Call Us: 1-888-447-1821

• Home
• Entrepreneurs
• Lawyers
• Investors
• Services
  • Company Formations
  • Conversions
  • Equity Incentive Plans
  • Document Portal
  • Certified Copies
  • SureComply Service
  • Corporate Secretary Services
  • Equity Financing Documents
  • Debt Documents
  • Other Services
  • White Labeled Services
• Learn
  • Starting a Business
  • Funding a Business
  • Managing and Growing a Business
  • Key Concepts
• About Us
  • Our Process
  • Team
  • Our Partners
  • Contact

asssessing a business (Due diligence)

Assessing a business, determining its probability of success, is a critical step before committing resources.  This holds true for entrepreneurs starting a company, talented employees considering a job at a new venture, or investors considering investing millions of dollars into a new venture.  At Early Stage Legal, we are big fans of the Minimum Viable Product concept.  Doing a great job of market research could save you millions of dollars and years of precious time.  It can also dramatically improve the chances of finding a good business idea and speed up the time to success.  The following section will provide you with a framework and tools for assessing a business idea and the management team's ability to make it succeed.

the elements of a good business

A good business is always more than just an idea.  To be successful, it will need to move quickly beyond the idea phase of the business to actual development and execution.  Assessing a business (performing due diligence) therefore should involve more than simply assessing the idea itself but also assessing the tools and resources available to successfully bulid and grow the business. Venture Capitalists have used variations of a common framework for assessing businesses for years.  Here is our own variation that we like to call "The 5 M's":

• Management--does the company or business have team members and managers with the right experience and know-how to be successful?
• Market--is the market large enough and are customers willing to buy the proposed product or service?
• Merchandise--Is your product or service unique and differentiated?  Is it hard to replicate or (even better) can you patent it?
• Machine--the "machine" represents the operations of your business and your business model (the ways you choose to sell and deliver your product or service).  Do you have all the pieces in place to be able to successfully and profitably deliver your product or service?  Does your business scale?
• Money--do you have the funding in place to be successful?

Management

Most sophisticated investors and entrepreneurs believe that the management team is the single most important ingredient in a new business.  Havng a great management team can often overcome the challenges associated with a tricky market, a poor product, a bad business model and a lack of funding.  The following factors are most important when considering whether you and your team are up to the challenge:

• Do members of the management team have direct experience in the industry in which they are starting their business?
• Have they had previous entrepreneurial successes and / or exits?
• Do the founders have the right protections in place to ensure that the company will continue even if there are founder disputes (e.g., vesting)
• Are key individuals on the team properly incented (e.g., equity incentive plans)
• Do the key team members have "skin in the game?"
• Is the team well-rounded with strong players in all of the core business functions?
• Do team members have good references?

Market

There is an age-old debate among Venture Capitalists as to what is more important to the future success of a new venture the management team or the market.  This is called the Horse vs. Jockey debate, where the horse represents the management team and the Jcckey represents the market.  While the majority of Venture Capitalists believe that the management team is the most important, a vocal minority believe that the market is more important.  Few would dispute that the management team and the market, taken together, are two of the most important elements in assessing the likelihood of success of a new venture.  The following factors are most important when considering the attractiveness of the market:

• How big is the market?
• How competitive is the market?  Are their particular competitors that you should be concerned about?
• What market trends might help or hurt the business?
• Are there barriers to entry?

Merchandise (the product or service)

The product or service is also incredibly important to the potential success of the company.  Most new ventures start with a clear product concept in mind but find that the product changes considerably if they are ultimately successful.  This is part of a process of refining the product or service offering based on feedback from the market (see Minimum Viable Product).  The following elements are most important when considering the attractiveness of a product or service:

• How much does it cost to build or maintain the product or service?
• What do customers think about the product or service?  Especially customers who have used it and paid for it.
• How likely are customers to become repeat customers or how likely are they to spread the word about the product or service to others?
• How hard is it to replicate the product or service?  Is it patentable or are there other forms of intellectual property protection available?
• How does product compare to competitive offerings?

Machine (The business model)

The business model refers to the collective set of choices that a company makes around how to 1) acquire customers, 2) price their product or service, and 3) deliver their product or service.  The business model does not refer to the market or the product itself but rather the "machinery" that surrounds the product.  Once you have decided on a market and product, the next step is to decide on the complex systems that will attract customers and deliver the product to them in the best way.  Business models typically emerge over time with experience working with many customers.  Business models can create a barrier against competitors.  Certain business models are much more attractive than others.  Here are some questions to consider when thinking about the business model for your company:

• How much does it cost to attract (and retain) customers?
• What pricing plan will you use?
• Can you sign customers up for a recurring pricing plan thereby creating recurring revenue for the business?
• How do you plan on delivering your product or service?
• How expensive is it to deliver the product or service?
• Does the business model create profits?

Money

99% of new businesses will require some kind of investment.  Even boostrapped companies usually require at least a small investment and they often have to give up more equity than non-bootstrapped companies to entice people to do work without cash.  Investment can come in the form of in-kind services, a grant from a rich uncle, a loan, an equity investment from a weatlhy friend, angel, or VC, or capital invested by the founder.  Raising money immediately increases the pressure on the entrepreneur.  It also generally comes with some big strings attached.  Some questions to ask yourself around the money follow:

• How much money do you need?  Do you have a buffer for unforeseen events?
• Do you have sufficient capital to either 1)  get the company to a cash-flow positive status or 2) get the company to a point where it can raise more money?
• What is the value of your company?  When you accept money how much equity will you have to give up or how much will the investor(s) get?
• What are the terms associated with recieiving the investment?  Are they onerous?  Will they hamper your ability to do business the right way?

Learning from Good to Great's Hedgehog Concept

The criteria above will help you understand whether a business can become a good business.  One of our favorite books at Early Stage Legal is Good to Great by Jim Collins.  As the title suggests, the purpose of the book is to understand how good businesses become great businesses.  Central to that purpose is the Hedgehog Concept--finding a unifying and organizing idea for a business.  Collins' describes three questions, which when vigorously debated, answered, and aligned will help determine a business' Hedgehog Concept and whether or not a good business can become a great business:

• What can the business be the best in the world at?
• What are the managers of the business deeply passionate about?
• What is the economic denominator that best drives the business' economic engine?

If a business can truly be the best in the world at something, its managers are deeply passionate about it, and they understand the economic drivers of the business, it will be successful.  As you assess a business, keep these questions in mind.  Can this company become the best in the world at what they are doing, are the managers deeply passionat about it, and do they have a deep understanding of the economics of their business.  If so, you have probably found a great business.

Testing a Concept

When you think that you have found a good business idea, you should test it using Minimum Viable Product techniques.  Most importantly, you want to test the product or service concept and the busines model concept.  There are numerous low-cost techniques for testing the value of a potential product including:

• Customer surveys
• Panel tests
• Prototyping
• Staging investment based on tests
• Staging a limited market offering
• Creating an alpha product
• Creating a beta product

Be sure to visit our Fundraising section to learn more about raising money for your company.