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How do you measure the risk vs reward of a potential new opportunity?

Especially when we are talking about startup ideas where it requires taking a huge leap of faith without knowing if there is cheese at the end of the tunnel.

11 Replies

Joe Albano, PhD
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Joe Albano, PhD Advisor
Using the business of entrepreneurialism to turn ideas into products and products into sustainable businesses.
Remember that a startup is not a business. It is a structured investigation of assumptions about what a business could be that MAY result in a business.

So how do you evaluate those assumptions? Talk to your potential customers, suppliers, and partners to get as accurate a picture of the opportunity BEFORE you spend lots of time and money pursuing it. There are many good tools and processes for doing this - the Business Model Canvas is a good start.
David Austin
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David Austin Entrepreneur
Entrepreneur
Joe's right. Customer knows besy for the reward part of the equation.

Customerdevlabs.com has some good advice on how to find out what the reward (value) is of your presumed startup. A careful analysis will determine the risk (your cost). On average I find the amature back-of-napkin analysis is 3x too small ... Takes 3x more $ and 3x more time. Do not forget to do an accurate CAC (customer acquisition cost) analysis. This is almost always a spot where startups presume too much ("if you build it they will come" mindset will doom you to failure).

In many cases you will not know the answer to the reward question without an MVP. You can usually get a ballpark idea looking at competition and doing careful customer interviews.

An entrepreneur however should be able to look at 10 ideas within an hour and sort them from best to worst risk:return ratio just in some rough logic. VCs do this when combing through many ideas they consider supporting. It is somewhat a dark art.
David C. MSE
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David C. MSE Entrepreneur
CEO at Business Development

Considering the literal definition of a startup is in fact "a business" I can't say I agree with a startup not being a business. It is, 100%. The question was properly addressed to the startup "idea" which is not a business until it is turned into a startup. And once it is, you should treat as a business in all regards including legal.


Years ago, I created an opportunity evaluation that I use. It basically goes through various questions and components of the business plan that gives a decent review of risks vs. rewards. I am sure you can find plenty if you google as well.


Certainly you want to do your research and put some serious time and thought into evaluating the full process. VC's in most cases are looking at businesses, not evaluating initial ideas.


At the 10,000 foot level, if you have two that you evaluate will both be rewarding, go with the one that inspires you the most.

David Austin
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David Austin Entrepreneur
Entrepreneur
Paul Ahlstrom's thebigcanvas.com is worth a look. Something I recommend anyone to do before presenting an idea to a VC.
Joe Albano, PhD
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Joe Albano, PhD Advisor
Using the business of entrepreneurialism to turn ideas into products and products into sustainable businesses.
It may be a bit semantic, but I find Steve Blank's definition of a startup to be useful. From memory, Steve defines a startup as "a temporary organization designed to discover your business model."

This definition has a few important features:
  • A startup is a TEMPORARY structure. That is, the goal of a startup is not to stay a startup. It is the precursor to your business.
  • A startup is designed to optimize the discovery of your business, not to operate it. A startup may make sales and even profits, but it is not optimized to run an ongoing business.
This leaves startups with at least a few challenges:
  • Focusing on discovering the business, not making sales of products that perhaps no one wants
  • Pivoting when the market tells you that something you are sure is right - isn't
  • Transitioning from the discovery phase of a startup to the operationalefficienciesof a business
So yes, the distinction between startup and business is semantic, but when understood and applied can be useful.

As a further note, it's worth mentioning that according to the Angel Capital Association, of the approximately500,000 startups created each year in the USA, less than 500 get classic VC funding. Inc. Magazine reports that 85% of the companies on the Inc. 5,000 have yet to receive any external funding. Yes, money is important is startups and SMBs ... but investors are just one tool.
David Austin
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David Austin Entrepreneur
Entrepreneur
Another valuation (reward) tool: https://www.caycon.com/valuation.php

Some templates for assessing cost:
https://www.score.org/resources/startup-expenses-template
http://www.wsj.com/public/page/news-small-business-startupCalculator.html - great sanity check
David C. MSE
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David C. MSE Entrepreneur
CEO at Business Development

I don't know how much it is semantics as opposed to an incorrect use of the term. A startup is a business. Now, will your business evolve as a startup? Of course it will the same as it will with an established business that wants to stay current. Within that we can get philosophical about when a startup is no longer referred to a startup. That was not the question.


But if I have an idea that I decide to pursue, I then decide my legal structure. If I choose an LLC or C or S-Corp etc, I am doing so because I project some form of value in the business and I want to shield myself from liabilities among many other reasons. That structure can be very temporary or very permanent depending on how the business evolves. I will say it is a startup, but it is a business. Nothing semantic about it. Legally it is recognized. And if your startup is not structured legally in a manner to limit liability, proceed at your own risk. And structure is one of the many points to evaluate when considering moving forward on an idea.


As for the stats, we don't know that the individual asking the question even needs VC funding. They may do fine with a small business loan, private investor...it could be a service that he can bankroll. Yes statistically you have more of a chance of getting struck by lightening under pool than raising VC money, as one VC put it. But if the entrepreneur does need a VC and applies those odds to his chance of success chances are being an entrepreneur is the wrong route in the first place. I do agree though that the needed financing is a pivotal element to evaluate when moving forward with an idea.

David Austin
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David Austin Entrepreneur
Entrepreneur
Not to beleaguer this segway, but I imagine the definition used to suggest that there are 500,000 new startups each year presumes a much more liberal definition of the term than I would embrace. I also consider a startup as a venture of a new product service or business model not yet given a fair chance to succeed, really in any venue (true innovation being its defining characteristic). As most "startups" seem to me as rehashes with insignificant tweaks my own personal estimate would cut that figure by at least an order of magnitude. I'm happy to admit however that my personal definition of startup is not a standard definition. Whether or not it's called a business seems to me a function of the definition of a business. That being the case I'm not keen on calling it a business until after it has proven its viability as such.
David C. MSE
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David C. MSE Entrepreneur
CEO at Business Development

David-You make a very good point regarding the 500,000 stat. That would be interesting to find out. The even greater inference you make is to be careful of quoting statistics as generalizations used as a wide sweeping brush. I don't think anyone will dispute entrepreneurship is challenging as is raising funding. BUT, out of 500,000 how many actually put together a solid plan, solid team (There are hundreds of other elements that play into the success or failure of raising funds)? I certainly wouldn't want someone to evaluate their fate on the fate of another who perhaps was not as prepared, and from what I have seen anyway, many are in fact greatly unprepared when reaching out for funding.



Regarding defining a startup, I could care less what someone wants to label the entity. Call it a bottle of ketchup if it makes you happy. However, my deeper point was in the structure. Most startups I see do in fact have employees if only one. They often have a product or a service they are selling trial stage or not. Personally, I am going to consider it a business from the second I turn an idea into an actionable pursuit in a startup, because I'm going to treat it like a business starting with the legal formation of the entity. Aside from the literal definition of a start up being "a new business" I just don't see the logic behind suggesting it is not a business.



As for revenue, out of curiosity I googled and found advice to transition away from the label of start up after $20M in yearly revenue. I think we can all see the can of subjective worms that is. But if success or proven revenue leads a startup to being a business in one's mind, I think the question is, "does failure and losses lead to retracting the term business" and the answer is no. In a down year, yahoo did not state they were no longer a business because they were not proven in that year. So again, trying to be philosophical in suggesting a start up is not a business just makes little sense. But hey...a person has to do their thing.

Guhesh Ramanathan
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CEO and co-founder at Excubator
You know what they say? Fools jump in where angels fear to tread? I've always recommended that startups do a ton of research before they actually .. well ... start up.

And its worked. Most of the startups I've advised (who have taken this advise) have found it prudent to modify their plans out a wee bit based on what they found. Some discovered that a minor tweak could get them customer interest, others that a tweak could get them franchisee interest, and others that no amount of pivoting would ever take them anywhere. So they dropped the idea all together.

Hope this helps.

--
Guhesh
https://www.excube360.com


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