3 Questions Every Startup Founder Should Ask Themselves

What do investors do when they want to cut to the chase and quickly evaluate the potential of your startup? What are some of the questions they ask to separate the wheat from the chaff? Let's take a look at three curveballs you can expect from investors during a meeting.

1 - Can you explain to me like a five-year-old what problem you are trying to solve? — Dave Peterson, Celonis

Investors want to see founders who attack urgent, frequently occurring problems. Actually, it should be so urgent that people are willing to "try half-baked ideas," as Michael Seibel suggests. As Dave Peterson and his co-authors lay out in their book Play Bigger, the business idea can be based on a technology insight or a market insight.

Technology insight arises from an advanced skill your company possesses that you want to apply to a problem. For example, mRNA technology has been around for a few decades. But its widespread application for vaccine development only happened during the Covid-19 pandemic. Faced with the pressing need to fight Covid-19, scientists looked for a way to put this technology to use and came up with the mRNA vaccines.

On the other hand, market insight receives its inspiration from an underserved need in the market. That's how Jeep launched Cherokee XJ, the first modern SUV, in 1984. There was a glaring need in the market for a vehicle with enough interior space for a full family, a big trunk, good ground clearance, and a commanding view of the road. Something that would bring together the strengths of a station wagon and a truck would corner the market. Jeep did not need to develop some deep tech to serve this need. It looked at its capabilities in a new light and repackaged its existing mobility solutions in a new, attractive fashion. There was nothing revolutionary about Cherokee XJ's technology. It was all about finding out what the market wanted.

When you start with a technology insight, you move from a skill to a solution that will solve a problem. With a market insight, you start from a gap in the market and use that information to develop a product that will plug that gap. Both are viable ways and good templates to introduce a problem to prospective investors.

2 - Can your startup become a ten-billion-dollar company? — Sam Altman, Open AI (previously, the Chairman of Y Combinator)

Everybody dreams of building a unicorn, but very few can because all the stars should align for a startup to become a billion-dollar company.

The founder, her idea, and the team she built all play roles in determining the potential of a startup. However, the most significant parameter here is the size of the total addressable market (TAM). The market trumps every other concern. That's why Sam Altman has that 10-billion-dollar rule: He will invest in any startup that he believes can become a 10-billion-dollar company, regardless of the valuation. Altman is not interested in things that worked a few years ago. He's looking for that new iPhone or Facebook that will shape our lives in the coming decades.

For founders, proving the market's potential, as in TAM, is getting half the job done in fundraising.

Dave Peterson looks at the same problem from a different perspective and asks the entrepreneurs pitching at the Fullpen sessions (Play Bigger, pp.145-6):

"If you win 85 percent of your category, what's the size of your category potential?"

With this question, Dave Peterson is encouraging entrepreneurs to think about category design. Peterson and his co-authors promote category design (or creation) as a strategic move to gain market dominance. This involves building a new category around an unsatisfied need in the market and becoming the king of that particular category. Category kings are known to capture 70 to 80 percent of the profits and market value. Peterson basically wants entrepreneurs to think about their odds of achieving that:

"Can you build a new category and become so dominant as to capture 85 percent of it?"

"If the answer is yes, is that category worth billions of dollars?"

3 - How big is your moat? — Omri Amirav-Drory, NFX

In startup talk, moats are the defensibilities or sustainable advantages you have that can stop other companies from eating your lunch. The moat is the barrier to entry you build around your category. Omri Amirav-Drory, an Israeli biotech entrepreneur and a general partner at NfX, refers to moats as the "defensible magic" and regards them as one of the three parameters to take note of during an investment decision.

Most founders claim to have some sort of a moat, but in reality, that's hardly the case. Because, as Elad Gil states, there are real and fake moats. Here are the two most prominent real moats a startup can hope to have while looking for investors:

Network effects: The term refers to how a new node added to a network makes the network more valuable to all nodes. It has, in time, turned into a buzzword that comes up in almost every pitch deck, although not many founders understand them properly. According to the venture capital firm NfX, there are 16 different network effects with varying degrees of applicability, strength, and defensibility. Patents and other forms of IP: Deep tech companies rely on patents and IP for lasting competitive advantage. A piece of proprietary software, a process, or a production method can give companies a healthy head start and acts as a deterrent against the competition.

Other moats like economies of scale, brand equity, or big, long-term contracts are not very realistic to achieve for early-stage startups. On the other hand, fake moats are features that promise defensibility but fail to deliver it when it counts. Just having a two-sided marketplace would offer one such elusive moat, as network effects take much more than building a marketplace. Another fake moat can be data, according to Elad Gil. You can keep hoarding data, but data can't serve as a moat on its own outside of particular fields like genomics unless you can leverage it to build an entry barrier.

Among the signs that you have a reliable moat are your revenue renewal rate and customer mix. If you have contracts locked in and people have to pay for your product every year, you are in good shape. That's why some deep tech ideas are not suitable for startups: It is difficult to monetize them and build a predictable revenue stream on top of them. The presence of a few big accounts in your customer mix hurts your bargaining power as a startup since you rely on them to survive. Thousands of small accounts that regularly pay for your product and keep renewing their commitment… That's the dream scenario for a startup.

Conclusion

Investors are busy people. They meet thousands of entrepreneurs every year, evaluate hundreds of projects and negotiate tens of deals. As a result, they have had their fair share of buzzwords like "network effects," "viral loops," or "disruption." They need no more.

To stand out from the crowd, a founder would be well-advised to do away with the marketing talk and get to the point right away. Succinctly laying out the problem you are going to solve, providing a rough estimate of the TAM you are looking at, and listing a set of durable defensibilities you can rely on go a long way toward convincing investors to back your project. Just tell them what you are trying to do, how you are going to do it, and what will happen when you finally do. If for nothing else, being remembered as "the only founder who took just 5 minutes to explain his vision" can be a good enough reason to give it a shot.