VC Expert George Deeb on the Four ‘Ms’ of Evaluating Startups

At some point in your startup journey, you’re going to need some capital to expand. That is for sure. So what do investors look for when evaluating startups? What’s attractive and what’s not? On today’s show, we’re talking to George Deeb, Managing Partner of Red Rocket Ventures and author of three entrepreneurial handbooks, is here to discuss the four M’s of evaluating startups.

incubators and acceleratorsTranscription:

Jim Fitzpatrick:
So, George, thank you so much. Tell us, we’ll start in the beginning here, because I’m anxious to hear what the four M’s are in evaluating startups. What, what are they?

George Deeb:
Yeah, no worries. There’s the market that you’re actually serving, the industry and the competition, et cetera; the model of your business, what are your economics of the business and how do you drive revenues; the management of the company, who’s making the decisions and kind of building the business; and the momentum of the company, what kind of growth rate and kind of trajectory that you’re on.

Jim Fitzpatrick:
And so let’s start in the beginning. How do you evaluate the market?

George Deeb:
Well, to me, it all starts with the size of the market. An investor wants to go after a big sizeable market opportunity as opposed to some niche. And in addition to the size of the market, how quickly is it growing? Is it a market that’s expanding or contracting? That makes a difference. And obviously, what’s the competitive set in that marketplace.

Jim Fitzpatrick:
Let me ask you though, as it relates to it, because I know there’s probably some entrepreneurs that are listening right now going, “Ooh, I was all about the niche. This is a very niche market and that’s what my particular product or service answers.” Can’t there be millions, if not billions, made in a niche market or some people say niche market?

George Deeb:
Yeah, yeah. Niches are fine. I mean, it’s all a function of kind of what your goals are and what you’re trying to build. I like to give this example. We’ll compare a huge market opportunity to a niche market opportunity. So let’s look at the travel industry as an example. Something the scale of Expedia or Airbnb, that will certainly get professional venture capitalists’ attention. You can build a multi-billion dollar business selling air and car and hotel and cruises and vacations and everything under the sun, under the high-level category called travel. But if you’re a whitewater rafting company in West Virginia, and you’ll never get more than a million dollars in revenue a year, yes. You can have a successful business. It just may not attract the professional capital that is looking to scale something bigger than that. That’s perfectly fine if you want to do that, just understand it’ll be more of a lifestyle business for you than it will be a scaling venture capital-backed business.

Jim Fitzpatrick:
It’s safe to say though, that even for that whitewater rafting entrepreneur, there can be money on the sidelines, right? Somebody might say, “Hey, give me 25% of it and I’ll give you a hundred grand to get started, to buy the rafts, to buy the signage, what have you.” Is that a safe assumption that somebody might be willing-

George Deeb:
Yeah, I like to think there’s an investor for every story. You just need to find the right investor for you.

Jim Fitzpatrick:
Right. Right.

George Deeb:
I do lots of research when I’m raising capital in terms of who is that investor group? What size companies do they like to invest in, what industries do they like to invest in, et cetera. If there’s not a professional venture capital firm that’d be interested, there might be a family office. There might be friends and family. There might be all kinds of people that would give you capital to fund your business. It’s just a function of what the pitch is and who it resonates with.

Jim Fitzpatrick:
Right. And that’s an entirely another show that we can do, a long show, to talk about who the right person is, right? Whether it be friend or family or somebody outside or whatever. So how does competition play into this?

George Deeb:
Well, pretty largely, I mean, an investor likes to get involved with an early mover in a space. If you’re a first mover, that’s great. A second or third mover, that’s probably okay too. There’s room for multiple players in the industry. And whether it’s Uber or Lyft, there’s multiple big players in that industry. But if you get to the point where there’s 10 or 20 big players in the space and your pitch is coming across as a me too story, you don’t want to be that. Because the investors have already looked at that space, they’ve already made their bets and they’re looking for the next new thing that hasn’t come yet.

Jim Fitzpatrick:
Right. Right. It reminds me of Mr. Wonderful on the Shark Tank where somebody will come in and, and he’ll say, “Well, what stops me from going out and creating a pillow like that and selling it and crushing you like the cockroach that you are?” I don’t know where that term comes from. But nevertheless, that’s true though, isn’t it? I mean, investors do look at that and say, “If I want to sell cups, why would I buy your cup? I can go out and create my own cups.” Right?

George Deeb:
Well, for sure. I mean, there’s also the capital aspect to this. If three other companies have already raised a hundred million dollars to tackle this space, and you’re the first mover raising a million dollars to kind of get your seed capital off the ground, you’re kind of going to war with one arm tied behind your back. And the investors know that and they don’t want you to waste the capital on something that may not be successful.

Jim Fitzpatrick:
That’s right. That’s right. So how do you evaluate the model?

George Deeb:
All right. Well, at this point now you’re talking about the unit economics of the business. To me, what’s the average order size, and how does that compare to your cost of customer acquisition? You are also talking about things about what’s your return on ad spend and how does that compare to the lifetime value of the revenues that are coming in over time? So it’s really looking at your business at the unit level and figuring out what the costs are of your advertising efforts up against the revenues per transaction.

Jim Fitzpatrick:
Okay. And is there a metric that businesses should manage towards to get a VC’s attention?

George Deeb:
Yeah, I mean, on the marketing front, I’d like to see the marketing somewhere in the 10 to 30 range as a percentage of revenues. I think that’s a good ballpark. If you’re eating up all of your revenues with marketing, that doesn’t leave a lot of money for running the company or for distributing profits. So that’s kind of a broken model. But 10 to 30%, whether you’re a B2B or B2C company is a good range. And then a return on ad spent perspective, something in the five to 10 times range, depending on your business model and whether you’re a B2C or B2B business. So I think that’s what the investors will be looking for, because they want to help give you capital on something that you know the marketing is working for to kind of accelerate a proven model.

Jim Fitzpatrick:
How do you evaluate the management?

George Deeb:
Well, I think first and foremost, there’s got to be a team, right?

Jim Fitzpatrick:
Yeah.

George Deeb:
You’ve got various roles and responsibilities around the table. You got to make sure you got the key people filling each of those holes, whether it’s a marketing person or a technology person or a finance person or whatever it is. So one, is the team complete? Second thing-

Jim Fitzpatrick:
I was just going to say, what if it’s a solopreneur and they have a great idea and they’ve answered all of those other questions, but they don’t have the team put together because they don’t have the capital to put the team together. Which comes first, the chicken or the egg, right?

George Deeb:
Yep.

Jim Fitzpatrick:
Because teams can be expensive. So as a VC person, do you go in and say, “What’s your intention on putting the team together if you don’t have one?” Or how does that work?

George Deeb:
Well, what would be great is if you’ve identified the candidates that you think can be part of the team, that want to be part of the team, and you can advertise their resumes and their background and their expertise for the role without actually having them hired. I think that’s one way to tackle that.

Jim Fitzpatrick:
And you would buy into that? That’s okay?

George Deeb:
Well, the counter to that is, the investors are sort of looking for history of the team and have they worked together, right? If you put five brand new people together, there’s a very high odds they’re going to drive each other crazy and that’s may not gel as a team, right?

Jim Fitzpatrick:
That’s right.

George Deeb:
But if you got a team that’s worked together for six to 12 months, and the kinks are ironed out and they like each other and nobody wants to quit, that’s a lot better situation to have a team that’s already in place. So that’s a really important thing.

Jim Fitzpatrick:
Let me ask you this, is it ever a situation where somebody says, “Listen…” And much Like Shark Tank, sorry to go back to that, two references in one show already. But is there ever a situation when somebody says, “Well, that’s what I’m coming to you for. I need that kind of advice and that kind of guidance, George, in order to go to the next level. I’ve got the widget, I’ve got the marketing, I know the market. We’re ready to take this to market. We know we need a good team and we’re kind of hoping, George, because of your experience that you can help us put that together.” Do investors want to get involved or do they just want to kind of write a check and say, “Hey, no, no, no, that’s what you need to do.”

George Deeb:
Well, there’s different strokes for different folks, and every investor approaches it differently. I think big picture, an investor wants to get involved, wants to bring their expertise and experience to a startup that they can help them avoid the pitfalls and have success in growing their businesses. The difference though is what an investor’s going to say is, “I’m willing to bring my wisdom to you at the board level, at the once a month kind of get together level, but I don’t have the time to give you to operate full-time job, 60 hours a week in the trenches kind of building this company.” So it’s very important that you understand the difference in role of the management team versus the guidance and the consulting you’ll get at the board level.

Jim Fitzpatrick:
That’s right. Now, my next question is one that entrepreneurs kind of shiver on, and that is, is the founder always the best person to lead the company? Because I think there’s a lot of people out there, a lot of entrepreneurs that start out and have the dream of leading their own company. “We’re going to build this thing. We’re going to have really cool offices and I’m going to be the team head coach or the quarterback. And these are all going to be my peeps, and we’re going to take this thing all the way to the goalpost or beyond.” And that’s not always the best recipe to build that business, right?

George Deeb:
Well, there’s several examples of entrepreneurs that have made it to multi-billion dollar company CEOs, and you can name them. You know the Bill Gates or the Steve Jobs or the Mark Zuckerbergs of the world that founded a company and carried it all the way through to scale. Most of the time though, entrepreneurs that understand how to take a business from zero to 10 million dollars in revenue are not the same people that know how to build a business from 10 million to a hundred or from a hundred to a billion. You need to make sure you understand the scaling exercise and the skills that are required and the tactics and the playbook that’s going to take you from where you are to where you want to be. And nine times out of 10, that early stage founder entrepreneur is not the same person that’s actually going to scale it to the next level.

George Deeb:
So it’s in your best interest as a founder, if you think of you wearing two different hats, you’re part CEO and you’re part chairman. Put on your chairman hat. It’s in your best interest to protect your shareholders, of which you are the largest shareholder, to put your investment in the hands of a proven winning management team, that’s going to carry your investment to the next level than trying to have the bravado of thinking you could do it yourself, and perhaps not be able to get it to the finish line.

Jim Fitzpatrick:
That’s right. I know you want to be in every writeup about your company and every PR release, that it’s under your leadership, but I completely agree with you on this, George, that for the entrepreneurs that are listening, the small business owners that are at this threshold right now, put your ego aside. Do you want to be the president of a company that is either floundering or not growing, or do you want to be the chairman of one that’s knocking the cover off the ball? And understand that. You got into the business to make money and to have an incredible lifestyle for you and your family. This is part of that growth process, is to know when to say when, right? And I know that there’s been a lot of consternation over this particular point in many boardroom, where the founder goes, “No, darn it. I’m staying on. I’m going to be the CEO. I’m going to run this company.” Only to find five years later, the company’s not doing so well, if it’s even in business still.

Jim Fitzpatrick:
And if they had just made that one pivot to bring in an expert that can pick up the ball and run with it because they are specialists in this field, you’d be so much better. It’d be kind of like going to your general practitioner, your doctor, and the guy says, “Oh, you have a toothache. I can do the toothache too.” You’d be like, “Whoa, what do you mean? I thought you were a general.” “Yeah. But I can put you under, I can rip that tooth out.” Same thing applies here. You’ve got specialists in different areas of business. And if it means that you’re going to bring in a professional CEO that’s comfortable taking a company from 10 million, as you said, George, up to a hundred million, great. Know that you did a great job and just sit back and say, “Fantastic. I’m so glad to be part of this deal,” rather than hanging on. Know when to say when.

George Deeb:
You just need to be honest with what your skill sets are and what you’re capable of doing. And I’ll give you an example, an early stage entrepreneur that’s scaling their business, yeah, they understand Google internet search marketing, and they understand Facebook advertising. And they know a handful of tactics that’ll take you from zero to a single digit million dollars. As you start to go from 10 to a hundred, things like product development, new end markets, international expansion, mergers and acquisitions, all these things start to play at hand, and they may not have any experience in any of that stuff. And either they need to surround themself with talent that has done that and can advise them, or they need to get out of the way and find somebody that has done it before.

Jim Fitzpatrick:
I agree. I agree. So the last M here I think is momentum. How do you evaluate momentum? I mean, when you talk about momentum, early stage, it’s like, “Momentum? We don’t have any momentum because we didn’t sell anything yet.”

George Deeb:
Yeah. A couple things there. I think, first of all, you got to see if they pass their proof of concept point. And that proof of concept point, it varies for every single company. And the metrics for a B2B business are different than a B2C business. But did they hit that threshold? And that’s the first thing. And the second thing is, how quickly are they growing? Are they growing 10% month over month? Are they growing 50% month over month, or a hundred percent month over month? Whatever can prove to an investor that, yep, there’s some interested customers that are out there that are willing to part with their hard-earned cash to give it to you in the form of revenues. And that’s what we’ll get their attention.

Jim Fitzpatrick:
Sure. Which is a perfect segue to my next question. What do you define as proof of concept? We hear a lot about that. Tell me what your definition of it is and how important it is in the overall scheme of things.

George Deeb:
Yeah. I think there’s a few things there. Number one is the revenue scale. Where are you in your revenues? So something with half a million to a million dollars of revenues that have been earned in the last 12 months, that says a lot, right? That’s a pretty sizeable proof of concept that someone will be excited about. That’s the first thing. The second thing is the growth rate, the speed of growth. A 50% grower each month will get more attention than a 10% grower each month. And it speaks to the success of the marketing investment.

George Deeb:
The third thing are, do you have happy clients that are willing to be references of yours that will say good things about you and impress the investor? That, “Yeah, I like this product and service and I’m out of pilot mode, I’m not testing this anymore. I really like this. I’m in a long term contract with them and I want to take it to the next level.” And then obviously we talked about it before, the unit economics of the business. How much is the average transaction value compared to the cost acquisition? And does the model make sense? If I pour more money into this business, will it produce more profits down the road? Because ultimately, profits will be the long term indicator.

Jim Fitzpatrick:
That’s right. Hey, before I let you leave… And I appreciate all the time you’ve given us. This is so great for you to take your time and share your ideas here and your knowledge with so many entrepreneurs here in Atlanta. We very much appreciate it. Is there a lot of money out there right now? We’ve gone through a lot in terms of COVID and companies, some not doing so well, others doing phenomenal. But in the scheme of things for VC money, is there money on the sidelines?

George Deeb:
I’m surprised how much money there is. I figured COVID would’ve screwed up a lot of things, it would’ve derailed a lot of businesses and taken them off their course or impacted their growth rates. The reality is there’s never a shortage of startups. An average venture capitalist might look at a thousand different business plans over the course of the year, and they’re only making an investment in five or 10. So even if half of the industry got wiped out and you’re seeing 500 business plans instead of a thousand, that’s still plenty to come up with the five or 10 that they want to invest in. So plenty of money. Investing is happening in high levels and high numbers, and no change in terms of the venture capital outlook.

Jim Fitzpatrick:
That’s right. It should also be said that there’s companies out there. One huge acquisition from Ben Chestnut’s company MailChimp here in Atlanta. Started 20 years ago, they pivoted a couple of times. They finally said, “Okay, we’re going to be in the email marketing game.” With a tremendous amount of big players out there, Constant Contact breathing down their back the whole time. And they just sold for $12 billion. No outside money. And by the way, the same CEO that was the founder, that is the CEO today, Ben Chestnut, an incredible story. So there’s also some of those stories out there too. We don’t want the business people out there and the entrepreneurs to think that you got to go down this road, it’s the only way to grow your business. It’s actually a very effective way, a very common way, but there’s still that old fashioned roll up your shirt sleeves, build your company, don’t take any outside money, be your own person and grow your company that way. Right, George?

George Deeb:
Yeah, I love those stories. And in the example, an investor looks at a thousand business plans and invests in 10, that means there’s 990 companies out there that did not get the capital and they’re on their own to kind of figure this out. So there’s plenty of those success stories out there. It will dictate the speed at which you are growing your business. You may not be able to grow as quickly because you may not have the discretionary capital to kind of throw a gazillion dollars at your marketing budget. But as long as you put down, slow and steady wins the race, you should be fine.

Jim Fitzpatrick:
So let me ask you this one last question and I hope you come back because I’m wearing out your time here. But with regard to some of the people out there in this world of VC, are they people that want to run companies and help entrepreneurs? Have you found that that’s pretty much the case, or are they mostly hands off?

George Deeb:
No, the VCs want to help their portfolio companies for sure. They’ve got skills they can bring to the table or relationships that they can bring to the table. They want to move them along. I’ll share this story with you. There was a venture capital firm in Chicago that I was close to that liked to invest in marketing technology businesses. And he had a network of chief marketing officers that had worked at a bunch of different Fortune 500 companies. And it was always intriguing to me that he stress tested these investments before he even invested penny number one with all these chief marketing officers. And if the chief marketing officers liked it and were willing to become customers of that business, he’d make the investment and then tee those companies up for a hundred new customers within the first year of doing business because he pre-sold it before he even cut the check.

Jim Fitzpatrick:
A beautiful deal.

George Deeb:
A smart investor knows how to do that. And I think that’s a great strategy.

Jim Fitzpatrick:
Right. Just like we see on Shark Tank where somebody says, “Well, this just needs an infomercial.” Okay, well that’s why I’m coming to you because you have all that knowledge and those contacts. And they know that, right? Mark Cuban knows that he can buy that donut and put it throughout the stadium. And it’s a beautiful thing when that happens. Well, George Deeb, managing partner, Red Rocket Ventures, and bestselling author. Thank you so much for joining us once again, here on the Atlanta Small Business Show. We get so many great comments when you’re on, so thanks so much.

George Deeb:
Jim, it’s great seeing you again.

Jim Fitzpatrick:
Great to see you.


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