This past week I started teaching a course about strategy and the CEO to 40 MBA students at Babson College in Wellesley, Mass. One of our topics was the CEO’s role in creating shareholder value.
We tackled the question for startups as well as public companies. We discussed the nine tests that entrepreneurs must pass in order to get a big check from a venture capitalist. (I came up with these criteria after interviewing startup investors for my book Hungry Start-Up Strategy.)
These tests are used by investors to decide two broad questions: Is the venture targeting a market that’s now small but expected to get big fast? Is the entrepreneur a great CEO?
Operating in a market poised to explode with growth. If your startup is pursuing a market that’s already big, it will face lots of other rivals. And that means the venture capital firms will be competing with other such firms that have already invested in the market, thereby raising startup valuations and reducing their expected investment profits.
Venture capitalists want to invest in a company targeting a market that’s small now but that will become big fast because that means they and the startup are likely to face less rivalry at the beginning. Therefore, the startup will be valued less and the venture capitalist will be able to boost potential returns.
Startups can be proactive when seeking capital by learning to think like the venture capitalist will.
To test whether your company will appear to a venture capitalist as being in a market poised to explode with growth, obtain objective data to answer the following questions:
1. Does your startup deliver so much benefit to customers that many of them would be willing to pay you more than it costs to produce and deliver the product?
2. Will rapidly growing technologies (such as smartphones or virtual reality machines), business models or social changes (like retirement of many baby boomers) boost demand for your product?
3. Will potential customers take a risk on doing business with your startup because they have a significant unmet need that no other companies are solving?
4. Are leading companies (such as Google or Facebook) already working to solve the problem?
Assessing if the startup is led by a great CEO. If your startup is going after such a market, the venture capital firm wants to know that your company can operate well enough to take a big share. To pass that test, you must be able to devise a great product and attract and motivate industry-leading talent. In short, if you are the head of your company, you must be a great startup CEO. Here are some additional questions to answer in this regard:
5. Do you have a winning track record (such as having been the captain of a successful sports team or having sold a previous startup at a huge profit) and the passion to keep winning?
6. Can you identify and manage business risks like growth outstripping your team’s capabilities or a competitor stealing your great product idea?
7. Are you smart and curious and do you learn by doing lots of inexpensive tests of your guesses about which strategies and tactics will solve your pressing business problems?
8. Do you know more about your industry than your rivals and can you articulate a compelling vision for its future?
9. Do you have charisma, integrity and the ability to attract, hire and motivate top people?
If you can answer yes to all these questions, you should have no trouble raising millions in capital.
Chances are good that you’re scratching your head and wondering how you could possibly come up with the answers in a way that would not come off as empty bragging. If you’re in that camp, get out and talk to people who know the market and who have worked with you.
Talk to customers and industry experts about your product idea. If customers think your product is a must-have-now item and industry experts are nervous about the potential competition, then you are on the right track.
And to settle the question of whether you’re a great CEO, ask your colleagues if they consider you to be one and can provide compelling examples of positive answers to the last five questions.
My students were particularly daunted by the five tests of being a great startup CEO. I reassured them that the most important of these tests is the ability to hire and motivate an A team. If a startup CEO can do that, he or she can hire others who can excel in the other four areas.
My students are humble but I hope by the end of the semester to have helped them see that they can flap their wings and fly out of the nest to achieve startup success.