sale prices and growth targets. Typically "your" market will start very small given your unproven offering and your initial position as an aspiring pioneer. But your plan should still try to support more than $50 million of annual sales within five years. As a rule of thumb, your long-term "baseline" plan should assume no more than 10%-to-15% ownership of the overall target market, though an upside case could be higher, perhaps 30%. Seldom will a new firm conquer much more than that. Also, penetrating an existing market usually costs you a multiple of the revenue your share will generate.
Model: The all-important business model includes the assumptions underlying revenue estimates, plus your ability to meet demand and growth. Investors may want to see the business model presented using three different cases: conservative, expected and aggressive. These diverse scenarios will illustrate the full potential of the business around a credible "baseline" operating strategy. This multiple-scenario approach will also help set benchmarks for monitoring and adjusting the business.
Ideally, the model's projections should cover at least five years, because investors typically evaluate their returns over that period. They may give you up to two years to build out the new venture, perhaps another year to reach profitability, and then they expect to see solid growth and profitability. This will allow them to calculate ROI metrics in, say, the fifth year as a basis for assessing the firm's value. Institutional investors will need this for their exit plan and to achieve their portfolio's target returns.
Moat: New businesses must also be able to play defense and create barriers to competition. First, you must build the case that you have indeed a "minimally viable product" (MVP) that is saleable. Ideally, the product has at least a two-year lead over any potential rivals offering a solution similar to yours. Your competitive edge can be a combination of invested R&D, domain expertise, intellectual property, team quality, partnerships, first-mover advantages, etc. To persuade skeptics, develop a clear picture of your current competition and what it might become in the future. If successful, "your" market will no longer be yours alone and quickly attract new entrants as it grows in size.
Start-ups sometimes fail to consider future market dynamics, including how they will sustain their initial lead as the market grows. Often, pioneers don't win the race because fast followers improve the offerings, leaving the original innovators behind with arrows in their backs. This happened to Friendster, Palm, Netscape, TiVo and many others. Large competitors can take the wind out of a young company's sails by commoditizing or marginalizing their offering. Your moat should include a product roadmap that lays out how and where to invest in the future so that you can protect your competitive edge against imitators and disruptors. This roadmap should cover your internal innovations as well as acquisitions. The latter may call for extra funding as a key part of your business model.
Management: None of the above matters if you don't have the right people on board. It starts with committed managers who can execute day-to-day. Entrepreneurial drive, conviction and ambition are all necessary ingredients when starting a new business. The personal motives of the management team also merit attention-- they should entail much more than money. A focus on sales is especially important early on, with a strong leader clearly in charge of generating the revenue that helps keep the doors open. Attracting and retaining seasoned talent is also critical; they understand the learning curve of a new business.
The core team should be guided by people with vision, experience and strong connections, at senior levels. Flexibility is fundamental, since new ventures may have to pivot their business model multiple times before becoming successful. This is where a strong board of directors is crucial to provide the experience, oversight and governance needed to anticipate, recognize and correct problems, as well as to keep many moving pieces, including strong personalities, in their proper balances. The board failed to do this when ousting Steve Jobs in 1985 from Apple in favor of John Sculley. Not surprisingly, Jobs fired almost the entire board after having been invited back as CEO in 1996, following a decade at Pixar and NeXT.
Momentum: Strong margins, steady growth and attractive operating leverage-- flow-down to the bottom line--are your goals. Investors, partners and employees love a business in which profits grow much faster than revenues as the business scales. The key here is demonstrating momentum, since there can be a vast gulf between the theory of a business and its execution. Once your flywheel is in motion, it will power a conveyor belt of talent. Top people like to see their equity grow in value. Apart from sales increases, you can perhaps demonstrate momentum via other metrics, such as growth in your sales funnel, retention and customer satisfaction.
Sustainable growth requires money, since few growth companies can rely on internally generated cash alone. Additional funding can come from multiple sources, such as friends and family (angel investors) or venture capital firms (VCs) whose sieve is usually very fine. A VC may review 1,000 business plans each year and invest in just five. Whatever your funding sources, remember that all key players involved will likely use the 5Ms to assess their level interest in your venture as well as its market value.
Co-authored with Charles Robins, Managing Director, Fairmount Partners, Conshohocken, PA.