different options. Have they thought
about what else they could do with
the technology and the skills they are
cultivating? For a software startup, a
potential investor might also ask how
tightly the code is tied to a particular
hardware or software platform, and
how general-purpose the functionality of the code is.
8. Potential for a Large
A startup wanting more than “angel
investors” or “bootstrapping” with the
help of friends and family should offer good prospects to professional investors for a significant payoff within
a time frame that is typically no more
than seven years. Venture capitalists
often look for >20% annual returns on
their portfolios, so they are looking
for big winners. Not surprisingly, they
tend to give most of their money to
the better startups, which often do not
need money to survive but need investment to get big fast.
It is impossible to know in advance
which firms will succeed, but the eight
points discussed in this column form
a framework to inform this murky
question of potential investor payoff.
For many venture capital firms, the
market opportunity has to be large
enough for the startup to become
worth at least $100 million. The busi-
ness model must demonstrate how to
scale up sales while maintaining some
advantage over the competition. Scal-
ing can be relatively easy (for example,
for a packaged software product com-
pany, although competition is fierce),
relatively difficult (for example, a SaaS
company that needs many customers
paying those small monthly fees), or
extremely hard (for example, a profes-
sional services company that is costly
and time-consuming to grow because
it must hire and train so many people).
Automated horizontal services deliv-
ered via the Internet, (for example,
Google, LinkedIn, Facebook, Pandora
Radio, Spotify, FourSquare) can scale
quickly because of platform dynamics
and network effects (see “The Evolu-
tion of Platform Thinking,” Commu-
nications, Jan. 2010). Still, there are
no guarantees these firms will build a
profitable business or go public. None-
theless, a large payoff might still come
from another “liquidity event” in addi-
tion to an IPO such as selling out to a
larger firm. We can estimate the poten-
tial value of such deals by using the re-
cent sale prices of comparable startups
or the market values for comparable
firms that are publicly traded.
Of course, success and failure are
easy to explain in retrospect but difficult to predict in advance. Potential
investors must therefore ask, with
each of the eight points mentioned
here: What can I know and how early
can I know it? Would-be entrepreneurs also should think carefully
about the items on this list. Unforeseeable factors such as chance
events and timing affect all firms.
But those startups that can objectively evaluate their potential and
improve their weaknesses should
be able to increase the possibility of
1. Christensen, C. The Innovator’s Dilemma. harvard
business school Press, boston, 1997.
2. gage, D. the venture capital secret: 3 out of 4 startups fail. The Wall Street Journal (sept. 19, 2012).
3. grove, a.s. Only the Paranoid Survive. Currency/
Doubleday, new york, 1996, 30.
4. Porter, m.a. Competitive Strategy. Free Press, new
york, 1980, 3–33.
5. roberts, e.b. Entrepreneurs in High Technology:
Lessons from MIT and Beyond. oxford university
Press, new york, 1991.
6. roberts, e.b. and eesley, C.e. entrepreneurial impact:
the role of mIt—an updated report. Foundations and
Trends in Entrepreneurship 7, 1–2 (2011), 1–149.
Michael A. Cusumano ( firstname.lastname@example.org) is a
professor at the mIt sloan school of management and
school of engineering and author of Staying Power: Six
Enduring Principles for Managing Strategy and Innovation
in an Unpredictable World (oxford university Press, 2010).
the eight factors framework and discussion is
adapted from m.a. Cusumano, The Business of Software.
Free Press, new york, 2004, 195–214.
Copyright held by author/owner(s).
of course, success
are easy to explain
but difficult to
predict in advance.
milestones must happen in a time-frame consistent with the available
funding. It is impossible to predict
whether or when a new firm will actually make any money. But investors
need to be extremely wary of business
plans that call for many tens of millions of dollars and years of R&D and
marketing before the venture is expected to generate any revenue. When
too much time and money are required, too many bad things can happen: New competitors can enter and
established firms can counterattack.
Technologies can become outdated or
government regulations can change.
Moreover, a venture that has to keep
raising new rounds of funding often
leaves both the early investors and the
entrepreneurs with little equity. Once
the startup becomes financially desperate, later investors can impose draconian funding terms. Promising MIT
startups such as E-Ink in electronic
displays, and A123 Systems in batteries, turned problematic in this way, as
did Akamai, which took a long time to
build what is now a great business in
digital content delivery.
7. flexibility in strategy
Investors look for focus in a startup because most have limited resources and
time compared to large, established
firms. However, most startups also
need to demonstrate flexibility—in
strategy, business models, and technology. Startups often get the product strategy and the business model
wrong the first time around. Even with
multiple chances, they often get the
second and third times wrong as well.
So both focus and flexibility, which
seem contradictory, are often critical
to success. The right formula is likely
to emerge only over time, through
trial and error, rather than through
deliberate planning in advance.a Startups need to focus their resources on
a particular approach, but then be
prepared to change course or “pivot”
quickly if the initial strategy is not
working. To gauge strategic flexibility, investors should talk to the founders and the management team about
a See, for example, H. Mintzberg, Crafting strategy. Harvard Business Review, July–August