Five Star Startup Economics
This is the sixth in a series of articles on what it means to be a Five Star Startup. In my first article, I explained the five dimensions that most startups are evaluated on. In my second article, I described the first dimension, what it means to have a Five Star PRODUCT. In my third article, I described the second dimension, what it means to have a Five Star MARKET. In my fourth article, I described the third dimension, what it means to have a Five Star TEAM. In myfifth article, I described the fourth dimension, what it means to have a Five Star STRATEGY.
The fifth (and final) dimension is ECONOMICS. In this article, I will describe five star economics (in my system of evaluation) and offer some of the underlining criteria by which you can score the fundamental economics of your startup. Here we go:
You are absolutely clear about how you are going to make money. Your business model has been validated by real customers who have the willingness and ability to pay for your solution. And there is enough of them to achieve and sustain profitability – or to at least position your startup for an attractive exit. You have charted a business model canvas that outlines the key activities required to generate and grow revenue. Whether you are B2B or B2C, your customers are motivated by the economic benefits (ROI) that your products and services provide to them over other solutions.
You have created at least one predictable revenue stream. You have proven that revenue is repeatable and scalable, either recurring from existing customers at regular intervals, or growing from a steady stream of new customers – preferably both! You have begun to develop and test top line assumptions for additional sources of revenue that can fuel growth and reduce dependencies on a single source of revenue. You have crystallized these revenue streams and assumptions into a cash flow forecast with 3-5 year projections. Your costs are mostly variable, your financial model minimizes the requirement for fixed or long-term expenses.
You know how much capital is required to achieve break even, or at least the minimum amount of money needed to achieve the milestones that will ensure follow-on investment. You have a budget that details “use of funds,” with a 50% cushion for the unexpected. With the appropriate level of financing, you can safely operate for at least 18 months without running out of capital – and that will be sufficient to get you to the next stage. Once the money is raised, investors have confidence in your financial discipline and money-management skills to spend it wisely. You know that the single biggest mistake a startup founder/CEO can make is allowing his/her company to run out of capital.
Your valuation and terms of investment make economic sense to new investors, but don’t put the founders or team at an economic disadvantage. Your valuation is at least 3X the amount of money you are raising, otherwise the long-term economics won’t likely work for your current investors or for your team. There is a high likelihood that the amount of capital you are raising will accelerate growth and increase the valuation of the next round by 3X….5X if you crush it. When discussing valuation with investors, you are not simply pulling numbers out of the air. You have a sound economic rationale and independent validation of your startup’s value.
After all the economics of financing have been weighed, you are not one to be penny wise and pound foolish. You are smart enough to know that the right investor at a slightly lower valuation is far more important than the wrong investor at a higher valuation. And you know the difference between the two. You would rather be a company-builder than a full-time fundraiser.
Finally, you understand the timing and economics of a favorable exit for your investors. As much as investors like you and your vision…as much as they know your company is your passion and perhaps your life’s work…they don’t want to be along for the ride for the duration of your natural life. You have the character to put their economic priorities above your own. That means selling your company, going public, or creating an opportunity for your early stage investors to be bought out by later stage investors with a nice return.
You can articulate the top 3 most likely acquirers. You know what these companies have paid for other startups and the economics upon which those decisions were made. You know what has to be done to put your startup in a position to be acquired, or to go public, and you know the time horizon. And everything you are doing…every decision you are making, increases the probability of an economic windfall for your team and your investors. You are starting with the end in mind.
Score the following criteria on a scale of 1 to 10, with 10 being the highest. Try not to use the numbers 4, 5, and 6 – they are fudge numbers. The economics of your startup are either superior, or they are subpar:
____ Your business model has been validated by paying customers and your solution delivers them a demonstrable return on investment.
____ You have charted a business model canvas with the activities necessary to generate and grow revenue.
____ You have created at least one predictable revenue stream that is scalable and repeatable, with plans to create multiple revenue streams.
____ You have proof that your top line assumptions are achievable and have 3-5 year projections showing the trajectory of your business merits outside investment.
____ Your costs are mostly variable, you have minimized the need for fixed and long-term expenses until the company has achieved profitability or otherwise becomes bankable.
____ You know how much capital is required to achieve break-even, or the milestones required to attract the next round of financing, and you have budgeted for adequate cushion to get there.
____ Your valuation and terms of investment make economic sense to new investors, as well as protecting the long-term economic interests of your team and existing investors.
____ You are focused on finding the right investors, not just any investors, and you know that every day spent raising money is one less day building a successful business.
____ You understand the needs of your investors to see a healthy return from their investment in your startup and you are committed to their time horizon for exit.
____ Every decision you make, every action you take, is designed to produce an inevitable economic windfall for your team and your investors. You are starting and funding every stage of your company with that end in mind.
Total your score, divide by 10. If your score is between 7 and 10, congrats, you have Five Star Startup Economics!
My final article in this series will discuss the role of timing and alignment between the five dimensions. Stay tuned…