How to Evaluate Your Startup Idea
Tags: Founders, Startup Lessons, Entrepreneur, Startup Ideas, Startup

Guest post from John Auckland, Founder at Tribe First.

“All truly wise thoughts have been thought already thousands of times.” -Goethe

They say that all good ideas have been thought of before. But before you tear up your business plan, take heart from the fact that an idea itself is actually far less important than the execution and the team behind it.

So often we see founders become heavily fixated on their product, leading to blind spots around other success factors. They assume that a good product will be adopted by the market and that’s enough to get investors, and the crowd, climbing aboard.

They also fail to ask what type of business they’re building, in particular:

Is this a solid business idea? Is it a lifestyle business or one that can grow quickly towards a large exit? Will it benefit from seed funding, or indeed crowdfunding?

So, how can you effectively review your idea and everything that sits around it? We’ve written a handy guide to help you navigate through the various ways of evaluating a business idea.

Good Business Test

Before investing too much time, and well before going to look for investment, you should consider all the critical factors of your business and ideally find that it has a distinct advantage over the competition. This might come from targeting a neglected niche, holding a USP protected by copyright, or simply having a stellar team and a head start.

Luckily there are many different business frameworks that can help you assess your company’s position and it’s relative advantages and vulnerabilities, be that SWOT, PESTLE, Business Model Canvas, or Porter’s Five Forces. These frameworks can help you understand the full picture surrounding your business — just pick the one that most suits your style, or blend a couple until you’re fully happy with the feedback you get from investors and/or advisors.

We’ve listed out the various tools we recommend for identifying, evaluating and articulating your proposition.

The Business Model Canvas

Rather than acting as a checklist, the Business Model Canvas helps you to map out your entire business model into one page. There are many templates you can download and fill in yourself, which will leave you with something that looks like the below:

Image by Business Model Alchemist

You should be able to fill in each of the nine building blocks easily, and crucially, understand how they all fit together. This isn’t just a model for startups, but for businesses of any size to reassess, rebuild and refine. Here’s a great 2-minute video explainer from Stratagyzer, which shows you exactly how it works, and in the most visual way possible.

Porter’s Five Forces

This simple framework gives structure to the way you think about competition and competitive forces, is there a supplier who could scupper your profitability or enter the market?

SWOT and PESTLE

Perhaps the most widely used (and misused) tool out there, the humble SWOT (Strength, Weaknesses, Opportunities, Threats) analysis can offer insight into the internal and external areas a company might need to focus on, whether to mount a defence or better exploit strengths. PESTLE, often completed alongside and feeding into the OT of SWOT, gives an outward-looking view on the conditions (Political, Economic, Social, Technological, Legal and Environmental) which might impact the business’ ability to succeed.

Seed Funding Test

These tools can be hugely helpful, but even if your company comes out with flying colours, a good business doesn’t necessarily equate to a good investment. Seed investors are entering a high-risk illiquid venture, and so they’re looking for a credible plan for future liquidity. If the business is so reliant on the founder, is an exit likely? Are there potential buyers out there or is the scale needed for an IPO realistic? Also, does everyone important in the process, the founders, managers, employers, shareholders, and even customers and suppliers, share your vision for an exit?

Ultimately your business needs to have the potential to scale rapidly, and everyone needs to be on board with this aggressive growth to exit. Models like the 7+1 test provide a good litmus test for the type of businesses which may be able to make it.

The 7+1 Model

The 7+1 Model is a good way to test whether your business stands up to scrutiny from an investor, Business Angel, or Venture Capitalist (VC). The model itself was designed by serial entrepreneur and VC, Dr Patrick Berbon, whom in-turn, gave his blessing for Stéphane Nasser to publish this great Medium article about how to apply it to your own startup.

To break it down, the “seven” assessments you’ll need to make are:

What is the problem — or “customer pain point” — your business is addressing? Why is your idea the best solution? Why is it the most profitable solution? Who’s in your team and why are they best-placed to implement your business plan? Why is now the best time to invest in the project, and why hasn’t it been executed previously? Can your business be scaled into new geographies and markets? Can you offer investors a strong chance of an ROI that’s worth their time and money?

Nasser then boils the “magic formula” down to its very essence: “The right team and timing to apply profitable, scalable, capital-efficient, superior solutions to large pain points in the market”.

However, he adds a few caveats. The model is designed for business aiming to become market leaders, and the formula only works if you can answer every question correctly, and execute your plans effectively.

Testing the solution is tricky. Most founders create a solution to a problem they’ve personally experienced, but that doesn’t mean other people have experienced it as well, or that there’s a big enough market to create a viable business. Has the pain point been shared by a large enough market who could adopt your solution?

Ultimately these are some of the key questions an investor will judge you on.

Modelling Your Business and Evaluating Your Model

A good place to start is to review this study of 200 pitch decks by Harvard Business School and DocSend. They studied all the elements investors spend their time looking at. Skip to slide nine, and you’ll see that investors put most of their focus on the financials, then the team, followed by the competition. The order of these should be taken lightly as it takes less time to read a bio than understand financials.

So what are investors looking for in a model and pitch deck?

A competent, experienced and diverse team. Depending on the business, different expertise is needed, but someone who is credible on financials is usually a mainstay. That you know your competition. Investors typically want to see your place in the market, how are you different from the competition — do you hold an advantage and understand how protectable that is? Clear financials that tell a story. Forecasts should offer insight into the margins and potential profitability of the business, present a strong but realistic projection of growth, and also feed into the valuation calculations.

In terms of evaluating your numbers, the best way to test your model is to play with the sensitivities. A more sophisticated investor will want to probe the variable factors of your financials, such as:

Compound Annual Growth Rate (CAGR)

Cost of Acquiring a Customer (CAC)

Lifetime Value of a Customer (LTV or CLV)

Profit margins

Overheads

Market penetration

When briefing an accountant to build a model, it’s worth mentioning that you might like to play around with some of these success factors. For example, this will allow you to see if you’re still profitable if the industry sees a slowdown, or if your cost per acquisition jumps right up. Above all else, investors will want to understand whether the numbers stack up. They will want to see them make sense, appear realistic and ultimately lead to a fair valuation.

Crowd Validation

Along with passing all the other tests, there is one additional validation that many people overlook: crowdfunding your idea. Should you choose to raise funding in this way, it will also bring the additional benefit of demonstrating significant early adopter interest. In many respects crowdfunding is the market voting for your idea with their wallets, so while it’s a great way of raising funds, it’s also a highly effective way to indicate the potential longevity to your business model. Seedrs alumni, Awfully Posh, used crowdfunding to demonstrate there was demand for two different trends in snacking, premium snacking, through London Crisp Co., and personalising flavour, which they achieved with their Create a Crisp brand. By having a series of highly successful crowdfunding campaigns, they were able to prove the direction the market was moving in.

A successful campaign is one that doesn’t just hit its funding target, it also brings on hundreds, if not thousands, of new investors, who not only validate that your idea is ready for the mass market, but also provide you with the kickstart you need to make your idea a reality.

Bonus Tip — Eliminate Bias From Your Feedback

Your friends and family, and indeed most people you speak to, won’t be great critics of your idea. It’s human nature to tell someone what they want to hear, not what we really think. If you ask someone if your business is the next best thing since Revolut, nine times out of ten the answer will be ‘yes’. So you should look for wider feedback from people who aren’t just telling you what you want to hear, or who stand to gain something from working with you. There’s also a way you can eliminate a founder’s worst enemy: evaluation bias.

I could write an entire guide on this subject alone, but since there isn’t enough space I will simply redirect you to Rob Fitzpatrick’s wonderful book on this very subject, The Mom Test, which explores ‘how to talk to customers and learn if your business is a good idea when everyone is lying to you’.

Summary

“The way to get started is to quit talking and begin doing.” - Walt Disney

With all this said, there is only so much that can be done on paper, and for an early-stage company to stand up to scrutiny, test trading or a soft launch may be the best way forward to test out your assumption and whether you’re capable of hitting your KPIs (key performance indicators).

It’s important to note that this guide takes analysing and evaluating to its most extreme. Most founders develop their product and then complete some basic research around their market. But go deeper, think critically about your strategy and work out where you fit in the market. By doing this, you’re far more likely to be able to raise money for your venture, and ultimately make it a resounding success.

Good luck!