There’s something I talk about often with those I mentor.
It’s the importance of understanding the type of startup you’re dealing with before making the investment.
That means asking the tough questions… like…
What’s the force that’s driving them towards success… or failure?
As angels, it’s easy to get caught in the hype of an innovative product offering.
But take that away and what are you left with?
I like how Launchpad’s CEO Janet Kraus breaks down businesses into three types. She explains that every business functions as one (or more) of these three classifications.
Oxygen, Aspirin, Jewelry.
Knowing How To Pick The Right Startup
Oxygen type businesses provide products or services that consumers can’t live without. Businesses that fall under the “aspirin” category offer products that reduce a certain kind of pain for customers, but aren’t necessarily essential to survival. Lastly, jewelry types are luxurious and elevate a customer’s lifestyle, while creating an addiction to the product.
So which of these business models is best?
The goal, of course, is to find a startup with a killer idea made up of a mixture of all three of these components.
Here’s an example of a product that’s a great combination of all three: the Apple iPhone. Within one phone, a customer’s basic need for making calls and checking emails is conveniently achieved (oxygen), while having access to GPS navigation, counting daily steps and tracking fitness (aspirin), all the while having their complete music collection, photo library, and social media platforms on hand (jewelry).
Finding a product that ticks off boxes in all three categories can feel a lot like searching for a needle in a haystack. Or hoping to spot a golden unicorn in the wild. It just doesn’t happen all that often.
So you don’t need to wait to invest until you find your very own golden unicorn. If you can’t find the enigmatic three-for-one special, focus your energy on looking into startups that fall into the “oxygen” category.
Find your investment home within a startup that’s aiming to sell stuff that people really think they need. Traditionally, these sorts of companies pan out as good investment opportunities. Even more so, when there’s a healthy amount of risk involved.
Today, I’m going to break down each category and help you know what to focus your attention on.
Determining Your Startup’s Type
When hearing pitches, there are a few things to keep handy in your back pocket. First of all, get used to asking yourself, “is this product a need-to-have (oxygen) or a nice-to-have (aspirin/jewelry) product?”
Of course, this alone can be tricky, as we’ve only gotten sneakier at manufacturing desire and presenting it as a necessity. Take the cosmetic industry for example – half of the beauty products sitting in our showers, we don’t actually need but we think we do (aftershave, shower gel, elaborately specific creams, etc.).
Lines separating these categories aren’t so rigid. It’s likely that oxygen buyers are only a subcategory of aspirin buyers, the only difference being the market size and spending priorities.
Oh, and how great a company is at marketing desires into necessities.
See that your startup CEO’s have done some market research of their own. They should reach out to current and prospective customers asking questions like:
“What problem does our product solve for you?”
“Amongst your top problems, how important is it to solve this one?”
They should spend a good amount of time gathering customer feedback (and feel free to do some market research of your own!) Dig deep and get the hard stats. Conducting due diligence in this way will help clearly steer the ship in the long term.
This kind of insight is tremendously helpful because it allows the chance to hear directly from customers, in their own words which problems of theirs are resolved. Does it match the supposed problem and solution that was pitched to you?
You’ll be able to see for yourself. If the pitch and the research line up, you’ll know that your CEO has an accurate read and does a good job listening to their audience.
Hearing how much of a priority consumers find the product to be in regards to relieving pain, can yield useful insight and help magnify which category the product truly exists in. If it solves one of the consumer’s top three problems, you can rest assured that you’re in oxygen territory.
Anything in the middle is aspirin and at the bottom tier, you’re in jewelry land.
There’s Nothing Wrong With Jewelry
Take a Tiffany & Co. diamond engagement ring, for example. It can be anywhere from 3 to 10 times more expensive than a worthwhile competitor’s. Yet the company rakes in sales year after year, with a valuation of 14 billion dollars today.
So there’s nothing wrong with getting behind a company whose product falls under the jewelry category, there are just a few things you should know.
Firstly, you have to know that this kind of investment requires a different approach. Mostly because prospective customers are based on demographics rather than a specific audience. Demographic targeting is typically aimed toward a specific gender and a general age range, while audience targeting is more specific to age and often interest-based.
Your founder should already be in the mindset of their demographic audience, displaying ample understanding of who they are and the general values shared within the group. They have to understand what the audience is willing to spend their money on and be sure to present their product line in a way that paints broader strokes, avoiding specificity.
So this is good news for you angels who’ve spent time in business selling to a specific demographic. It’ll be like muscle memory. You can draw on past experiences and lean on developed skills to determine whether customers will buy the products at hand. But know that you yourself are a golden unicorn, as most investors aren’t market experts.
Hambleton Lord, cofounder of Seraf and all-round angel investment extraordinaire says this of “jewelry” companies,
“Suppose you are thinking of investing in a new video game company. They’ve built an awesome new game and you and your kids really enjoy playing it. Now, ask yourself the following question: ‘Am I confident that 5 million American Teenage boys, ages 12 to 18, will play this game for the next 3 years?’ If you can’t answer this question, you should think twice about investing.”
I get wanting to invest in a jewelry company. Maybe you’ve fallen in love with the product, or you just really like the founder. Whatever the reason, it’s totally fine! You just have to be willing to accept greater risk since the product isn’t essential within its market. And be sure that jewelry startups make up only a small portion of your investment portfolio.
The Value Of Differentiated And Defensible Products
The products that come from your startup should be smart, standing out amongst the competition, differentiated, and defensible.
Once again, asking brand champions will help glean some insight here. Founders should be asking current and prospective customers these sorts of questions…
“How are you solving your problem today?”
“Have you used similar products before?”
“Did you look at any competitive products?”
“Are you considering any alternative ways of solving the problem?”
Differentiation is all about noting the distinctions that matter most to customers. Startup CEO’s are obsessed with their products and are often too close to recognize potential blindspots. Your job as an investor is to help bring a wider perspective, helping to incorporate the differentiators that matter most to consumers. Make sure those key markers are present and prominently displayed in the product.
This is all about customer retention. Your startup worked hard to fish out a customer base, but can they keep them engaged? Will pricing power hold up? Will their margins stand strong against the existing and future competition? Against a changing environmental market? Does the startup have a compelling offering and will they stand the test of time?
Your founders will do you a favor by including outside market experts in research gathering. The more the merrier, and the less chance of getting blindsided by competition that’s already doing well in the market.
As we covered in 8 Success Hacks For Angel Investors, there are a handful of questions that can serve as a sort of checklist when considering your next investment. Add this to the checklist!
Developing the habit of identifying which category a company falls under will help you more clearly determine where you want to put your money.
Remember, oxygen is the safest bet, but with the right kind of marketing, aspirin and jewelry can be worth betting on!