Gygax EF-02 Semester 1, 2024
Entrepreneurial Finance
Lecture 2
Evaluating Venture Opportunities
André Gygax
Bibliography:
Da Rin & Hellmann (2020) Chapters 1, 10 & 13
I acknowledge the Traditional Owners of the land on which I work, and pay my respects to the
Elders, past and present.
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Gygax EF-02 Semester 1, 2024
Course Outline 2
Week Date Topic Required
Reading
DRH (2020)
Further
Reading
S&S (2003)
1 February 28 Introduction to Entrepreneurial Finance 1,10,13
2 March 6 Evaluating Venture Opportunities 2
3 March 13 The Financial Plan 3
4 March 20 Ownership and Returns 4
5 March 27 New Venture Valuation Methods 5
March 29 –
April 7
Easter Non-teaching period / Mid-
Semester Break
6 April 10 Entrepreneur versus Investor’s Perspective 5 11
7 April 17 Venture Capital 12
8 April 24 Term Sheets 6
9 May 1 Structuring Deals 7
10 May 8 Corporate Governance 8
11 May 15 Staged Financing 9
12 May 22 Exit 11
Gygax EF-02 Semester 1, 2024
New Venture Life Cycle 3
The Financial
Plan &
Ownership and
Returns
Venture
Capital, Term
Sheets & Deal
Structure
New Venture
Valuation
Methods &
Perspectives
Exit
Corporate
Governance &
Staged
Financing
Evaluating
Venture
Opportunities
1
2
4
3
5
6
Gygax EF-02 Semester 1, 2024
Sample Exam Question 4
Question 1 (5 marks)
What is the main challenge that investors
who are looking for entrepreneurial
investment opportunities face?
Gygax EF-02 Semester 1, 2024
Today’s Agenda
Today, we learn
n how to use the Venture Evaluation Matrix, a structured
framework for evaluating venture opportunities.
n how to break down a business’ value proposition into its
individual components.
n to assess the attractiveness, risks, and competitive
advantages of a new venture.
n To perform due diligence on a new venture’s business plan.
5
Gygax EF-02 Semester 1, 2024
Evaluating a Business Opportunity
n The starting point for any investment is evaluating the
proposed business opportunity:
q Will the opportunity be profitable enough (for a given risk)?
n Will the entrepreneur be able to appropriate a fair share?
n Will each resource provider be able to do so?
q Importance of conceptual strength: method vs. ‘gut feeling’
q Absolute and relative evaluation
6
Gygax EF-02 Semester 1, 2024
Evaluating a Business Opportunity
n Evaluating the opportunity is a key exercise also for the
entrepreneur, in order to anticipate investors’ view:
q Will the opportunity be able to generate the returns an investors
seeks (for given risk)?
q How can the opportunity be refined and improved?
q Venture Evaluation Matrix tool
7
Gygax EF-02 Semester 1, 2024
Key Actors 8
Customer Company Entrepreneur
Demand Supply Implementing a Solution
Gygax EF-02 Semester 1, 2024
Key Perspectives 9
Value
Proposition
(micro)
Can the company create value?
Industry
(macro) Can the company scale up?
Strategy
(dynamic) Can the company capture value?
Gygax EF-02 Semester 1, 2024
Venture Evaluation Matrix 10
Venture
Evaluation
Matrix
Customer Company Entrepreneur
Value
Proposition
Industry
Strategy
Gygax EF-02 Semester 1, 2024
Venture Evaluation Matrix (VEM) Logic
n Evaluate the strength of an entrepreneurial idea by assessing
how it proves able to generate value:
q Start with micro perspective, move to the macro perspective and to the
ability to be dynamically sustainable
q Derive the opportunity’s competitive advantages and attractiveness
q Assess the long-term economic viability of the opportunity
n Solid
n Comprehensive
n Easy to use
n VEM takes both entrepreneur and investor perspectives into
account
11
Gygax EF-02 Semester 1, 2024
Need 12
Venture
Evaluation
Matrix
Customer Company Entrepreneur
Value
Proposition Need
Industry
Strategy
n Know your customer!
q What exactly is the customer need?
q How strong is the need, and how well do customers understand it?
q How much are the customers able and willing to pay?
n Individual vs. corporate customers: decision process
n Learning from early adopters, iterative exploration
Gygax EF-02 Semester 1, 2024
Solution 13
Venture
Evaluation
Matrix
Customer Company Entrepreneur
Value
Proposition Need Solution
Industry
Strategy
n Know your product!
q Does the proposed solution solve the customer’s need?
q How does the proposed solution compare to the alternatives?
q To what extent can the innovation be protected?
n Role of product experimentation, customer vs. solution
n Nature of innovation, compelling or not?
q How to come up with the right solution? Design thinking
Gygax EF-02 Semester 1, 2024
Team 14
Venture
Evaluation
Matrix
Customer Company Entrepreneur
Value
Proposition Need Solution Team
Industry
Strategy
n Talent is the scarce resource:
q Do the founders have the required skills and experience?
q Do the founders have sufficient motivation and commitment?
q Is the founder team complementary and cohesive?
n “I invest in people, not ideas” Arthur Rock
n Importance of integrity and trustworthiness
n Solo founder vs. founding teams
Image Source: Microsoft’s team
in 1978; Wikipedia 2021.
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Market 15
Venture
Evaluation
Matrix
Customer Company Entrepreneur
Value
Proposition Need Solution Team
Industry Market
Strategy
n How big is the opportunity?
q How large is the target market?
q How fast will the target market grow?
q How will the customer adopt?
n Transformative vs. incremental innovation
n Adaptation process and market timing
n Product life cycle: S-curve
Number of Customers
Customer Need
Market Size
Time
Gygax EF-02 Semester 1, 2024
Competition 16
Venture
Evaluation
Matrix
Customer Company Entrepreneur
Value
Proposition Need Solution Team
Industry Market Competition
Strategy
n Know your competitors!
q Who are the current and future competitors?
q What is the nature of the competition?
q How can the venture differentiate itself?
n Cooperation vs. competition
n Nature of barriers to entry and product longevity
Gygax EF-02 Semester 1, 2024
Network 17
Venture
Evaluation
Matrix
Customer Company Entrepreneur
Value
Proposition Need Solution Team
Industry Market Competition Network
Strategy
n The founder’s network allows to access resources
q What is the reputation of the founder team?
q What networks does the team have access to?
q How does the team forge and maintain new relationships?
n Importance of network centrality
n Quality of network ties: connectedness, diversity,
position
Fig. 1: US board interlocking network
Fig. 2: Founder’s network
Gygax EF-02 Semester 1, 2024
Sales 18
Venture
Evaluation
Matrix
Customer Company Entrepreneur
Value
Proposition Need Solution Team
Industry Market Competition Network
Strategy Sales
n How is the product brought to customers?
q How does the venture reach its customers?
q What is the distribution strategy?
q What are the revenue model and pricing strategy?
n Transformative vs. incremental products
q Natural resistance to adopt – adoption costs
Gygax EF-02 Semester 1, 2024
Production 19
Venture
Evaluation
Matrix Customer Company Entrepreneur
Value
Proposition Need Solution Team
Industry Market Competition Network
Strategy Sales Production
n How does the company capture value creation?
q What is the development strategy?
q What is the scope of activities, and what partnerships are necessary?
q How efficient are operations?
n Importance of technical milestones / key inputs
n Choice on the boundaries of the firm
Gygax EF-02 Semester 1, 2024
Organization 20
Venture
Evaluation
Matrix
Customer Company Entrepreneur
Value
Proposition Need Solution Team
Industry Market Competition Network
Strategy Sales Production Organization
n How to develop and maintain company leadership?
q How will the founder team expand and evolve?
q What is the governance structure?
q What is the talent strategy?
n Developing a cultural imprint
n Talent recruiting and retention
n Founders’ succession
Gygax EF-02 Semester 1, 2024
Venture Evaluation Matrix 21
Venture
Evaluation
Matrix
Customer Company Entrepreneur Attractiveness
Value
Proposition Need Solution Team Value
Industry Market Competition Network Scale
Strategy Sales Production Organization Grow
Competitive
Advantage Access Entry Barriers Competencies
Gygax EF-02 Semester 1, 2024
Venture Evaluation Matrix: Taking Stock
n The VEM allows to draw conclusions across rows by
assessing the attractiveness of the venture in the three
perspectives:
q Ability to create value
q Ability to achieve scale
q Ability to grow and capture value
22
Gygax EF-02 Semester 1, 2024
Venture Evaluation Matrix: Taking Stock
n The VEM allows to draw conclusions across columns by
assessing the competitive advantages of the venture in
the three domains:
q Ability to gain access to customers
q Ability to erect and maintain entry barriers
q Ability to develop key competencies
23
Gygax EF-02 Semester 1, 2024
Venture Evaluation Matrix: Taking Stock
n The VEM allows assessing the venture’s main risks, also
across the three vertical dimensions:
q Market risk
q Technology risk
q People risk
24
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Venture Evaluation Matrix: Decision 25
Venture
Evaluation
Matrix
Customer Company Entrepreneur Attractiveness
Value
Proposition Need Solution Team Value
Industry Market Competition Network Scale
Strategy Sales Production Organization Grow
Competitive
Advantage Access Entry Barriers Competencies Decision
Gygax EF-02 Semester 1, 2024
The VEM in Practice
n We have built a 3x3 matrix that encompasses the key
questions both entrepreneur and investor should ask.
q We now move to see how both parties can operationally
make use of the VEM
26
Gygax EF-02 Semester 1, 2024
How Entrepreneurs can use the VEM
n The entrepreneur can use the VEM to look at the
strengths and weaknesses of their venture, and assess
whether:
q It is fully convincing
q It requires some dose of pivoting
q It should be dropped
27
Gygax EF-02 Semester 1, 2024
How Entrepreneurs can use the VEM
n The VEM provides a framework for testing the strength of
the business opportunity:
q Identifies where uncertainty is greatest
q It exposes the assumptions that underlie the opportunity
q It reflects where the business model is rooted
n Is the opportunity cogent and convincing?
q Which parts can be improved or are sinking the project?
q Role of the VEM at different stages of development
28
Gygax EF-02 Semester 1, 2024
How Entrepreneurs can use the VEM
n If the entrepreneur decides to proceed with contacting
investors, they can use the VEM to structure their
business plan. The Business Plan has two meanings :
q A strategic framework for guiding the venture
q A document for describing it to outside parties
n The VEM, by itself, contributes both. We focus on the
second.
29
Gygax EF-02 Semester 1, 2024
How Entrepreneurs can use the VEM
n A Business Plan (BP) needs a simple but convincing
structure. A convincing BP requires:
q An overview of the business opportunity
q A detailed, yet concise, analysis of the main challenges
q A set of financial projections
n The VEM provides all these elements, and a possible
structure is the following.
30
Gygax EF-02 Semester 1, 2024
The VEM and the Business Plan 31
Section Business Plan Heading Venture Evaluation Matrix Cells
1 Executive Summary Summary of cells, rows, and columns
2 Customer Need Need
3 Product / Service Solution
4 Market Analysis Market
5 Competition Analysis Competition
6 Marketing and Sales Sales
7 Development and Operations Production, Organization
8 Business Model Sales, Production
9 Management Team Team, Network, Organization
10 Financial Projections See Lecture 3
Gygax EF-02 Semester 1, 2024
Nobel Insights: Signaling your Venture
n George Akerlof (Nobel, 2001) introduced the
concept of ‘adverse selection’ as a
consequence of asymmetric information:
q Market for goods (e.g., used cars) may break down if
sellers cannot credibly communicate to buyers the
quality of their goods
q The same happens when entrepreneurs aim to sell
shares in their ventures, whose quality is difficult to
tell
q Pitching the business plan and engaging in due
diligence help reducing asymmetric information and
make markets for new ventures viable
32
Image Source:
George Akerlof
in 2007;
Wikipedia,
2021
Gygax EF-02 Semester 1, 2024
Nobel Insights: Signaling your Venture
n Michael Spence (Nobel, 2001) showed that
costly ‘signaling’ can help one party to
convince the other party of the veracity of
their claim.
q To be credible the signal must be costly, for
example the entrepreneur must work hard
enough to rack up initial sales, rather than simply
promise them.
33
Image Source:
Michael
Spence in
2008;
Wikipedia,
2021
Gygax EF-02 Semester 1, 2024
How Entrepreneurs can use the VEM
n What is the role of the business plan?
q It provides a structured narrative along the VEM logic.
n What is the role of the financial projections?
q Exercise in verifying the assumptions underlying the
business plan.
q Focus on operational viability and profitability:
n How profitable is this opportunity? The bottom line does
matter!
q Focus on timing and milestones:
n What financial resources are needed?
34
Gygax EF-02 Semester 1, 2024
How Entrepreneurs can use the VEM
n Financial projections reflect the underlying business plan:
q Profit and Loss statements identify the underlying profitability
q Balance Sheet statements identify the growth pattern
q Cash Flow statements identify the timing and extent of the
funding needs, and allow for testing alternative financing plans
n Importance of delaying fundraising to avoid dilution
n Importance of crystallizing entrepreneurs’ expectations
35
Gygax EF-02 Semester 1, 2024
How Investors can use the VEM
n The investors can use the VEM at two levels:
q For a first screening, using the spreadsheet tool
q For guiding due diligence, providing a structured approach to a
decision
36
Gygax EF-02 Semester 1, 2024
How Investors can use the VEM
n Investors can make the VEM operational with a simple
radar chart that summarizes and visualizes our
assessment:
q Comparative advantages and risk (columns)
q Assessment of each perspective (rows)
n The VEM Tool makes this operational. Try it out!
37
Gygax EF-02 Semester 1, 2024
How Investors can use the VEM
n The investor’s decision will then depend on a careful
assessment of the BP strengths as well as of the
financial appeal of the deal.
n Different investors have different decision processes and
rules, but the quality of the BP is always at the heart of
their decision.
38
Gygax EF-02 Semester 1, 2024
How Investors can use the VEM
n Due diligence (DD) is how investors figure out the
venture’s business fundamentals, considering how
convincing are the assumptions underlying the BP.
n DD is a time-consuming activity that is undertaken only
when the investor is already inclined to invest and has
negotiated a preliminary deal structure (term sheet).
39
Gygax EF-02 Semester 1, 2024
Investor Due Diligence 40
Using VE Matrix
for Due Diligence Customer Company Entrepreneur
Value
Proposition
Primary market
research
Assess
technology Meet the team
Industry Secondary market
research
Research
competition
Listen to the
network
Strategy Verify customer access
Site visits &
suppliers
Discuss
aspirations
Gygax EF-02 Semester 1, 2024
How Investors can use the VEM
n About the customer dimension:
q Need is verified by asking directly customers
q Market requires secondary market research
q Sales needs verifying the quality of customer access
41
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How Investors can use the VEM
n About the technology dimension:
q Solution is verified by expert testing of the technology
q Competition is assessed with primary and secondary market
research
q Operational efficiency needs verifying that milestones are
appropriate and can be benchmarked to the operations of
competitors
42
Gygax EF-02 Semester 1, 2024
How Investors can use the VEM
n About the talent/people dimension:
q Evaluating the team requires fact checking but also Evaluating
entrepreneurial vision and group work
q Networking is evaluated by looking at the professional standing
of the founders
q Organization is about being able to guide a large organization and
transiting leadership to new hands
43
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Concluding Remarks
n Today we discussed the Venture Evaluation Matrix.
n We highlighted the importance of credible and costly
signals by the entrepreneur to address information
asymmetry between entrepreneur and investor
n We showed how entrepreneurs can use the VEM in
practice.
n We showed how investors can use the VEM in practice.