A 6 Question Framework For Start Up Success

How do the best venture capitalists in the world rapidly assess the value of complex and novel products or business ideas?

They use mental models and heuristics that simplify complex valuations into intuitive mental exercises. The secret here is to understand what features and attributes of businesses generate massive value over time.

This idea was made clear to me listening to the All In Podcast - a Podcast where four prominent venture capitalists and angel investors shoot the shit and deliver razor-sharp advice for entrepreneurs. During the podcast, David Freidberg provided an incredibly succinct but powerful rubric for value creation. The 6 questions he posed serve as an incredible guiding framework for anyone trying to create value in an early-stage company.

Before we dive into the rubric itself it's important to remember that a start-up is different from a regular business and thus value creation will be assessed differently. The main differences are that start-ups operate in an environment of uncertainty due to the white space they occupy, and they are looking to achieve rapid, outsized growth. Thus the 6 questions in Dave's rubric are focused on validating three fundamental assumptions 1. Feasibility - does this organization have the right resources or partnerships to build the product and is this product embedded in a business model that will create commercial value (profits) over time? 2. Value - does the product solve a high priority and frequently encountered problem for customers by generating essential gains or relieving severe pains? 3. Growth - will the product will easily be discovered by target customers due to effective market pull?

Without further ado, David Friedberg's value creation rubric (Daves comments are in quotations and all other thoughts/opinions are my own).

1. "Can you make a product?" - This is a question of feasibility. Is the right team in place to create a product with the features and specifications that have been validated by customers as essential to its unique selling point? A good concept to keep in mind here is Y-Combinator's criteria for start-up product success; can your product be 10X better than competitors within at least one dimension that customers deem important, or can it be delivered for 1/10X the cost.
2. "Do people want to buy your product?" - This is a question of value. This question is ultimately about product-market fit. For product-market fit, you need to have a value proposition that customers recognize as a solution to their most important problems and have evidence of genuine customer purchase intent. Good models to use to assess if the value you are providing is enough are the following: do 40%+ of users report they would be very disappointed to stop using the product? (see Sean Ellis's commentary on customer research), or, are customers enthused to tell their friends and family about it? (see Alex Hormozi's concept of "The Last Customer"). I've written extensively about creating valuable products and testing product-market fit in my article on value proposition design.
3. "Can you make a positive gross margin selling that product to those people?" This is another feasibility question. This has two components - a product component and a market component. The first and most immediate question concerns the product component; this asks whether the gross revenue generated from this product is sufficient to cover the costs of producing the product (i.e what is the gross profit margin?). Secondly, the market component asks whether you are selling to a large enough total addressable market and/or selling to a market with high enough purchasing power to make the business model viable at that level of gross margin (i.e can you generate enough gross margin within your target market to make the business profitable considering all other fixed and variable costs?).
4. "Can you make a return on the marketing dollars you need to spend in order to generate that gross margin e.g can LTV exceed CAC?". This is ultimately a question of value potential vs growth potential. Let's look at the two sides of the equation posed by this question. The question states that you need to assess whether the value you provide to customers over time is enough to command a LTV (lifetime customer value) that is greater than the cost of growing your company (customer acquisition cost). LTV considers the revenue on a single product as discussed above but also the potential for that product to generate recurring revenue through repeat purchases e.g subscriptions. Customer acquisition cost is determined by the cost of market push activities (usually paid sales and marketing) balanced against the market pull (unpaid natural/organic/viral growth) your product experiences due to the value that is immediately obvious to consumers e.g through word of mouth.
5. "Can you scale the amount of money you deploy to grow your business such that as you grow, the return goes up, not down?". This question is about the relationship between value and growth. It's asking whether the value you provide (as measured by your ability to generate revenue and profit) can increase with the growth you experience. This means that the growth in your annual revenue and profits needs to be somewhat exponential relative to spending over time (i.e money deployed later is more effective at creating value than money deployed in early stages). This is only possible if investment in your business at later stages has higher leverage for producing value due to the economies of scale or scope that have been created.
6. "Can you be a platform - can you transition into being a multi-product company that gets leverage out of the same user base or technology?" This is an extension of question five in the sense that it is using leverage as the ultimate way to efficiently create value. Becoming a multi-product company leverages the synergies between your products and/or users to significantly reduce marginal costs while increasing LTV by growing the potential average order volume for each purchase. In a subscription-based model this can be particularly powerful and generate massive annual recurring revenue through a bundle of products in one subscription (as Scott Galloway likes to call it, a rundle, i.e a recurring revenue bundle).

The order of these questions is also important, Dave suggests these questions should be addressed in the order presented above. Questions 1&2 assist you in your product development stages and finding product-market fit. Questions 3-4 are essential in your launch and go-to-market strategy. Questions 5&6 are essential to scale using leverage (for more on leverage see Naval Ravikants concept of new, permissionless leverage)

These questions are simple but powerful. When building anything it's important to understand the perspectives of potential investors, this way you can consciously build a value proposition and business model you know will attract funding.

6 simple questions but if you can nail all 6 as Dave says "you can build the next Google".