Good Idea? Good Business? Good Investment? A Venn Diagram

I’m currently winging my way on the friendly skies to Washington DC to act as a judge in the MedTech Innovator East Coast Pitch Event. Between this and teaching my UC Berkeley healthcare venture capital class and a few other discussions I’ve had lately about how investors think (really, they do…mostly),  I’ve had numerous opportunities of late to talk about what I believe to be the biggest question that needs to be answered in this work:  is the opportunity being considered a good idea, a good business and/or a good investment.  The ability to identify the difference between these three possible states is really the essence of the role of a venture capitalist, business development executive, an entrepreneur or anyone who is going to spend time and money evaluating, leading or investing in a so-called innovation, at least in my opinion.

I have to say that as a percentage of all opportunities, it is the rare animal that hits the goodness trifecta.  There are lots of good ideas out there; there are also an amazing abundance of bad ideas being packaged as good ideas.  It’s been a long while since I wrote a blog post summarizing some of the silliest things I’ve been pitched, but let me tell you, there are some real crazy ones.  One person’s great idea can be another person’s WTF?  But honestly, it is sometimes hard to tell those two states apart without a lot of data and squinting.

I remember the first time someone told me about Uber.  I remember thinking, “So you’re telling me that random people are going to drive up in their car and I’m just going to get in and hope they don’t murder me? I don’t think so.”  And yet, in the first quarter of this year I spent something like $750 on Ubers in cities around the world and so far, still alive.  These days, all some stranger needs to do is say “are you Lisa?” and I jump in their car without a care in the world.  My mother would freak the heck out. Getting into strangers’ cars was definitely on her “What?! Are you an idiot?” list of never-do things.  If my daughter told me she was going to get in some random stranger’s car because he drove up in front of her house and knew her name, I’d be thinking, “Oh no! What I just said inside my head made me sound exactly like my mom – kill me!”  But if she told me she was grabbing an Uber? Well, bon voyage kiddo and don’t forget to borrow their phone charger.

To a large degree, good ideas are in the eyes of the beholder; but fundamentally whether something is a good idea can be determined objectively by an old-fashioned thing called sales.  If the dogs eat the dog food, it’s a good idea.  When lots of people flock to pay money for something, it is clearly solving a problem, real or perceived.  Lots of people paid cold hard cash for over 1 million pet rocks and to buy metallic water bottles that hold 6 billion ounces of water.  Not my personal notion of good ideas, but hey, who am I to judge.  But just because something is a good enough idea to attract revenue does not mean it is also a good business.

What is a good business?  It’s one that achieves the goal that the business owner(s) hoped to achieve.  In venture capital that is often determined by achieving great penetration and meteoric revenue growth in a massive addressable market.   But social impact investors may define a good business as one that achieves maximum social impact and has the ability to do so at large scale and sustainably, even if profits are immaterial.

Individual business owners may define a good business as one that gives them a satisfactory living wage and personal happiness.  There’s a couple down the street from me who run a dry-cleaning business.  It’s pretty busy and there’s often a line, so it probably does reasonably well financially.  The couple are married and seem to love working together.  They walk to work and home together, are open 9-5 and are closed on Sundays.  Every time I am in there they seem pretty happy, even when busy.  This is not a business that is going to change the world, make a billion dollars or create a major paradigm change.  But it is convenient and solves my personal gaping market need of having to shorten the sleeves and hems of every piece of clothing I own. The total addressable market for the dry-cleaner is the few thousand people that live in our neighborhood, nothing more.  And my guess is that they feel this is a great business for them.

Too many people in the venture/innovation community forget that 99.9% of all American business are really small businesses and those can create real happiness and wealth for their owners, who are free from dealing with annoying people like me.   Note that there are over 32 million small businesses and only about 54,000 venture-backed businesses. We in the venture world are only dealing in a microscopic slice of business reality. Of those 54,000 venture-backed companies, 53,999 of their CEOs are cursing out their investors right now.  The other one is still asleep.

So a good idea is one that garners a lot of paying customers, logical or not.  A good business is also one that makes a good income for its operators and owners.  These two things are precedent conditions to, but not the same as, the definition of a good investment.  A good investment must produce a measurable and meaningful return on investment (ROI) to those who put money into the business and deliver that ROI in the time frame that the investors expect.

When a small business owner puts their own money, or that of their friends and family, into a business, the return expectations may differ from those that a venture capitalist has.  For my dry-cleaner friends, I’m guessing they aren’t measuring ROI the same way I would.  For them it’s more about current income and the life that income allows them to lead.  Are they counting on getting a 5x cash-on-cash return when they retire and sell the business? I doubt it.

But when I and my VC colleagues invest millions of dollars in a business, we are betting on the Hard 8, not the Come Line (fyi: these are craps terms and if you think that VC investing is not the same as craps, you are incorrect; the odds on the Hard 8 are 10:1; the odds on the Come Line are 1:1).  Fundamentally we are thinking that we have done enough research to say: Good idea? Check! Good business? Check! Good investment? I am 5 times my capital investment to roll back in about 8 years from now or so, maybe 10-12 if it’s a healthcare business. Now roll those dice! And that assumes that the people who work at the target company are making a good wage and that this not only does not conflict with my returns, but amplifies them because I’m paying great people who will leverage up the value of my investment.  VCs don’t count the current income of the business in our returns; we count that money as the cost of doing business to get our returns.  When do VCs know if a good idea/business was a good investment? They know the day they sell the business or exit the public stock they got in an IPO.  Until then, it’s all prayer and dice rolling.

If you want a great example of the great idea/business/investment concept, look no further than the Taylor Swift Eras Tour.

• Great Idea? Well, it seems that over 4 million people have so far paid more than the cost of a car payment (and often more than a mortgage payment) to get one ticket, so clearly people are into this idea. It is one of a few types of products that is desired across the globe, spanning 152 shows across 5 continents.  I have a hard time believing that Pet Rocks had this much demand.  I wonder if there remain any indigenous tribes in the Amazon who haven’t been humming Bad Blood while tending their crops. Penguins in the Arctic are a little ticked off at having to travel to Australia to see the show.  Two telling statistics:  Ahead of the second leg’s presale on August 11, 2023, Ticketmaster estimated that 14 million users were vying for roughly 625,000 tickets; approximately 31 million people registered for the Toronto Verified Fan presale (more than 77% of Canada’s population, eh?!).  The tour sold over 4.3 million tickets by December 2023 and, in addition, more than 4.4 million people had also streamed the movie of the tour.  That doesn’t count 2024, when more than 80 additional shows are planned.  Demand? Check!
• Great business? Oh, hell yes. This is the highest selling concert tour of all time.  It had grossed well over $1 billion, with a B, by December and should do between 2 and 4 times that, depending on who you ask, in 2024.  Taylor herself gets $10M to $13M per show.  So I’m guessing that she is pretty happy with her personal income.  That doesn’t even include the impact on sales of her music or any other tangentially related items.  Never has one concert tour produced so much indirect economic benefit that doesn’t even go to Taylor Swift. It is estimated that the concert will “generate $5 billion for the U.S. economy. At the same time, the U.S. Travel Association said that figure may be closer to $10 billion when factoring in the indirect spending of consumers who may not have actually attended the concerts, but joined in on spending around the events.”  Judging by my interaction with the concert (I am one of those people who saw the movie and then went to see the actual concert live in Melbourne, Australia, joining her biggest audience to date, nearly 100,000), the real winners in the indirect economy are people who make things with sequins.  Every concert attendee with X chromosomes, and even some with Y chromosomes, was wearing something adorned with sequins.  If sequins were alive, they would now be extinct because of Taylor Swift.
• Great Investment? Who knows?  But it looks pretty good to me.  It’s impossible to say how much has been spent/invested to put on this show and thus what its margin/profit is, but it is reported to be one of the most costly tours of all time.   Still, judging by the manner in which they keep adding shows, I’m guessing the investment is worth it.  Taylor herself is the primary producer of the tour, in keeping with her model of owning her own destiny (go girl!), and she keeps touring, so I think the all-in ROI for her given tickets, movie, music sales, merchandise sales, and incomes of babies being born with the name Taylor, probably adds up to one hell of an ROI.  Us VCs should be so lucky.

Too many people considering investing in companies, particularly in healthcare, don’t do enough to distinguish between the quality of the idea vs. business vs. investment and that can be the kiss of death to an investor.  Great ideas cross my desk every day and with a glance there are times I know that they are not great investments because they couldn’t reach profitability ever, even by making it up in volume.  The unit economics have to work eventually.  There are also numerous factors that aren’t financial that prevent good ideas from becoming good businesses and good investments.  Key among them is the ever-present antibodies to innovation that come from misaligned financial incentives, inertia due to workflows that no one wants to change, and the cost of bringing certain products to market in this lifetime.

Thus, buyer beware.  If you are looking for investor ROI and are about to judge a business competition or write a check to a new portfolio company or give $1000 to your niece to start a pet-sitting business, make sure there is demand, not just a hypothesis. Make sure there is a real path to revenue and profitability, not just a person or two who has validated interest.  And above all else, make sure that the valuation and cost of footing the investment is not more than you can ever get back in your lifetime.  We are in the throes of watching this last problem play out in the venture world today, and it isn’t pretty.  There is a whole generation of companies, especially in healthcare, that had equity valuations so high that they could not achieve escape velocity and thus will fall victim to the ever-present pull of gravity.

PS – my ever-favorite YouTube video about how people often mis-evaluate businesses at their peril is HERE.