You're considering investing in a company - but some details about it are raising some serious doubts. There's only one founder, the founder's brother is the CMO, and they want to use a freemium business model for their up-and-coming personal drone manufacturing business. Now what? Unsurprisingly, that laundry list of taboo start-up features probably set off a few alarms in your head. For years you've been given advice - be it solicited or not - about how to make smart business decisions.
In this post, I'm going to discuss a few examples of well-known potential risks that an investor should take a second look at before investing in a company - and why they're trickier than you think.
Not (Yet) Demonstrating Revenue - The Freemium Model
A business without revenue is like a fish without water. Or at least that's how we used to think.
These days, many companies are opting for the Freemium model. The Freemium model is based upon collecting lots and lots of users who use a company's product or service for free, and a small minority of users paying to use a premium version of the product or service. There is speculation around this model because oftentimes companies begin to offer a service for free without having fully conceived how exactly they are going to monetize. The benefit is that companies get to (hopefully) build a large user base and fast. Companies get user contact information, and the ability to win over the customer with their product. Customers are far more likely to try new products if they don't have to pay anything.
While in the past an investor might have investigated a company, discovered it was intent on using the Freemium model, and then moved on without hesitation - with many companies now using this model, many have taken a second look on the merits of it.
There are both success and horror stories of companies who have used the Freemium model.
The real-time messaging platform, Slack is a great success story of a Freemium model. The company's user base increased dramatically in the Fall of 2014, thanks to what the company called "customer-referral growth." The Slack team didn't care about making sales right off the bat - they wanted their customers to love their product so much, that their customers recommended the product to others on their own accord. Then, eventually, once the customers are hooked some may begin to want access to the features only available on the premium plan, and thereby become paying customers. Through this strategy, Slack was able to become the one of the fastest B2B SaaS companies - most recently having raised $200M in April 2016 at a $3.8 billion valuation.
On the other hand, the model has been scrutinized heavily throughout the years. Chargify LLC was using the Freemium model when they started in 2009 and was going to have to declare bankruptcy, before deciding to charge all their customers which eventually led to them becoming profitable. The company HitTail, which helps websites with SEO, is struggling with the Freemium model and has had to spend tens of thousands of dollars trying to increase the number of paying users they have. These are examples of companies that used Freemium at one point, and quickly had to react and/or change gears in order to make it work. Alternatively, there are countless examples of businesses who try the Freemium model when launching their app, service, or product, and fail completely.
A while back, TechCrunch published a really interesting article on all of the questions a company should consider before using a Freemium model to decide if it's right for them. It is also a good resource for investors, so that they know what kind of companies have the potential to successfully use a Freemium model, and which ones should really be avoiding it.
Like it or not, the Freemium model has seen success, and it's gaining in popularity. Forbes features a fascinating piece engaging with the stories of a few start-ups using the Freemium model who have seen success. Y Combinator said that about a quarter of the companies they invest in intend to use the Freemium model. Although it might mean that earning revenue and eventually turning a profit is much further down the line than it would have been with a "regular" buy-and-sell product, it's worthwhile listening with an open mind to what a young business has planned.
For a no-friction "do it yourself" experience.
There is a lot of stigma surrounding companies with a single founder. For one, it can be viewed as there being a lack of confidence in the person or the product. Forget about convincing peers in the industry to co-found a company - think about it for a minute - if there's just one founder, it means that person wasn't even able to convince a friend to start a company with them! And friends are the people who are supposed to like, support, and believe in you the most. There is an exorbitant amount of stress that comes with founding a company, and a founder needs someone to help with logistics, fundraising, brainstorming, moral support, and so much more. After all, no one can do everything alone, right?
Let's ignore that for a moment, and assume the solo founder has a great idea.
Often, one person in executive leadership is seen as a single point of potential failure. One person in charge means one holding the power to make executive decisions, and mold the future of the company. What if that person makes a substantial mistake because they didn't consult with someone else first?
However, there are rare occasions when a brilliant single founder really can do it all on their own, and more. For example: Steve Jobs. And, well... that's all that needs to be said about that.
But I'll give a few more examples, anyway, to help convince you that some people can do it all. Below are examples of solo founders who have recently graduated from accelerators and/or completed funding rounds, and whose companies are on a successful path.
Sara Blakely (Spanx)
Jack Ma (Alibaba)
Natalie Gordon (Babylist)
Nikhil Nirmel (Lawdingo)
Ray Grieselhuber (Ginzametrics)
Olga Vidisheva (Shoptiques)
Laura Fitton (OneForty - acquired by Hubspot in 2011)
Naoki Shibata (Appgrooves)
Damian Madray (Hunie)
Aihui Ong (Love With Food)
Below are a few single founders whose companies are now considered to be unicorns (private companies valued at over $1 billion).
Successful companies with solo founders definitely are in the minority - but they are there. When considering whether or not to invest in a company, it's important to look at the fabric of the company - a sole founder with committed expert employees might have no problems growing a successful company. Well, no company is without problems at some point along the way, but a well-supported solo founder is more likely to succeed than an unsupported one.
When scoping out companies to invest in - don't walk away just because there's a solo founder - it's important to look at the many people who make up a business. Are the tech heads committed? Does the head team die and bleed for the product? Is it a close-knit and well-experienced team? Look at the whole picture before deciding to turn away.
Familial Relations In The Workplace
The term "brofounder" didn't create itself.
An article from Go4Funding warns that investors should be wary of familial relations in a company because it can lead to "dynamics and drama that may arise in the workforce." In addition to that, the internet is riddled with horror stories of workers complaining about their bosses (parent-child/siblings/cousins/etc.) or workers who have left their jobs simply because they couldn't deal with constant bickering or conflict.
A top reason that start-ups fail is that the heads can't get along. Well, think about it - siblings have spent at least two decades figuring out how to get along in a variety of situations and if they work well together. It's just one of the unique experiences they bring to the table.
The Co-Founders of Moat are brothers, and have co-founded multiple companies together. Jonah and Noah Goodhart have a history of co-founding companies together including: Colonize.com, Smarter Ad Group, WGI Group, and billions.org.
Business Insider describes how twin brothers Ali and Hadi Partovi founded social music service, iLike, which they sold to MySpace for about $20 million in 2009.
Irish brothers Patrick and John Collison also have a history of working together. They founded Auctomatic, which was a Y Combinator company. They sold the business to a Canadian media company for $5M. Now they are involved in a new venture, Stripe, which is backed by Silicon Valley VCs and important players such as Peter Theil and Elon Musk. Not too shabby.
That being said, familial relations in the workplace can definitely cause drama and make other workers uncomfortable. No one knows how to light your fuse quite like a relative. Remember - they were there with you for all those embarrassing and awkward moments growing up.
See how the family interacts with one another before dismissing a potential investment. While it's certainly true that having one or more family members involved in a business can lead to unwanted drama, there are exceptions to this. There are siblings who work well together and drive one other to strive to do their best and push forward. There are parent-child pairs who work professionally to skillfully pair decades of experience and new innovative ideas and strategies. If you're interested in a company, don't write it off before fully understanding the situation.
What does this tell us?
Each company is different and should be viewed as an individual. Each has had different experiences thus far and is coming from a different environment and is being nurtured by people from different backgrounds.
At the end of the day, generalizations are not going to work for every company you consider investing in. Just because one dog bit you when you were a little kid, doesn't mean that all dogs are going to bite you. Similarly, just because one company you invested in years ago had a solo founder and ended up failing, doesn't mean that every company with a solo founder is going to fail. Every company should be viewed and analyzed critically on an individual basis. There are definitely indicators of features worth taking a deeper, more thorough, look at, but by and large one cannot draw upon overused generalizations to decide whether or not to invest. Each company is an individual, you have to get to know its story.
The concept of red flags or things to avoid is problematic, because it assumes a clean cut scenario. In fact, as we know, nothing in life is as straightforward as we would like it to be. That's why when we at Zirra discuss a company - we don't discuss reasons to avoid investing in a company. Instead, we identify potential risks. Signs to look out for. Indicators of issues that may arise.
At the end of the day, evaluating potential risks like a pro means recognizing that you have to take the entire company's journey into account, and not jump to conclusions solely based on the warnings of others.