The current economic crisis marked the end of the Web 2.0 era and the comeback of the “Business Model”. Having a business model is no longer enough: it better be solid if the company wants to survive the current downturn. Even with millions of users, Facebook and YouTube still struggle to monetize their traffic.
So when does a good business model translate to a tangible investment?
As the venture capital pool dries up, I recommend start ups to get the mindset of an investor. Suppose you were a venture capitalist considering an investment in a company that offered:
– a clearly specified product or service (and I can’t stress “Clearly specified” enough)
– with a large potential number of paying customers (paying doesn’t have to be through a direct purchase, but you still have to make money somehow)
– at a price well above what it would cost to produce and had the know-how and means to deliver this product/service at a handsome profit (meaning that you would earn more than you spend while getting customer satisfaction)
Would that be enough to make an investment decision? What else do you need to know?
You would probably need a good business model. One that offers genuine choices of:
1) Who is the target customer? Why was that segment chosen?
2) What is the product? What would the company consider as a conversion? Is it registration or click on an ad? the choices a start up makes in the product development process are critical, and they need to be aligned with the company’s strategy
3) How is the company planning to deliver the product and maximize margins? Would you be interested in a road map? Does the company have a marketing plan? How is money allocated? This step goes even deeper, to the hiring decisions and business development efforts that the start up is planning to take.
Answers to all of these questions should be easily found in the company’s business plan. An investor doing due diligence would probably go one step further. First, make sure you can pass the ‘narrative’ test – meaning that your product choices coincide with the brand and customer, creating consistency across the brand. Then, only after everything else seems to ‘make sense’ you will have to pass the ‘numbers’ test. Investors will look for consistency here as well, and even though cash flow numbers are only projections, they will verify that the financial statements in the business plan add up. External consistency is needed as well, so make sure you’ve got the latest market knowledge. Plan your projected sales numbers conservatively, and base them on research reports from eMarketer, Forrester, PEW, Hitwise, Gartner, etc. Finally, a business model alone is not enough, it must be part of a strategy, that also addresses competition, differentiation and barriers to entry.