Framing the Risk in Your Business
Growth requires risk. But don’t overdo it.
Originally published on NewCo shift
I was asked by a CEO recently, “How do I know if my product is ready to scale?” He thought he was ready to raise money and start growing the company, but he didn’t really know how to be sure.
Venture capital exists to invest in enterprises that have a huge opportunity but are also a big risk. Yet VC firms tend to actually be pretty conservative, relying on pattern recognition and social networks to make their decisions. This turns investor pitches into bizarre encounters where you have to help them see the huge risks in your business and how this risks can generate massive returns, but you also must convince them that you have all of that risk managed, so there’s no reason to be afraid. I’ve been turned down so many times by investors “until we’d taken the risk out of the business,” and every time, I’d sit in the car outside their office park thinking, “But don’t you exist specifically to make big bets?”
I can’t tell you how to raise money, because no matter what it’s hard, and there’s no special trick to it. Well, there’s one trick: Sell a company for a billion dollars. Do that, and you’ll never have trouble raising money.
This article is only for those who are not quite so lucky.
What I can help with is framing your company so that you can more coldly see and explain where the risk is, and with that hopefully you can help others get excited about the vision in your head, the beautiful thing you’re trying to build.
Step one is understanding your market risk. If you’re raising money, you have to convince your prospective investors (if you’re talking to typical valley VCs, anyway) that you can build a company that can do $100m in revenue at some point. So, convince me your market can support a company that can hit that scale and still grow. That means the market needs to be hundreds of millions, and probably billions. With Puppet, we knew the overall management market was between $6B and $25B a year, depending on your definition, which made this part pretty easy for us, but lots of companies are creating a market, so they have to spend a lot of time on this topic.
The next big question is why you, particularly, will win. Sometimes this is called technology risk, but companies win for many reasons other than technology, especially these days. Puppet didn’t necessarily have the best tech in the world, but we had a focus on the user that no major player in our space had. Everyone else was worried about the buyer, and we focused on helping the individual users succeed. Other companies have a cultural edge, or even just a mindset that others can’t copy. Whatever it is, though, there needs to be some reason why you’re going to take this big, awesome market.
I call this strategy risk. You’re planning to take the market in a particular way, and you think it will work but you don’t really know until you play.
A high-growth company usually trades off strategy and market risks. If everyone else agrees this is a great market, then you’ll have lots of competition so you need a unique strategy that sets you apart. If it’s a mature market with clear revenues and margins, you need a great strategy to fight against big incumbents, who won’t go quietly. If, on the other hand, no one else agrees this is a good market, and you get it all to yourself, then the strategy doesn’t need to be differentiated, so you can run the least risky strategy you can think of.
You can’t walk into a VC’s office and say there’s neither market nor strategy risk, because that business is just too obvious. It’s either so obvious it’s actually stupid, or so obvious that you’re one of a hundred players running the same game - both of these are bad bets. You’re not getting that funding round.
The last piece is execution risk. You’ve got a good market, you’ve got a solid strategy. Now convince me that you, particularly, can build a team and make this happen, within the window you have available. This is 99% about the team. Can you hire people? A lot of them? Get them working together? Do you know how to ship software, sell software, market it, etc? Some of this you can do through force of will, some you can do by just being smarter or faster, and some requires that you really nail a couple of pieces, but most of it is about building and scaling a company that can execute your strategy. This is the grit, the work, the hard part. The best strategy in the best market is worthless if you can’t do the work.
There’s one more critical point about risk. It should be obvious, but somehow it’s not.
You want to minimize the risks you take. There’s something about what you’re doing that’s unlikely, probably scary, and quite possibly stupid. That thing has to exist, because it’s what makes your business valuable. Without that huge risk, you can’t possibly achieve the massive payoff you’re looking for. Take that risk, put it on a pedestal, love it.
And then do everything you can to not let other types of risk into the rest of your business. If you know your major risk is strategy, why introduce a massive execution risk at the same time? No. Your work is scary enough that you should be conservative everywhere possible. Pick something you know works when you have that luxury, because you won’t get it very often.
This frame should at least get you the first three slides of your presentation. There’s plenty more to know before you can convince someone you can go out there and win, but being able to clearly talk through the risks in your business and how you’re managing should at least help you get a seat at the table.