Steven N. Kaplan Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance Faculty Director, Polsky Center for Entrepreneurship How Do You Evaluate and Encourage Start-ups?
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Steven N. Kaplan Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance Faculty Director, Polsky Center for Entrepreneurship
How Do You Evaluate and Encourage Start-ups?
Introduction • How Successful is Start-up Investing?
• How Do You Evaluate Start-ups?
• How Do You Encouraging Start-ups? – The New Venture Challenge at Chicago Booth.
• Questions?
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Creating, Building and Investing in Successful Start-ups is Hard
• Roughly 600,000 businesses with employees are started each year in the U.S..
• Roughly 2,400 of them receive VC funding for the first time. – That means on the order of 0.40% of businesses get VC funding.
Creating, Building and Investing in Successful Start-ups is Hard
• Roughly 600,000 businesses with employees are started each year in the U.S..
• Roughly 2,400 of them receive VC funding for the first time. – That means on the order of 0.40% of businesses get VC funding.
• Between 100 and 200 companies go public each year. – That means that fewer than 0.04% of business go public.
Creating, Building and Investing in Successful Start-ups is Hard
• It is hard, even for VCs.
• A lot of VC investments are losers.
Distribution of VC Outcomes
Creating, Building and Investing in Successful Start-ups is Hard
• It is hard, even for VCs.
• Since 1999, returns to VC funds have been mixed.
PerformanceofAverageU.S.VCFundCashReturned/CashInvested
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Source: Burgiss
U.S. VC MOICs by Vintage Year, 1991 - 2013 Pooled Ave. as of December 2016
PerformanceofAverageU.S.VCFundRela>vetotheS&P500
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Source: Burgiss
U.S. VC PMEs by Vintage Year, 1991 - 2013 Pooled Ave. as of December 2016
PerformanceofAverageandMedianVCfundRela>vetotheS&P500
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1999 2001 2003 2005 2007 2009 2011 2013
Source: Burgiss
U.S. VC PMEs by Vintage Year, 1999 - 2013 Pooled Ave. and Median as of December 2016
Average Median
How Can You Improve Your Odds of Success?
• Frameworks • Process and Networks
Framework: How Should You Evaluate A Start-up?
• Huge issue in class and practice.
• Framework is based on: – Spending time with several VC firms. – Reading and coding investment memos of 11 VC firms in
almost 70 investments.
• More recently: Based on a survey of over 800 VCs.
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OUTSIDE - IMPACTS Opportunity, Uncertainty, Team, Strategy, Investment, Deal, Exit.
• (O) Opportunity: Is this a positive present value opportunity? (Does it have IMPACTS?)
– (I) What is the idea / industry? – (M) Is the target market large enough to support substantial
growth / valuation? – (P) Why does the opportunity generate a positive present
value? What is unique? – (A) Acceptance: Will customers in that market accept / buy
this new product / service? – (C) Why won't the value be competed away? – (T) Why is this a good time to enter? – (S) Speed? How quickly can this be implemented?
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(O) Opportunity: Is this a positive present value opportunity? (Does it have IMPACTS?)
(I) What is the idea / industry? u Explain the idea / opportunity clearly and succinctly u What problem does it solve? u What is the pain point?
(M) Is the target market large enough to support substantial growth/valuation? u How large is the overall market? u How large is the market segment you are targeting?
• Who are the key customers? • How many are there? • What will they spend? • Provide solid support for your analysis.
u Are there additional opportunities?
OUTSIDE-IMPACTS
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(O) Opportunity: Is this a positive present value opportunity? (Does it have IMPACTS?)
(P) What is proprietary? Why does the opportunity generate a positive present value? What is differentiating? u The answer to this should be implicit in other parts of OUTSIDE-
IMPACTS. But, doesn’t hurt to be explicit. • Why will you make money? • How will you make money? • What is your “edge?”
• First-mover advantage? • Network effect? • Switching costs? • Execution?
• Technology? • Advantage? • Defensible?
OUTSIDE-IMPACTS
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Is this a positive present value opportunity? (Does it have IMPACTS?)
(A) Acceptance: Will customers in that market accept / buy this new product / service? u Who is the customer in the target segment?
Put yourself in shoes of a customer. • How does the customer spend the day
u Why will they buy your product / service? • What do they buy now? • Why do they buy what they do now? • Why will they switch from their current product?
u How will you get to the customers? • Direct Salesforce? Resellers? Distributors?
• How much of each? How quickly? • Advertising • How much will it cost? • Common to underestimate time / cost
u How will you keep customers? How much will it cost?
OUTSIDE-IMPACTS
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Is this a positive present value opportunity? (Does it have IMPACTS?)
(A) CUSTOMERS, CUSTOMERS, CUSTOMERS u Will the dogs eat the dog food?
OUTSIDE-IMPACTS
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(C) Why won't the value be competed away? u What will existing competitors do? u What will other new entrants do? How will you respond?
(T) Why is this a good time to enter? u Why hasn't the opportunity been taken already?
(S) Speed? How quickly can this be implemented?
OUTSIDE-IMPACTS
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Good opportunities have positive IMPACTS. If the opportunity does not have IMPACTS, then it should not be pursued.
OUTSIDE-IMPACTS
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(U) Uncertainties: What are major uncertainties? u Possible uncertainties:
• Market size • Customer acceptance • Customer approach • Competition • Management team
OUTSIDE-IMPACTS
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(T) Team u Can management team implement opportunity?
• How does previous experience relate to opportunity? • How “hungry” is the management team?
u If management pieces are missing: • What pieces are missing? • What type of person will you look for to fill them? • How will you find that person?
(S) Strategy u Is strategy consistent with opportunity, uncertainty, team, and
exit?
OUTSIDE-IMPACTS
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(I) Investment Requirements u Forecasts and cash flow requirements
OUTSIDE-IMPACTS
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(I) Investment Requirements u Forecasts and cash flow requirements u CIMITYM.
OUTSIDE-IMPACTS
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OUTSIDE-IMPACTS (D) Deal
u Does deal structure provide appropriate incentives? • Is the deal priced attractively? • Do key individuals have incentives to do deal? • Do key individuals have incentives to make deal work?
u Does deal structure provide / ensure appropriate governance?
u Does deal structure help manage the uncertainties?
(E) Exit u Can investors exit the deal? How?
• Is the deal priced attractively?
If an investment does not pass the OUTSIDE tests => leave it outside.
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What do VCs actually consider? • Studied VC deal memoranda for 67 investments by 11 VCs.
– Top five reasons to invest: • Market 69% (M) • Management 60% (T) • Strategy 54% (S) • Competition 33% (C) • Product and technology 30% (P), (A)
– Top five risks: • Management 61% (T) • Strategy 51% (S) • Competition 40% (C) • Market 31% (M) • Product and technology 31% (P), (A)
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What do VCs actually consider? • Surveyed over 800 VCs. • What did VCs say were important?
– Management 95% (T) – Business Model 83% (P, A, C) – Product and technology 74% (P), (A) – Market 68% (M) – Industry 31% (C)
– Valuation 56% (D) – Ability to Add Value 46% (P-VC)
• What did VCs say was most important?
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Most important
Management Team, 47%
Fit, 14% Product, 13%
Business Model, 10%
Market, 8% Industry, 6%
0%
10%
20%
30%
40%
50%
Jockey Horse Fit
What Did VCs Say They Look For in a Team?
Peter Thiel
• Founded PayPal and Palantir. • Early investor in Facebook, LinkedIn and Yelp. • Wrote Zero to One: Notes on Startups, or How to Build
the Future.
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Peter Thiel’s 7 Questions Every Business Must Answer
• Can you create breakthrough technology? [P] • Is now the right time to start your business? [T(iming)] • Are you starting with a big share of a small market? [A / P] • Do you have the right team? [T(eam)] • Do you have a way to not just create, but to deliver your product? [A] • Will your market position be defensible in 10 or 20 years? [M / C / P] • Have you identified a secret opportunity that others don’t see? [P]
– Notice the focus on P.
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Does the Framework Deliver?
I – website for finding and ordering from restaurants that deliver. M – Make money from on-line ordering.
– Any one city not a huge market, but large enough. – Can go to many cities.
P – First-mover advantage / network effect for consumers. – Consumers can get all takeout orders from one site.
• Do not have to give credit card info to many sites. – Consumers have no reason to switch because restaurants pay. – Costly and time intensive to get menu / delivery info.
• Had to call or go to every restaurant in city to get menu / ask if and where they deliver.
• In 2006, info was hard to collect. A – Useful and cost effective for consumers.
– Do not have to give credit card info to many sites. – Restaurants follow once consumers are engaged.
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Does the Framework Deliver?
C – No category winner yet back in 2006. T – Internet and, now, mobile makes this possible. S – Can you get cities before someone else does?
– How much will it cost?
Uncertainty – – Can you get to the big markets quickly enough? – Is team up to the task?
Today – Valued at $3 B.
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Does the Framework Deliver? Bump
I – iPhone App to exchange contact info / photos / etc. Uses unique identification of two phones from: GPS Synchronicity of Bump
M – ? P – First-mover advantage / network effect.
– With lots of downloads, many people had the app. – If everyone downloads it …
• Huge piece of luck when billionth iPhone Aapp • Lots of free publicity. • Top 10 app downloads for a long time.
A – Consumers liked it / found it cool.
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Does the Framework Deliver? Bump
U – Uncertainty – What is the market? – Who are the paying customers? – What will they use it for? – What is the revenue model?
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How Can You Improve Your Odds of Success?
• Process and Networks. • Example:
– The New Venture Challenge at Chicago Booth.
New Venture Challenge
1. Team creation - idea generation, team formation. 2. Team selection. 3. Course - mentorship, criticism, time pressure. 4. Finals.
The NVC launched in 1997. Has grown to be among the best business creation competitions / accelerators in the world. Process is key:
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NVC - Team Creation
Team Creation Methods New Venture Challenge Kick-off • LinkedIn website • Ideation &
Innovation Workshops • EVC Student Group Start-Up Factory Events • Other Community and Cross-University Events
Polsky Center helps students put teams together for the NVC. Teams must have at least one Chicago Booth student.
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I-Corps Collaboratorium
NVC - Team Selection
• 80-90 plans typically received by early February deadline. • Judges, coaches, faculty select 25-35 viable plans to advance. • Advancing plans announced in late February.
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NVC - Course • Two sections with ~ 15 teams each.
• From end of February to end of May.
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NVC - Course • All teams have access to five coaches and NVC faculty, who suggest
other mentors and facilitate introductions.
• Mentor network grows every year; alums / friends with domain expertise.
• Each team presents in class in April. • coaches, mentors, and judges attend. • provide brutal, but constructive criticism.
• Teams incorporate feedback into plans and present again in class in May.
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NVC - Course
• Each team presents in class in April. • coaches, mentors, and judges attend. • provide brutal, but constructive criticism.
• Teams incorporate feedback into plans and present again in class in May.
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NVC - Finals
Major incentives to get to finals: • Full day with 20+ senior
judges. • $400K+ in prize money. • Space in the ARCH incubators
(Polsky Center and downtown) • In-kind legal/business services
Based on in-class presentations and feedback from judges, faculty, and coaches, 10 teams are chosen to present in the finals in May.
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NVC - Course • Stunning improvement / progress over three-month period.
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The New Venture Challenge – Results
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NVC Results
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$4+ BILLION
in mergers and exits
150+ COMPANIES still operating today
$600+ MILLION
funding raised
NVC Results: GrubHub
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§ Won the 2006 NVC. § Raised $81M + from Benchmark
Capital, DAG Ventures, others. § Merged with Seamless in 2013. § Used by 40,000+ restaurants in
1,000+ U.S. cities and London. § Completed IPO in April 2014
(NYSE: GRUB). § Market Cap $3.2B.
NVC Results: Braintree
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§ Won the 2007 NVC. § Raised $70M from Accel
Partners, NEA, etc. § Acquired Venmo in 2012. § Clients include Uber, Airbnb,
Living Social, Opentable, etc. § Sold to eBay PayPal for $800M
in 2013.
NVC Results • Rated the top university accelerator in U.S. three years in a row.
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Why is the NVC so effective? • Focus on team creation builds strong teams:
– Great students, great inputs. • Careful selection process:
– Teams are vetted and do not waste anyone’s time. • Substantial and growing mentor network adds real value. • Tight timeline / deadlines force teams to get a lot done quickly. • Strong frameworks.
• è Great outputs.
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Summary • Entrepreneurship is hard.
• But you can take concrete steps to increase your likelihood of success. – Strong Frameworks. – Strong Processes and Networks.
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Steven N. Kaplan Neubauer Family Distinguished Service Professor
Entrepreneurship and Finance [email protected]
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