This article is the seventh in an ongoing series on Due Diligence. To learn more about performing due diligence quickly and effectively, download this free eBook today Stones Unturned: An Investor's Guide to Due Diligence in Early Stage Companies or purchase our books at Amazon.com.
We are all familiar with how technology made dramatic changes in our lives over the past few years. Computers, the Internet, mobile phones, etc. all conspired to make our lives more efficient and more chaotic! And, these disruptive changes touched all aspects of how companies run their operations. It’s not surprising that Sales and Marketing professionals have seen some of the biggest changes in how they operate their day-to-day tasks.
Marketing used to be all about PR and Advertising. Now, if you don’t understand Content Marketing and how to apply Data Analytics to dig into your customer’s behavior you won’t be effective. With Sales, you need to understand that your customer knows a lot about your product even before you talk to them. Customers are able to research both you and your competition without engaging a salesperson.
As an investor in early stage companies, you must be aware of the new world order in Sales and Marketing before you are able to understand whether a company is well-positioned to achieve success in their Go-to-Market Strategy. That said, many of the old rules about how to successfully go to market are still in place. Sales and marketing is still work and it still costs money. It is just different kinds of work and spend. So what are we looking for in an early stage company that may or may not have any customers?
Q: Ham, when a CEO is presenting the company’s Go-to-Market strategy, what are some of the key points you are listening for?
The CEO has to be specific about how the company is going to crack their market. Selling is really hard, especially to certain types of customers. S/he will need to convince investors that the company has a very detailed plan or business model innovation that is going to allow the company to acquire their intended customers affordably (relative to their life-time value).
Key questions that an investor must ask include:
Is the company selling with a direct sales force, over the web, through partners, through distributors?
Where are the customers and how will they locate them, talk to them, and bring them on board cost-effectively?
What is the customer acquisition cost (CAC) going to be relative to the lifetime value (LTV) of the customer? (Hint: LTV better be higher than CAC, or they're in trouble.)
There are many different Go-to-Market strategies and they vary from industry to industry. Since we can’t dig into all the possible strategies, let me give one example from an industry that I know well, the Software-as-a-Service (SaaS) market.
If you are going to invest in a SaaS company, the CEO will need to describe which of the following approaches the company will use to acquire customers. In the list that follows, I name the approach and then put a dollar range that represents how much you should expect it will cost to acquire one customer (i.e. CAC).
Freemium ($0 - $50)
No Touch Self-Service ($50 - $250)
Light Touch Inside Sales ($250 - $2,000)
High Touch Inside Sales ($2,000 - $10,000)
Field Sales ($10,000+)
Once you know how the company is going to sell product, there are a handful of metrics that you must understand to get a sense for whether the company has a viable, scalable Go-to-Market plan. The metrics are as follows:
Customer Acquisition Cost (CAC) - This cost will vary depending on how the company sells its product (see bullet list above - but you will need to verify that their costs align with this list)
Months to Recover CAC - In an ideal world, the company will be able to recover CAC in under twelve months. Anything greater than two years is a red flag.
Customer Churn Rate - Companies with a low churn rate (e.g. under 1% customer loss per month) can grow faster without having to raise as much capital
Life-Time Value (LTV) of a Customer - If you can find a company with LTV more than three times CAC, then you’ve found a great investment opportunity
For early stage SaaS companies that are just starting to ship product, it will be difficult to get accurate numbers for each of these metrics. That said, the company’s financial plan should reflect the reality of these metrics. Make sure their assumptions in the financial plan are reasonable based on their Go-to-Market strategy.
Q: With an early stage company, what are you expecting to see when it comes to the Sales & Marketing team?
As an early stage investor, I am used to investing in companies where the team is small. In many cases the CEO is the chief salesperson and the company might not have any full time marketing people. But that lack of a formal sales organization shouldn’t scare you away from investing. In fact, I am sometimes more worried when a company has a high powered VP of Sales who comes from a big company background and is accustomed to having a staff and doing things according to conventional wisdom.
In the early days of a startup company, you want sales people who are willing to do the grunt work of opening a new market and closing sales. You don’t want a CEO who is looking to build a large sales organization before the company figures out a scalable Go-to-Market strategy. That’s the fastest way to burn through your investment without producing results - nail it before you scale it!
Often, some of the dollars we are investing will be used to hire a few sales and/or marketing people. In an ideal situation, the initial sales talent are self directed individuals who don’t need much training to sell to the target customer. And with marketing, the early hires are individuals with experience building compelling content and filling the top of the sales funnel with qualified leads.
Q: As we mention in the introduction, Marketing changed dramatically over the past several years. Can you be more specific as to what you look for in the marketing plan for a startup?
Isn’t going viral how everybody grows these days?? Just kidding… I cringe when an entrepreneur proclaims the company will grow just by word-of-mouth. I know it can happen on the rare occasion, but I wouldn’t want to bet the farm on it!
With early stage companies, it can take a while before you figure out what marketing programs will work best for the business. And, it’s not unusual for a plan that’s successful in the early days of the company to lose momentum as the company matures and the customer base evolves from early adopter, to early majority to mainstream.
So at the point in time when we are doing our diligence, I am not looking for a set of marketing programs with a detailed 12 month marketing calendar. Instead, I expect to see answers to the following questions:
Market Segmentation: Who is the target customer(s)?
Market Opportunity: How many customers are out there? How much are they willing to spend?
Marketing Channels: Where will you find them? How will you reach them?
Want to learn more about performing due diligence quickly and effectively? Download this free eBook today Stones Unturned: An Investor's Guide to Due Diligence in Early Stage Companies or purchase our books at Amazon.com.