Too many markets...I want to go into all of them!

Someone recently asked me the following:

"If what you're developing can go in many different products, but you need a product to select a market, do the market research, diligence, and even look for partners with experience in that specific product space...what's a good way to go about that, and still keep yourself open to pivoting in the future?   For me, say you can go into the personal app space, or the healthcare transcription space, or the commercial IVR space, or license technology capabilities, or any number of others, the initial people I'd want to reach out to to bring on board or help are all different for each."

Good question.  Unfortunately, there's no easy, quick solution.  As soon as you have your core product somewhat defined, you (or someone from your team) should be doing a comprehensive market analysis, which looks at all possible markets.  For each market, one needs to assess the market size, how difficult is it to penetrate, what are the margins, how much does your solution benefit them, etc, etc.  Lots of work here!  If you're lucky, you can get a team of business students to do this, maybe even for free, but the timing has to be right w.r.t. their course series.  Or, you might be able to find a business student to do an independent study project, again, for free.  Other options exist as well.  But, before you do any of this, you must have a list of proposed product features to help you define potential markets.

Sometimes, an easy, low-hanging-fruit kind of market is obvious, and that's often a good starting point, even though it might not be a huge market or perhaps not a high-margin market, but it could potentially bring in some early revenue.

Which market to target first?

My past posts have included discussions about the importance of a market niche and the importance of a product family (not a one-trick pony).  So, you've picked a niche and are developing a product family.  But how did you decide upon that niche?  Was it the largest one?  That would be a logical answer, but what if that niche requires much more money to develop and sell into?  What if that niche has a much longer sales cycle?  Be sure to consider all aspects of the niche you plan to target first.  The best one just might be the one that will provide the quickest revenue for you.  This is sometimes called the "low-hanging fruit."  Now that you have some revenue coming in from this niche, you can fund some other niches that might require more money to develop and/or have longer sales cycles.  Oh, and beware of niches that have seasonal sales cycles.

Compensate your advisors appropriately

Good advisors can be the difference between success and failure of a start-up.  Seek out advisors who have expert knowledge of your company's business and market (or some aspect of it).  And when you find one, make sure you make it worth his/her time to give you dedicated time.  If you're just starting up your business and know you still need to raise lots of money, don't offer your advisor 0.25% of the company vested over four years...there's just not enough upside for the advisor to justify spending any time with you, especially after one considers all of the dilution that is still to occur as subsequent financing rounds occur.  Two percent vested over two years is more appropriate.  Now, if you've already raised all the money you need to for a while and little or no dilution is foreseen, and you're close to revenue, then 0.25-0.50% over two years is more appropriate.  There are other factors that play into this as well, like what is the total projected upside for the company, etc.  Bottom line:  If you find an advisor who can provide great value, work with him/her to achieve a reasonable compensation package.

But my company is worth more than that!

How do you value a high-tech start-up?  There are many ways, but very few, if any, result in a value with which both the founders and the potential investors are comfortable.  I've seen methods like discounted cash-flow and net-present value, which isn't very accurate for a start-up with no revenue yet.  I've seen outlandish methods like "$1 million per patent" or "$1 million per employee" but these can be highly inaccurate as well.  Some kind of relationship between level of product development and potential revenue in the next one or two or five years is much more accurate, but still a guessing game.

If you're going for friends and family money, or even an angel round south of, say, $1M, the best general advice I can give is to avoid pricing the deal.  In other words, attempt to do a CPN (convertible promissory note).  This allows you to offer a discount to investors, and not having to commit to a valuation.

If, however, your investors are requiring preferred stock, and therefore most likely an equity round, then you will have to price the stock.  What should your valuation be?  Whether you try to use and justify any other methods, the bottom-line answer is "what the market will bear."  In other words, you and your investors should try to find "comps"...similar deals that have recently closed, then use that valuation, possibly adjusting for any differences between your company and theirs.

Design your next product like a competitor would

In one of my previous posts, I emphasized that you need to get your product out-the-door.  It's also important to have a product roadmap, as stated in this previous post.  So after you get that first product out, what should your next product look like?  Here's one answer, or at least an exercise you should do.  Pretend you are your competitor, looking at that first product.  What features would you add or change to make a compelling competing product?  Now, consider that product to be our next one.

Determining product pricing...bottom-up or top-down?

You have your first product done, and you're going to sell it for $15.  How did you determine this price?  Bottom-up method:  Simply put, determine how much it cost you to make it, add to this how much margin you need to make on it so that your company is profitable, and you get your ASP (average selling price).  This isn't as simple as it seems, since you have to factor in not only COGS, but shrinkage, returns, sales costs, and then going beyond just gross margin, you have to fold this into your overall financials that account for operating costs, etc.

Top-down method:  How much are competing products selling for?  Do a market survey of how much customers are willing to pay for the product.  Do a sensitivity analysis of how much product you'll sell at $X versus how much you expect to sell at $Y.

Which method is correct?  You need to do both to see if you have any overlap or not.  If the price you need to sell it at to make your financials come out is above what the market will bear, then you have a problem and you'll have to go back to see what can be adjusted.  But if it's the other way around, then you have some freedom to make extra margin, or to keep your price low and go for increasing market share to make that extra profit.

Above all, be brutally honest with yourself.  Be ultra-conservative in your numbers, and don't talk yourself into unreachable numbers just to make the financials look good.

Focus on your core competencies

There are many "layers" of product development, from core IP to a complete system.  To get a new, disruptive product out the door, sometimes you need to develop layers that are beyond your core competencies.  But be sure to do this for the right reason:  because it's necessary to gain market acceptance.  Then, once the market has accepted your disruptive product, shed the layers that aren't part of your core competencies and don't have high gross margins.  After all, it's your core competencies that help give you that unfair advantage over the competition.  Here's an example:  Qualcomm developed CDMA back in the late 80's and early 90's.  But to get this new, disruptive technology accepted in the market, it had to make handsets and infrastructure equipment (not part of its core competencies, and becoming commoditized).  Once CDMA became a popular standard, it shed its handset and infrastructure divisions, and focused on its core competencies:  IP licensing and ICs.