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As early stage entrepreneurs make the funding rounds, they are going to be pitching to a lot of people like Carter Cast.
Cast, a clinical professor of entrepreneurship at the Kellogg School, was an operating partner of the Pritzker Group Venture Capital team from 2012–2022. This means that for the last decade he has met with hundreds of new and growth-stage entrepreneurs, listening to their pitches and reading their business plans. His aim: decide whether to invest.
”When I’m on the receiving end of a pitch, broadly speaking, I’m considering three things,” Cast says. “First is the entrepreneur’s passion, commitment, and drive to solve the problem they’ve uncovered. Second is the attractiveness of the business concept—is there a real need for this product or service, is it in an attractive market, and does the company have any traction in that market? And third, do I believe the founding team has the knowledge and experience to execute their idea in competitive market conditions?”
Preparing for a big investor meeting? Here are Cast’s suggestions for what entrepreneurs should keep in mind when positioning their company.
Make sure your product need is crystal clear
When investors are kicking the tires of a potential investment, one of the most important things they look for—after the entrepreneur’s dedication to their idea—is whether their offering is really necessary. Given that about 35 percent of startups fail because there is no real need, this is a critical, if tricky, question to answer.
So investors will want to know: Which primary research (and preferably in-market tests) shows the product or service is needed? And how does it compare with other, similar products? (That is, by the way, the second most common reason startups fail: the new products just weren’t distinctive enough.)
“I’m listening for proof that there truly is a need, that the prospective customers aren’t getting an itch scratched and this will do it,” Cast says. “And it’s not just a question of whether potential buyers like it, but does this startup have proof that they are willing to change their existing behavior for this new idea? Because inertia is a powerful force.”
This kind of proof can be particularly difficult for early stage companies to generate. After all, how can you tell that something is necessary until it is out there swimming or sinking in the marketplace? When Evan Spiegel first developed his unique idea for a photo-sharing app, for instance, he was told his idea was terrible and that no one would use it. That idea turned into Snapchat.
All of this means that, the more unusual or unexpected your idea, the harder you will need to work to show that the demand is there. And of course you may need to wait longer for that investor to come around.
Also read: Predictability is a big innovation when it comes to VC term sheets
Make sure your product works
Many entrepreneurs are, quite understandably, not inclined to see the flaws in their fledgling product. And it’s never easy to hear criticism—to hear that your baby is ugly. But the research process isn’t complete until entrepreneurs have tangible proof that the product works the way it’s intended—and have the in-market research data to back them up.
“It’s common for entrepreneurs to bring their unconscious biases to bear in the early phase of concept development,” says Cast. “So it’s really important to talk to potential customers during that discovery process, and to approach those interviews and early product demos with a beginner’s mind.”
When Cast’s former student Tim Brown co-founded the shoe company Allbirds, he immediately created prototype shoes for groups of test wearers. They then interviewed the testers and asked them to describe their full experience with the shoes: when they wore them, when they didn’t, where they chafed, did they pinch or wear poorly. This gave Brown a sense of how the shoes fit—and how they could be improved.
“Tim quickly got those novel, merino-wool shoes on people’s feet and then followed up with the users,” Cast says. “Your potential investor is going to ask you to talk about the research that led you to conclude you have product-market fit. Having real answers, real proof, is critical.”
Try to open up multiple revenue streams
When considering a funding opportunity, Cast is primarily interested in the company’s ability to execute on its core proposition as a business. But that doesn’t mean he isn’t interested in where a company might find additional revenue opportunities.
“First, I’m looking for their primary offering to be strong,” Cast says. “It’s absolutely critical that they know their market entry point and their ‘tip of the spear’ customers—those early adopters—and how to reach them.”
Entrepreneurs should also be ready to respond when funders ask them about what Cast calls “horizon two” opportunities.
“This could be version 2.0 of the product, or a second geographic market to enter, or a second distribution channel to pursue that opens up an additional addressable market,” Cast says. “Doing so reduces failure due to revenue risk. When new ventures fail, it’s often because they can’t generate enough revenue.”
One company that did this well in the early days was Pelaton, which not only sold their exercise equipment but also classes and branded merchandise that reinforced the sense of community that its core product offers.
Less-established companies, of course, may not be able to capitalize immediately on these potential revenue opportunities. But having them in their sights sends a signal to funders.
“It shows investors that they’re thinking one or two moves ahead, trying to look around the corners,” Cast says.
Also read: Why demographics matters more than ever – catching tailwinds for businesses and investors
Know the state of the market
All of this advice is important to follow in any market. But it’s also fair to say that, in a hot market, investors may not be as discerning about the strength of your fundamentals lest they lose out on an opportunity.
“When markets get frothy, it’s not uncommon for investors to pursue ‘momentum investing’ by putting stakes in startups that are in hot categories,” Cast says. “This can obviously be problematic, because startup valuations can soar without them having the business fundamentals for the expected growth to be sustainable.”
When the market cycle does turn, funders tend to go back to the basics and ask a lot of questions before opening their wallets: Does the startup have any real market traction? Are early customers repeating? Does the startup have revenue-paying customers who are under solid contracts? Does the product generate enough margin dollars to pay down operating expenses?
“In a downturn, you see investors move pretty quickly from investing in the ‘high concept in a hot space’ to investing behind tangible market traction, where they’re looking to startups that have revenue growth and show profit potential,” Cast says.
This can be a particularly hard pill to swallow for startups that raised their early rounds of funding in a frothy market.
“The deals investors executed that weren’t highly vetted because they were in a momentum market—those deals might not get further funding when the market conditions change,” Cast says. “This is where you start seeing stranded startups that raised a seed or series A round a few years ago and are now stuck and operating on fumes.”
But this need not spell doom for your startup. One way to counter this market volatility is to pull back and grow more organically, not overspend on customer acquisition, and to carefully and systematically watch your operating expenses. And, even for stranded startups, sometimes a savvy funder will see potential and invest at a lower valuation.
“A startup that has a sound business model that’s in a super choppy market may get value investors coming in,” Cast says, leading to “a situation where the company survives and later thrives and the investor finds value.”
“As an investor, I kind of like these down markets because it prunes the trees and reveals the more-durable companies.”
[This article has been republished, with permission, from Kellogg Insight, the faculty research & ideas magazine of Kellogg School of Management at Northwestern University]
