Platt Perspective on Business and Technology

Internet companies, the new-old economy and the mainstreaming of innovation (cont.)

Posted in in the News, macroeconomics, startups by Timothy Platt on September 28, 2009

Yesterday I started a news analysis piece on the reported billion dollar valuation of Twitter, and something of the context for this, both as to recent history and the arguments pro and con for our facing a new economics. I offered a fair amount of background detail connected to this from the first dot-com bubble and its bursting and from the Google story and I left off saying that I would continue on this today, offering thoughts in the direction of answering a key question:
• How can you tell if a startup or early stage is going to be that next big thing?

I see this as the single most important question that potential startup and early stage investors should be asking, that they even begin to know if they are making effective due diligence decisions in selecting where to put their money. I will note here that recent history has shown that a lot of angel and even venture capital groups have a long way to go in getting this right. So how can a prospective investor know where to place their bets? As I said yesterday, requiring a well drafted business plan with realistic financials, and insisting that the CFO really know and do the job is important.

In other postings I have gone over the need for clarity of vision and a real ability to communicate that with, for example, a clear, brief plain language description of what the startup’s great new product or service is and how it would create and capture new market share. There has to be more to this though. How can a potential investor improve their odds for distinguishing early and pre-investment which one is the prospective Google and which the prospective Pets.com?

This becomes particularly important when the new and upcoming Googles (and their less successful cousins) can gather both skyrocketing valuations and funding, and build foundations to grow from before they seem to have a monetizable product or service, let alone a clear explanation of what it is, and before they have thought through a path to even try to turn themselves into a revenue and profit generating enterprise?

Here, I am not calling for a new economics a la the pre-dot-com bubble burst but I am acknowledging that a lot of things including a lot of real opportunities can happen before the momentum of the old economics and its realities step in. There are real lag times in any system and even with the speed of electrons and cyberspace.

Any answer to this set of issues that can really add value has to meet three very specific criteria.
1. This is a case where less really is more. A list of 37 indicators and metrics would be of little value, first because that size would suggest that no single metric or measure in it, in and of itself has any real statistically significant predictive power. I used to see this as an issue when I was still doing and managing clinical research and teaching others how to do it. A seeming million proposed causal factors that collectively seem to cover and explain 95% of all valuation in the data but that are individually indistinguishable from background fluctuations in that data mean nothing and even when taken together. So this should be a short list that can help develop a focused, clearly defined and stated analysis.
2. It should be possible to convert any qualitative factors in the list to clear and clearly relevant quantitative factors, as qualitative factors in and of themselves lead too easily to reliance on anecdotal stories. That is the problem now with post hoc analyses of the Googles that make it and their counterparts that do not, and efforts to extrapolate from that.
3. It should also, of course, be possible to develop realistic values for the measures selected here to predict and not just for post-game analysis.

I would suggest a short list of three factors and considerations (meeting point 1, above) that I would argue can be evaluated relatively early in the development of a startup or early stage under consideration (point 3). The one detail I am not going to delve into in any detail here is my thoughts as to how I would quantify them (point 2) as that, among other things would mean a posting a lot longer than a 2X sized (1X normal length and 2X double that). So I will just offer some brief notes for now as to point 2, further below.

The three test criteria factors I would propose are as follows.
1. The company under investment consideration should be addressing a significant unmet need that is of importance to a significant potential market. Here, that can mean offering a product or service that addresses an issue or problem that others have tried to respond to but in a way that can capture the attention and use of that marketplace because it is functionally so superior to the competition.
2. The company should be able to argue that it has captured or is heading in the direction of capturing that market share.
3. The company should be able to clearly state and justify a claim that they have and will have significant momentum in developing and offering new innovation to expand on that initial advantage where this would validate the company is going to continue to meet points 1 and 2.

As far as quantifying these three points is concerned, I offer a few brief suggestions that connect to my approach.
1. It is necessary to develop a numerical measure of the significance of the problem or issue that can be expressed in monetizable terms. If the problem this company is addressing is so soft and squishy that it is not possible to discern anything like a precise value of resolving it, it is probably not all that pressing after all.
2. It is necessary to be able to coordinately quantify how the company’s product or service would reduce that cost, at least with a range (think best case, worst case and normative financials models in the business plan here as that should connect to this).
3. Point 3, above is more challenging to quantify, though it would definitely help to be able to have a clear, bias-free conception of the momentum of the business and its prospects for further effective innovation and in bringing that innovation to market. I will simply cite Xerox Park here, noting they had all the momentum to innovate great and even world changing ideas and product/service prototypes in the world, but they were never able to take that next step with them to bring their bounty to harvest as profitable businesses. Others picked up on the gems they created and made entire new industries out of them.

I will close this posting citing a possible objection to what I write of here as a solution to this. Everything I seek to cover in my three factors should already be covered in the business plan, largely in the financial analysis section as supported by as and as numerically justifying the market analysis. I will only add that if this were routinely the case there would be no story here, but clearly there is. So as a fourth point on quantifying this:
4. Any quantifiable measures developed here are probably going to have to both coordinate with and expand on those already added into a current standard-model business plan, and will have to be developed in as unbiased and objective (as replicable) a manner as possible, and with data obtainable from the prospective investors and not just and entirely from the startup or early stage for their investment planning and decision purposes.

Oh, I will also add that the prospective investors should do that point 4 as a standard part of their due diligence.

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