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How to evaluate business ideas

How to evaluate business ideas [1]

POCD was first introduced by HBS professor Bill Sahlman and stands for People,
Opportunity, Context and Deal. People are the individuals or groups who perform services
or provide resources for the venture. People are, for some investors, the most important
aspect of the business, as many fund people rather than ideas. The past experiences of the
founders and their successes or failures are an indicator of future performance. A complete
team needs to combine business and technological expertise and potentially other specific
knowledge or experience depending on the industry. Team motivation and commitment are
crucial and many investors reject funding entrepreneurs for whom the success is not really a
win or die game. Moreover for practical reasons, and since VCs receive hundreds of
business plans every day, having a network and being known in the entrepreneurial
community helps at least passing the first scan. The model and the author do not state that
not having experience definitely leads to a failure, but for sure probabilities are against you.
After all investments are a game of statistics, where you try to increase the success
probability and decrease risk.
Opportunity is any activity requiring the investment of scarce resources in hopes of future
return. Regarding the opportunity, the main question is about the total addressable market,
which ideally should to be large enough and growing (as a rule of thumb VCs expect the
venture to be able to reach $50m in revenue in five years). That stands for the simple reason
that it is easier to take a market share in a growing market, than fight incumbents for their
share. Knowing the customers needs and having a simple financial model of how much it
costs to serve him (create and sell the product) and how much you can sell the product for, is
the minimum requirement for market understanding. The go to market strategy has to be
realistic and able to adopt. It is a fact that most startups pivot at least once in their life until
finding a viable business model. A simple way of evaluating industry attractiveness is the
Porter five forces model. The five forces defining the level of competition are the bargaining
power of suppliers, the bargaining power of customers, the threat of substitutes, the threat of
new entrants and the rivalry among existing players. The intellectual property, patents and in
general any way to create a competitive advantage are important in assessing the
opportunity.
Context is all those factors that affect the outcome of the opportunity but are outside of
direct management control (interest rates, regulations, economic conditions). We are
concerned about context but maybe more importantly about context changes. For example a
deregulation can open an entirely new market, creating new opportunities.

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Deal is the set of implicit and explicit contractual relationships between the entity and all
resource providers. Besides the valuation of the company and the shares that each player
holds, there are other important factors such as restrictions and terms about funding in next
rounds. According to Sahlman, from whom you raise capital, is often more important than the
terms. His main argument is that the connections and expertise of your investors will create
opportunities and help you in ways money cant. A good deal should be simple. Its function is
to ensure that the company has enough time (money) to reach the next goal (develop
technology, bring the product to market) and raise the next round of funding. Moreover it
should align the incentives of all participating parties.
Overall what is important is the fit between these four factors. We are not looking for over
performance in just one or two of the before mentioned dimensions, but more of a general
alignment in order to achieve the final goal. Evaluating business ideas is not easy. There are
so many factors and variables that the outcome is unknown. Whoever supports the opposite
is at least naive. What entrepreneurs have to do is try to play with positive odds. Only that
way they can increase the chances of success. I will close with Sahlmans words using the
Nike model (slightly less sophisticated, but almost equally valuable) to advice young
entrepreneurs Just do it! If not, just say no!.
References
William Sahlman, Some thoughts on business plans HBS 1996
Michael Porter, Understanding industry structure HBS 2007
Sequoia Capital Website [2]
Marmer, Herrmann and Berman, Startup Genome Project May 2011
Michael Roberts and Lauren Barley, How Venture Capitalists evaluate potential venture
opportunities HBS 2004
Paul Graham, How to start a startup Harvard Computer Society 2005
Bing Gordon, Partner at Kleiner Perkins CEO 2.0

1. http://leadersjournal.org/index.php?option=com_content&view=article&id=106:how-to-evaluatebusiness-ideas&catid=39:issue-4&Itemid=113
2. http://www.sequoiacap.com/ideas

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