This is a great question and you should be well prepared for it.
It is your opportunity to provide a case study of the ideal customer for your company. Describe the problem that they had in detail and how your solution fixed that problem for them. Highlight how you reduced their costs and pain otherwise known as the value proposition. You have a minute to really shine!
This is covered in more detail in the Perfect pitch workshop.
This is your opportunity to give some realistic expectation on how large the company could be in the future. How you measure size is up to you. You could measure size by the number of people employed, by the turnover or by profit margins. Use this opportunity to sell the dream of the company just before it is likely to be bought or go to IPO or when it has reached its maximum potential.
To prepare for this question you will need to have another a detailed financial plan based on information about the size of your market. This is the subject of the Financial Model Creation.
Investors asking this question are trying workout whether you could grow to be a large organization and give them a correspondingly large return on their investment. So how do you evidence the market size? There are two approaches you can take; one is top down approach and the other is bottom up approach.
The top down approach starts “there are 7 billion people in the world half of them are women and 50% of those have access to make up, of these 30% of those people are like to have the particular color of lipstick. So therefore our market is 500 million people”. This is called the “Total Addressable Market” (TAM). In general investors are not very interested in TAM because it really doesn’t indicate how many people you could actually each with your solution, so you need to do more work…
The Served Available Market (SAM) is the proportion of the addressable market you can reach with your product or service based on your current business model. Reasons you may not be able to reach the total addressable market include geography, language competition and the ability to get in front of customers.
Finally the Share of the Market (SOM) is the subset of the Served Available Market you can realistically reach taking into account company limitations (i.e. the maximum number of customer you can serve) and competition. Generally the investor is interested in the SOM when he was about the actual addressable market and will want to know about the assumptions you made to reach your conclusion.
The bottom up approach starts by saying “We spoke to 1000 people and found 300 potential customers, 20% of them went on to buy the product at $1000.” This is then combined with more general statistics: “We know from the Australian statistics bureau that there are 1,000,000 people in this market segment. Therefore we the size of market from Australia in 200,000. This gives is a local market size of $200 million.” This approach is more detailed and more believable since it is based on real evidence.
Ultimately investors will want to see both approaches to estimate market size and if they are similar it gives some comfort that your proposition is good.
You can find out more about the importance of the market opportunity on the Funding Startup to IPO workshop.
For an investor there are two important steps: 1. the company paying its running costs; and 2. the additional return on their investment of money and/or time.
In the first case, explain how the income will pay the monthly wage bill, suppliers, insurance, etc. and still end up with a significant sum to reinvest and/or distribute. On average Investors hope to sell their equity in 3 years (although in practice this is 8-10 years) so they want to know that you will make money well before them.
To prepare for this question know your financial model inside out and use it to show how you are going to generate revenue. There is no right or wrong answers, but some answers are better than others. Poor answers include “we are going to generate from advertising”. Good answers include “we are going to sell our product for $1000 with an annual maintenance fee of $500 and expect to sign the customer up to 30 per month by the end of the year”.
There are several reasons that you may be asked this question – to discover the profile of company growth and how they can recover their money.
Investors are putting a large sum of money into your company looking for a very large return to cover their time and investments that fail on average. Only 1 in 10 of an investor’s investments make a significant return. Therefore they want to know that you can produce enough money to cover the 9 failures so that their portfolio makes an overall return.
Investor want to understand your long term intentions are for the company. You have several long term options: IPO; trade-sale; dividends; and share buyback. Investors in general are very wary of IPO’s and share buybacks and they are much more interested in the any opportunities that may be for trade sale. To demonstrate this, show that there are companies who could purchase you in the future and what sort of valuation you are expecting.
This is covered in great detail on the Finding Startup to IPO Workshop.
There are two key words in this type of question. “Big” and “Problem”:
- Big: Demonstrate how many people and/or organization have this problem. Is it ten, a hundred, a thousand or a million?
- Problem: Succinctly identify the problem that you are solving. Thinking about why it has not been solved before may help your answer this more effectively.
Problems can be broadly split into two types:
- Aspirin: Those that are essential because they fix a pain. Customers are driven to buy these solutions quickly and is/are less price sensitive. For example: How do I get to work?
- Vitamins: Those that are to nice to have fixed but are not urgent. Customers are less likely to need these solutions and will often use discretionary spending to buy them. For example: Where shall I go on holiday?
If you can illustrate how you can convert your “vitamin” to an “aspirin” you have increased the value of your proposition. See the review of "Hooked" for more insight.
An investor will be much more interested in your problem if it solves a real pain that a large number of potential customers have right now.
This is covered in greater depth on the Funding Startup to IPO Workshop.
The wording of this question may change - it is the traditional “give me your elevator pitch”. Or put another way “In the shortest amount of time explain why I should be interested in what you are doing. And please give me all the answers to questions I’m likely to ask.”
The answer to this question depends upon when you have spoken to the investors. Think about giving a 90 second answer that draws them in so they will ask more detailed questions about your company. Use examples of customers who’ve been successful using your solution.
Lean quickly about what works by watching how investors respond to your answer. What resonates? Do they ask you more questions? Should you have included the answers to those questions in your initial pitch?
You are then in a position to start asking the investor questions and get to know more about what they are looking for. If they are the sort of person you want to work with, get their contact details so you can keep them informed of progress. This strategy is covered in more detailed in Funding Startup to IPO Workshop.
If an investor has already seen your company pitch and then asks this question, it suggests that your pitch has not demonstrated what the company does and why the investors should be interested. Time to go back to drawing board and make sure you include the key points.
There are many ways of asking this question - it is your opportunity to state why the Investor should be interested in your company. Highlight the key differentiating points that makes your company and product more likely to succeed than any other. This is covered in greater detail in the Perfect Pitch Workshop.
If you have just pitched your idea to the company/investor and they ask this question, then your pitch has failed to cover a basic element of a pitch. It did not highlight the real benefits of what you are doing. It is time to revisit your pitch and work out how you can improve it.
Succinctly demonstrate that you understand how your customers go about making decisions to buy your solution.
If you're selling to businesses, the investor is trying to work out the size and sector of the businesses that you're selling to. They know that different sectors and different company sizes have different buying characteristics. For example in a large business all members of a committee may need to agree a purchase over $100k while in a small business it may only be the CEO.
If you're selling to consumers, you need to be able to demonstrate that you understand the consumer. For example, if you're selling a method by which consumers can order cups of coffee rather than waiting in the queue, investors need to understand the profile of customers which have that problem.
The location of the head office is important to investors for two reasons: legal and emergencies.
Legal: The country of origin of the head office dictates which legal jurisdiction the investment will be made. If it not local there are two additional risks for the investor: unknown legal jurisdiction; and currency fluctuation (which may reduce the value of the investment).
Emergencies: If anything goes wrong with the company the investor may want to come and help out and need to know if this is possible for them. Clearly it would be difficult to help if it takes a six hour plane flight to reach you.
In June 2015 Bill Gross presented a TED 2015 talk in which he revealed that Timing was the most important success factor accounting for 42% of the differences between Success and Failure for 200 companies. The other four factors he compared were Team (32%), Idea (28%), Business Model (24%) and Funding (14%). So if your idea is too early (customer are not ready) or (especially) too late (too much competition) there is little you can do.
Being early exposes you to additional problems of surviving until customers are ready and/or educating the market about a solution to a problem. The primary benefits are 1: that you can fine tune your product with early adopters so when the mass market is ready you have the “go-to” solution; and 2: being able to own the market. Being first in the market demonstrates that you are able to capitalize on your idea and make significant returns as others catch up with you. Those first into a market can own >50% giving them on unassailable lead.