How to evaluate a business idea

Startups Strategy

Posted by Enrico on Jul 23, 2016 1015

It is estimated that 75% of all startup fail and only a few of the remaining 25% gets a successful exit. Either as an investor or as co-founder, if you embrace the idea you’ll be stuck with it for the next 5 to 10 years. Therefore it is very important to carefully analyze an idea before just jumping into it. Analyzing a business idea is not easy and many parameters have to be taken into account. I personally think that the overall chances to succeed are connected with the following parameters: IdeaPotential, BusinessModelQuality, ClientsAcquisition, Team, Competition, CurrentMetric and Luck

Since you cannot decide how lucky you’ll be, I decided to leave this out of the equation. The final formula will be something like:

Chance to succeed =  MarketPotential * BuseinssModelQuality * ClientsAcquisition * Team * Competition * CurrentMetric * Luck

where all the parameters are rated from 0 to 1.

This means that the chances to succeed will be close to zero only by the fact that one of the parameters is close to zero. For instance, only the fact that the team is not good enough can mean that the startup will fail. In the following paragraphs, I describe some of the typical questions that I ask to set the score for each parameter. Of course, those are very basic questions. You should dig even further by asking field related questions. For this, you’d need to be an expert yourself in the field or ask a domain expert to assist you.

In practice, every time I have to evaluate a business idea I ask myself the following questions one by one. If I’m not able to answer all those questions exhaustively or if the result isn’t conclusive I just discard the idea and I move to the next one.

The potential of the idea

  • What is the company going to do exactly?
  • What is the problem/pain that the company is trying to solve?
  • How is the idea going to solve that problem?
  • Is there any competitive advantage compared to the competition?
  • Is this a potentially multimillion dollars idea?
  • What is the market size from the top down?
  • What is the market size from the bottom up?
  • What can go wrong?
  • Is the technology doable?
  • What will be your main problem in 6 months?
  • What additional field the company can expand into?
  • Is trust in the product/service an issue?

Business model

  • What is the revenue model?
  • What could be the expected income?
  • What is the investment needed?
  • When will the company be ramen profitable?
  • Why do that now and not in two years?
  • Who could be interested in buying the company?

Clients Acquisitions

  • Who will be the first paying customer?
  • How will the company reach new clients?
  • What is the acquisition cost?
  • When will the company have the first paying customer?
  • What is the customer lifecycle value?

The team

  • Have the co-founders already did something impressive?
  • Why did the co-founders join?
  • How long did they know each other?
  • How many things have they done together before starting up?
  • Have they already succeeded something together?
  • Do they have domain expertise?
  • Do any of them have experience in the entrepreneurship?
  • Have they already raise money?
  • Have they already exited a company?
  • Are they complementary?
  • Do they need extra people in the team?
  • What offer would you accept to sell your company?
  • Are the co-founders willing to pivot into something else?
  • Do they already have an established network?

Competition

  • Who are the competitors?
  • How many are they?
  • Who is the most dangerous competitor?
  • What is the concentration of the market?
  • Is this a chicken and egg problem?
  • How are you going to solve chicken and egg (if relevant)?
  • What would make reluctant users/clients try you out?
  • Why are you better than the competition?
  • In which way you are unique?
  • What is your competitive advantage?
  • Who can become a competitor?
  • What are the possible substitutes?

Current metric

User/client acquisition:

  • What is the growth like?
  • Is it linear? is it exponential?
  • Is there a type of user/client that is more difficult to attract? which one?
  • What is the bottleneck?

Engagement:

  • How many users/clients fully use your product features?
  • What is the liquidity like? (Ratios suppliers-selling-to-demand-requests-ratio; provider-to-customer-ratio; repeat-purchase-ratio)
  • What is the gross merchandise volume (GMV)?

Retention:

  • How many users/clients are coming back more than one time?
  • What is the average time between visits/sales for the same user/client?
  • How will you improve your users/clients retention?
  • What is the 1-to-10 net promoter score (NPS)? With less than 7 a customer would talk negatively about your product/service.

Luck

Now, don’t forget luck. Some people tend to be more inclined to luck than others. Some seem to be systematically lucky. If you look deeper, they attract luck because they put themselves in a favorable condition to be lucky. They work harder than others, they never give up and they fight till luck eventually plays its role. My point here is that no matter the business idea, luck will have a word to say as well. And if you want to maximize the chances to get luck on your side, you’ll need everybody in the team to put themselves in a favorable condition. This means working harder than others and never give up.

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    Enrico Tam

    MBA, PhD, tech entrepreneur, maker

    Hi, I’m Enrico and I started hacking at 9 years old back when it was Visual Basic. After trying to become a professional tennis player I somehow got entangled in a PhD in engineering, an MBA programme and a big consulting fir... (continued)

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