Why Investors Prefer Lean Startups
For many Startups, it’s a major challenge to attract investors. This is because usually the risk is high and the potential of payback is hard to prove. With the Lean Startup method, you can reduce the risk of losing money and prove your potential. This is why investors prefer Lean Startups.
It can be a very frustrating experience to pitch your Startup to potential investors. You have an idea you know will be a huge success, but the potential investor may not understand it… Investors in general have two main questions: 1) What can I earn?, and 2) What is the risk? If the potential earning is low or the risk is high they would rather keep their money invested elsewhere. This article is about how you can prove potential and reduce the risk, and why Lean Startups are preferred.
What is different with Lean startups?
Over the last few years this new startup model has gained great attention. It favours experimentation over planning, customer feedback over guessing and iterative development rather than traditional large scale water-fall projects.
Today entrepreneurs build a “minimum viable product” and test it with real world clients. They develop their business model, products and services based on learning from customer feedback and behaviour. And investors love this type of Startups.
What do you want from an investor?
Investors can bring more to the table than just fresh capital, they bring experience, contacts, customers and sector knowledge. You need to decide if you want an active or passive investor, what type of investor you would like, how much capital you need to raise, what share of the company you are willing to offer and also what exit strategy you suggest for the investor.
Pitching for Investors
When you are ready to present your business for potential investors you should start by making a list of ideal investors you want to approach. Start by pitching your ideas and plans to the ones at the bottom of your list and study what’s expected of you and take interest in what kinds of questions they ask. You can safely assume that a professional investor would know a lot about Lean startups.
It is likely that you will be overwhelmed at first and your first initial meetings will probably take you by surprise. This gives you the opportunity to improve your presentation before you invite the most interesting investors for a meeting.
Prove your potential
So this is where the rubber meets the road. Lean startups build their business model by testing a set of hypotheses. You build validated learning step by step by documenting your experiments, which you can then build into your business model. This is also what you need to show to your potential investors. There will be a few unique numbers that all investors are looking to understand:
- Customer Acquisition Cost (CAC): How much does it cost to get a new customer. You should be able to document through your initial product/market fit analysis how big your average marketing and sales spending is per customer. Also you should be able to predict development in CAC going forward with a target CAC.
- Lifetime Customer Value (LCV): How much estimated earning will you make from one customer during the whole duration of your relationship. Research churn data from your sector and prove the average revenue and cost for your delivery.
- Your ability to scale the business model: If you can prove that the LCV is (substantially) higher than the CAC the next question will be if you can scale your business.
- All the other questions: Sure, you will have to answer a ton of other questions too. You need to tell your story of the reasons behind why you started your company, your big vision and business idea. What problem are you solving? What is your business about? what is your unique competitive advantage? Who is your main competitors? Who are your team? Why will you be a success? To name a few important ones.
Lean startups reduce risk
One of the really unique ideas of Lean Startups is the fact that you build a lean company. This mean that your business model can be tested and proven with significantly lower investments and reduced risk. Investors do not like taking risks and that’s why they love Lean startups.
The best strategy for many is to self finance the first step of building your company, until you can provide evidence on your CAC, LCV and scalability. With that proof you have successfully reduced the risk of investing in your Startup. Then investors are more likely to want to invest in your company and help you scale your business model.
Here at Cloudnames we work with many Lean startups and follow the same principles ourself.
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