Week 3 – Evaluating

Reading this chapter was enjoyable, and I’ll tell you why: insight! There were many great insights to the evaluation process from the eyes of an angel investor, but one aspect really hit home with me. That concept was risk. I had always assumed that risk was one general idea and more of a gut feeling, rather than something investors spend time looking for. It seems a bit strange, from the point of an aspiring entrepreneur, that investors would spend so much time looking for ways that the business won’t work, rather than reasons why it will. To be fair, investors certainly look for both, but I can imagine investors spend so much time looking for faults because of the monetary risks and the idea that “an A entrepreneur with a B project” is still a good investment.

According to Winning Angels: the 7 Fundamentals of Early Stage Investing, there are 8 types of risk that an investor should be looking for during the evaluation process. These types of risk are: technological, product/service, market, sales, competitive, financing, operating, and people. Who knew there were so many?

Technological risk is “the risk that the technology will not work, is irrelevant, or will be surpassed soon in a significant way” (105). Tech companies are becoming a dime-a-dozen nowadays with the way society is becoming more dependent on technology. As with all entrepreneurs, there has to be something about your business that sets it apart from others. In technology, that could be a completely new type of technology, a system that makes things easier or cheaper, or a system that operates much faster than previous versions.

Product/service risk is “the risk that the company’s product or service will not work” (105). Every business wants to focus on customer service, right? Treating your customers well will keep them coming back. In fact, many businesses in the sales industry depend on customer satisfaction surveys to maintain funding, or even keep their jobs! A company that only looks out for themselves is missing the most important aspect to running a business…the customers. Entrepreneurs who run businesses that are not concerned with the satisfaction of the customer, outside of satisfaction with their product or service, is destined for failure.

Market risk is “the risk that the market will not accept the product/service on a significant scale and the risk that the market will change” (105). Think about the Virtual Boy system, from Nintendo, that debuted in the mid-90s. Never heard of it? That’s because the market was not ready for 3D gaming yet. Virtually everyone has heard of the Samsung Gear VR, or Playstation VR…that’s because it’s now time for the market to accept 3D gaming. If you’re product is too early, or too late, it doesn’t matter how good it is…it won’t be successful.

Sales risk is “the risk that the sales process will not work or will be too costly” (105). A good example of this is comparing franchising to just opening a chain of corporate stores. Sometimes an entrepreneur starts a business with the franchising model in mind, but it may not be the best model for their business.

Competitive risk is “the risk that one or several competitors will get an unapproachable lead or dominate the market early or take some action to create a barrier to entry, such as securing a business process patent which prevents the company from operating” (105). Competing with an established business that has a lot of money can lead to this type of risk. If you want to get into the fashion industry, what stops someone else from mass producing your product if it catches on?

Financing risk is “the risk that the company will not be able to raise further rounds of capital” (105). There are a number of reasons why investors would not want to invest in your company, no matter how successful it is. Read about Dov Charney if you need to learn what NOT to do.

Operating risk is “the risk that management will not be able to competently or cost efficiently operate the company” (105). What you are spending your money on to keep your business operating is one of the most important things an entrepreneur can do to make sure the business is successful. Investors want to see that an entrepreneur is spending their money appropriately.

People risk is “the risk that key people will either not perform or will leave the company” (105). Read more about Friendster and learn why changing the CEO more times than your socks is detrimental to success. The founder was ousted early on, then the company lost all of it’s traction in a field it created!

 

Source

Amis, David and Howard Stevenson. Winning Angels: the 7 Fundamentals of Early Stage Investing. Pearson Education Limited, 2001.

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