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© 2019 The Failure Report

For Investors, it is all about the Unit Economics.

October 30, 2019

 

 

 

 

And more advice from Fabrice Grinda, Co-Founder of FJ Labs.  FJ Labs is a stage-agnostic New York-based investment firm with a global focus.  They concentrate on marketplaces and consumer-facing startups and have backed over 500 companies.  According to Forbes.com, Grinda is the leading angel investor based on volume and number of exits.

 

1. As a startup, the odds are against you.

 

Every year you have 5000 seed-funded companies that raise $500K more. Of these, 25% are going to raise a Series A.  Of the remaining 75%, 95% are going to fail. 40% raise a Series B. Of the 60% remaining, over half fail. If you take this all the way through to 5 years, the survival rate is about 7%.  Startups generally fail for three fundamental reasons. One, they never find product-market fit. Two, they don't get the economics to work to make the company profitable. Three, the co-founders disagree on strategy or thought process.

 

2. If you are looking for funding, don't think small!

 

You want a market which is large enough. The total addressable market size has to be at least a billion dollars. More likely, more than 5 billion dollars. The reason is if you are going to be raising money from venture capitalists, they want to make 10 X their money. That means if you are investing at a 10-20 million valuation, it will sell for 200 million. That is not possible if you are going into a market that is too small. It needs to be a large market that is scaleable and tech-enabled.

 

Also, you need to think about the timing. What is the best time to enter a market? The 7% survival rated is assuming you are going after an established category. If you are going after a new sector, then you are adding another layer of risk.

 

3. It is all about unit economics!

 

What makes a company attractive to an investor is unit economics.
On a per-transaction level, are you profitable?  After six months, on a net contribution margin basis, you need to have fully recouped your customer acquisition costs.  And, after 18 months, you need to have at least 3 X your customer acquisition costs at a net contribution margin basis.  Ideally, you have a negative churn, which means even though you have lost 25 or 50% of your customers, the remaining ones are buying so much more.  

 

Many companies launch without a business model, hoping that they figure it out later.  Once in a blue moon, those people succeed like Facebook and Google.  They started without a business model and ultimately got enough scale that they needed. More often than not, if you launch without a business model, you die. The other problem is that companies launch but ultimately don't have favorable unit economics. They are losing money on every transaction. The bigger they get, the more they lose money.

 

4. If you haven't launched yet, map out your theoretical unit economics.

 

If you haven't launched yet, you don't know what the unit economics are going to be. But, you can find out what is the average order in the industry.  You need to understand the typical cost structure.  If you do the math, theoretically, how much does it cost? I keep pounding entrepreneurs on their unit economics even though they haven't launched.  If your unit economics are not good when you start and if you don't recoup your CAC after six months, do you have a vision or a story that is compelling of how you get there with scale? For example, you could tell me we are doing food delivery, and the driver is making $15 an hour making one delivery. And that makes my margin not work. Once we have scale, and I am doing three deliveries in the same neighborhood, then my margin will be very good. 
 

5. Be deliberate in the teams that you build.  

 

People need to be very deliberate on the teams that they build.  You need people that have the right skills, a shared vision, and that work well together.  All those elements are relevant.  Founder dating is essential. Spend some time to get to know them. Go away for a week to work on the idea, meet their spouses, go for drinks. This partnership is a marriage, for better or worse, for at least the next five years. 
 

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