In any new company, there are 4 distinct types of risk to a successful business outcome. It’s my experience that seeing these risks in different ways is often at the root of problems between investors and entrepreneurs.
This is the risk that your product won’t work. This is why drug companies say they need such high prices: because it costs to much to find a new drug that works. This is also why some things can only be accomplished by non-commercial organizations. No sane board of directors in the 1960′s would have let their CEO bet company money on sending a man to the moon. But it was a great thing for government to invest in. For economic as well as other reasons.
This is the risk that enough people won’t want to buy it at the right price. MySpace is currently experiencing this problem right now. The price is FREE and yet they just announced a lay-off of half their employees. Why? Even at FREE not enough people want to buy it. They prefer Facebook.
In some ways these two risks are opposite ends of the same line. The cure for cancer is entirely technology risk with zero market risk. If you can make it work, people will buy it. Making a video game, however is the opposite. There’s no doubt you can get the technology to work. The entire risk is in the market.
The web has reduced technology risk for a lot of new ideas. It’s now cheaper and easier to build things that people could barely conceive of a few years ago. FourSquare anyone? But that has not eliminated market risk. This is what makes the Customer Development Methodology so powerful. You start early in the process to connect with customers so you don’t waste time building something people don’t want to buy. And you learn quickly how to sell to them.
This is the risk that even with a technology that works and people who will buy it, management won’t find a business model that makes a profit or won’t be able to execute on that model, or scale the company properly. It’s common that inventors often don’t make good CEOs (and vice versa). One is all about technology and one need to focus on running the company.
A key to minimizing this risk is first to understand that being a CEO is a definable skill. And that being a CEO of a start-up is a different skill than being CEO of a growing company. Experience helps here as well. Experience on the team, experience in your board and experienced advisors. Don’t shy away from asking for support.
Even large established companies are not immune to this risk. It’s what led to the need for General Motors to need a bailout to survive. They had a sizeable market, wonderful technology, ample capacity but for decades management just couldn’t put the pieces together properly.
This risk is to the investors. The risk is that the technology will work, people will buy the product, management will run a profitable company, and you still won’t make a good return on your investment. Maybe there won’t be an exit. Maybe the deal will be structured so that only some of the investors make money.
There are different types of investors and investment vehicles. Be sure to pick the right ones so everyone’s goals are aligned as much as possible. Of course bootstrapping is one way to go – without investors you don’t need to make deals with them. I’m a big fan of bootstrapping. But there are occasions when not taking on investors slows your growth and that can open up the risk that a competitor will get exploit the market before you do.