Those of us who evaluate business plans for a living, or at least for part of a living, are accustomed to reviewing dozens, maybe even hundreds of plans before finding one that gives us a rush of excitement. It appears suddenly, like that needle in a haystack you had grown sure you would never find. Eureka! I have found the great disruption!
It’s so easy to get worked up about potential investments when you read them – the best ones are more seductive than the best romance novel, with their hockey sticks and fancy bios and their plots to take down the biggest baddest businesses of the Fortune 100 with only a cape and a marketplace. It’s enough to make an investor swoon. Assuming you aren’t so cynical by now that swooning is off the table entirely.
When you see these opportunities, it’s so easy to become enamored, fall in love, and put on those entrepreneur-colored glasses that only allow you to see the sultry outlines of all that you love in the world – launch, growth, cash-on-cash returns. Those of us who have been doing this a long time know all-too-well what can all-too-often come next: disappointment, despair, write-offs, no celebratory personalized fleece vest at the closing party.
There is a moment in time, that moment right after you fall in love with how great a new company sounds and right before you write a check to prove it, where you, as an investor, need to dig deep and ask yourself to slow down and ask three key questions. And then you have to cold-heartedly go figure out the answers to the best of your ability so you can make a steely-eyed decision about handing that check over. Ready for it? Here they are:
- Is this a product or a company?
- Is this a charismatic person or a great leader?
- Is this a good idea or a good investment?
These questions are not about intimate details of the financial model or the ins and outs of prior or future financings. Rather, these are the questions that sweep in so many important issues and can, if you let them, allow you to balance your inner optimist and with your inner cynic while you figure out the answers.
When evaluating these questions, you have to do all you can to stay neutral with respect to the answer. I’m not going to lie, it’s tough to do. It’s so easy to make excuses for business plans or to overlook the holes in what entrepreneurs tell you and don’t tell you. But if you don’t get these three questions right, it’s pretty easy to blow your money on a bad deal and to find that out so much sooner than you can imagine.
Is This a Charismatic Person or a Great Leader?
We all know charming, charismatic people who we wouldn’t trust to run our dishwashers, much less a company. I mean, my mail delivery guy is awesome, but I’m not going to ask him to take over my Fidelity account. And yet, every day investors get bowled over by the acting prowess of entrepreneurs because they can spin a helluva tale while exuding hip and fresh vibes. VCs are suckers for these guys, and they are usually guys, because they look like the actual successful entrepreneurs that have graced the cover of Fast Company Magazine or cut in front of them in line at Blue Bottle. I mean seriously, Pied Piper (from the Silicon Valley HBO series) could not have been a better name for an (admittedly fake) company*, suggesting as it does that people would blindly follow tech gurus. But it happens. All the damn time.
In the class I teach at Berkeley/Haas, I invite CEOs to come pitch to the students. I am always amused by the mixed set of reactions to each and every one. Some people love all the presenters, some people think all are terrible. Most prefer the ones that look most like themselves, at least age-wise. It’s all a great lesson in the old adage, “beauty is in the eye of the beholder.” Although it’s not beauty, but badassery that most VCs are looking for.
Considering the wide range of responses to most people, you would think that there would be a lot more effort to checking references and really understanding people’s leadership capabilities before handing them a bucketful of money. But investors often skip this step and mistake intellect or vision or, worse, charisma, for leadership. There is a huge bias towards young entrepreneurs full of wild-eyed passion and straight out of central casting (hey pal, nice Allbirds) when all of the research shows that older entrepreneurs tend to create better financial outcomes. I can assure you that leadership skills beat charm every day of the week.
Is This a Product or a Company?
Here’s why it matters to know this. If you think you’re dealing with a company, you are going to hire and spend money like it’s a company, not like it’s a product line. And then, when you go to sell it, you will get paid like you’re a product line and not a company. And that’s bad math.
We are seeing a lot of this problem in digital health today. There are hundreds of companies out there that are really so much less than companies. This is particularly true in clinical apps, digital diagnostics and therapeutics, where products have been designed to treat one unique (and often somewhat small) body part or condition. These companies come to find out that buyers don’t want to deal with them because they are one of 10 or 50 or 100 vendors that treat other small discrete body parts or conditions. If they could get away with it, buyers want to deal with one single expansive solution set that can all be bought from, serviced by and implemented with one vendor. The buyers want that one vendor to bring other products and capabilities together in an integrated fashion and send one bill.
But digital health entrepreneurs have tended to be so focused and specialized that there are solutions for every individual finger, not to mention each toe. As a result, we are starting to see the inevitable roll-up of products that thought they were companies into platforms that actually are. Sadly, those who have funded these rolled-up “companies” are going to wave good-bye to a lot of money, funded to create full-blown enterprises when there really wasn’t one to build. But while they were figuring that out, they were hiring a whole tribe full of Chief-whatever-officers and investing in oversized teams and infrastructure that will unfortunately be someone’s future synergy (aka cost-reduction target).
Is This a Good Idea or a Good Investment?
In the end, this question is the culmination of so many others and no question is more important to answer to a reasonable level of satisfaction. It is so easy to get excited by what seems like an amazing idea – oh wow! I can make healthy juice at home for only $700! But then it is even easier to get unexcited, and fast, when you find out no one thinks it’s worth paying for. It may have been a good idea, but it wasn’t a good investment because it was basically a vastly overpriced set of hands.
Similarly, there are great ideas that result in popular products, but the cash needed to get to the promised land, assuming such a place even exists, is more than the company could ever get in its ultimate exit, meaning that it breaks the cardinal rule of venture capital: make more money than you piss away, to use the technical term. We have all seen a lot of these lately, though the poster child for perennial cash burn is somewhere between WeWork and Uber. Both are good ideas, maybe even great ideas. But it’s very hard to say if either can ever be a good investment given the valuations at which they have raised money and their inability to stop consuming it.
Again, digital health is filled with examples of the difference between good ideas and good companies. Take, for example, the 11 billion companies that are trying to help convince surgeons that there are better, cheaper alternatives to surgery for a variety of conditions, including apps that result in zero revenue to the surgeon. These may well be great ideas and result in the avoidance of unhelpful, expensive, risky surgical procedures, but since the key decision-maker in the buying process is mostly likely paying his or her bills by doing those threatened surgeries, it is a bad investment because ain’t no one gonna buy it. Good idea, bad investment. Digital health is, sadly, rife with them.
Investors must be particularly hardcore about trying to get to the root of these questions when you find yourself falling in love with a deal. There are no prizes for backing companies that feature good ideas and no financial return, weak leadership or products masquerading as companies. Unless you consider disappointment and sadness to be prizes. It takes a lot of discipline to remember this when you are excited about an amazing story that has captured your imagination. But it’s kind of like counting to 10 when you’re really mad and want to ensure you don’t say something you will regret. By and large, this is also a good rule for investing. When you’re really hot for a deal, count to 10 and deeply consider those questions so you don’t have to count to negative 10 million later.