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 BLOG >> May 2021

10 Questions Investors Ask [Investing
Posted on May 25, 2021 @ 05:58:00 AM by Paul Meagher

Andrew J. Sherman in his book, Raising Capital (2012, 3rd Edition), provides a useful list of 10 questions that, in his experience, all venture investors ask (p. 18). I am repeating them below. Andrew claims that the answers to these questions determine if and how the deal gets done.

  1. How much can I make?
  2. How much can I lose?*
  3. What is my exit strategy from this deal?
  4. Who else says this deal is viable?
  5. Does the founder (and others) already have resources at risk?
  6. What other value (beyond money) can I bring to the table?
  7. Can I trust this management team?
  8. Is this company's target market large, growing (not stagnant or shrinking) and reachable?
  9. Does the company have (or will it have) a sustainable competitive advantage, as a result of either operational effectiveness, its strategic positioning, or its intellectual capital or other barriers to entry?
  10. Is the company's business, revenue, and profit model credible, verifiable, efficient, and sustainable?

* Andrew points out that investor loss is not just equal to the investment made but could be much more and include "potential liability costs, reputation costs, favors/chits used, time costs, commitments to follow-on capital, and other such factors".

These are good questions for entrepreneurs to consider so they can see things from an investor perspective and anticipate the type of due diligence questions they might be asked by potential investors.

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Mechanism of Action [Business Models
Posted on May 21, 2021 @ 04:43:00 AM by Paul Meagher

Nature Magazine defines "Mechanism of Action" as "the process by which a molecule, such as a drug, functions to produce a pharmacological effect." We might wonder, for example, what mechanism of action a particular vaccine uses to block covid or reduce the likelihood of dying from covid. Research is still ongoing on exactly how the newer mRNA vaccines instruct our immune systems to identify and deal with covid and its variants. It is possible to know that something works, and in general why it works, without having a detailed understanding of its mechanism of action. Knowing its mechanism of action allows us to better understand how the drug works, what its limitations are, and how we might improve it.

The reason for discussing the mechanism of action concept is to suggest that it might be useful to apply this concept to business ideas. Sometimes the uneasy feeling we might have over a business idea arises because we don't understand the mechanism of action that will cause that idea to be successful. The idea itself may be a good one, but to get to the stage where the idea might generate a return for an investor a number of additional steps need to take place which may or may not be likely.

Some might argue that in business we have the concept of a "business model" that covers the same or similar ground to the "mechanism of action" concept.

Wikipedia defines a business model as:

... the rationale of how an organization creates, delivers, and captures value, in economic, social, cultural or other contexts. The process of business model construction and modification is also called business model innovation and forms a part of business strategy.

In theory and practice, the term business model is used for a broad range of informal and formal descriptions to represent core aspects of a business, including purpose, business process, target customers, offerings, strategies, infrastructure, organizational structures, sourcing, trading practices, and operational processes and policies including culture.

While the concept of a business model may overlap with the concept of mechanism of action, the overlap is not guaranteed because the term business model is used to refer to so many different core aspects of a business such as the "purpose, business process, target customers, [etc...]". In other words, the concept of a "business model" can be pretty vague and refer to many different aspects of a business depending on who is using the term. Maybe we would do better to come up with a different term than business model to account for business success or failure?

The mechanism of action concept focuses our mind on identifying causal mechanisms responsible for the success or failure of a business idea. It makes us look more deeply into how the business idea might lead to success and may involve a level of modelling that is more detailed than verbal descriptions of the idea or projections of ever increasing sales. How, exactly, are these sales going to happen?

In the context of business, we might say that the "mechanism of action" is "the process by which a business idea produces a successful outcome". Identifying the mechanism of action involves reasoning of the form A leads to B which leads to C. When starting a new business the full causal chain may not be clear or confirmed because we lack alot of information that can only be provided through marketplace testing, however, we should be able to point to similar businesses and what appears to be the mechanism of action leading to their success. We may not be able to replicate that success if that success depended upon limited competition and there is already alot of competition, unless we have some way to outcompete them by offering, say, a mobile version (i.e., bring it to you) or online version of the business.

The reason why a drug produces a particular outcome may not be due to a single mechanism of action. If a drug is particularly effective, it may be because it has several different mechanisms of action that all contribute to achieving the outcome. The success of a platform like facebook is not attributable to one mechanism of action. Through R&D and acquisitions facebook is developing new mechanisms of action that collectively contributes to its social media dominance. In an evolving marketplace, this is necessary because other platforms are striving to dethrone facebook and would do so if it didn't keep evolving. The vaccines we are developing today may not work against future variants so we need to keep researching new vaccines and antivirals that have different mechanisms of action.

In conclusion, this blog proposes that the term "mechanism of action" as used in drug research, might also be useful when evaluating a business idea or implementing a business idea. Often there is more than one "mechanism of action" that causes a business idea to succeed or remain successful. Sometimes when people use the term "business model" to explain why a business idea will succeed, we might need to ask what the proposed mechanism(s) of action are for that business model in order to focus on the additional details that need to be specified in order to properly evaluate exactly how it could succeed.

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Pruning Decisions [Decision Making
Posted on May 10, 2021 @ 04:55:00 AM by Paul Meagher

In today's blog I want to discuss some similarities between pruning decisions and business decisions, specifically, the distinction between primary and secondary decisions.

The usefulness of the distinction between primary and secondary decisions recently came into view for me when I was pruning some grape vines in a small vineyard I own. When you are pruning grape vines you need to first decide what primary cuts to make. When you are using a cane pruning approach, these are the cuts that reduce the complexity of last year's growth down to two new canes and often some central spurs for next year's canes. Once you make these primary cuts there are alot of secondary cuts that don't have to be made because they are no longer options (the canes were removed). The secondary cuts are those that reduce the overall length of the remaining canes and remove debris from these canes (i.e., tendrils, side branches, skeletons from grape clusters that were not harvested). Once your are done making your primary and secondary cuts, you can wrap your canes to the lowest trellis wire. Here is a video illustrating how I made the primary cuts on a couple of grape vines.

What you will often see in novice pruners is that they will focus on making secondary cuts (removing tendrils, shortening canes) and when they eventually make some primary cuts they may end up cutting out the canes they worked on. This is wasted time and effort. In my imagined instruction manual for novices I would emphasize that some cuts are more important than others and your first cuts are the most important ones. I would call these the primary cuts. Once you make these cuts, then you can focus on making any remaining secondary cuts that are required to finalize the form of the vine.

In business decision making, we may start up a company within a framework of primary decisions which constrain how we go about the day to day secondary decision making involved in running that business. We make primary decisions with some ideas about what we expect to happen and if we find that things are not turning out as planned, we may need to make some new primary decisions about which lines of business to pursue and which ones to drop.

It is easy to get complacent and run a business without questioning the primary decisions that framed how the business would conduct itself. We can easily lose site of the fact that our decisions are mostly secondary decisions within the path we have chosen. If we were to engage in primary decision making again, we might focus on pursuing other paths and the secondary decisions that we previously regarded as important may become irrelevant and time sucking.

When a novice initially tries to prune a vine they may be overwhelmed by the complexity of branching from last years growth. The distinction between primary and secondary cuts is useful in drawing their attention to the fact that certain cuts need to be made first (primary cuts) and once made, determine the other cuts that should be made (secondary cuts). When confronted with the complexity of starting or expanding a business, certain decisions will be primary decisions to reduce the options to a manageable number, and secondary decisions you make with respect to these remaining options. We may have expectations about how things will pan out, however, because we haven't engaged in alot of the secondary decision making as it confronts reality, we may end up learning that one or more of our primary decisions was unsound and that we should reexamine our primary decisions. This shift back to revising primary decisions is usually referred to as "pivoting" in the business literature.

One of the most difficult primary decisions I had to make was to remove 7 rows of vines that I mistakenly planted on my absentee neighbors property. After failing to secure an agreement with the owner for the upcoming season, I decided to remove them rather than dedicate all the time and effort required to maintain them for another season. I couldn't see myself spending all that time and effort working on something that I no longer had clear ownership off. I learned the hard way the value of precisely mapping your property boundaries. After I removed the grape vine rows, I made another primary decision to purchase land that had 14 acres of wild blueberries growing on them which are easier and less costly to manage and very productive. I would have never made this decision if I didn't make this mistake and was lucky to be able convert lemons into lemonade. The way I recovered from a bad primary decision was to make another primary decision to focus on growing a different type of berry that I could use for wine making.

Managing a vineyard takes a significant amount of time and money. When you are exerting all that effort and money year over year for very little benefit you have to wonder whether you are making a good primary decision. What motivates the primary decision to maintain a vineyard for me is not just the production of grapes, but the fact that people who will eventually be coming to the farm to sample our wine will have the visual of a vineyard and the option to sample some wine made from those grapes. Also, if a vineyard is not too big, it can be a good excuse to be active outside and engaged in a productive activity that you can get better at. In these times of covid, it takes my mind off the world and is good for my mental and physical health. Good business decisions are not just about making more money, they must also balance other factors that are important to your overall context.

So how do we make good business decisions? In this blog, I have argued that it is first necessary to distinguish between two types of decisions you need to make, primary and secondary decisions. Making good primary and secondary decisions are necessary to achieving success, but they involve different constraints. Primary decisions take into account your wholistic context where secondary decisions are more about making good decisions within the context of your primary decisions. Most business decisions involve making secondary decisions within the context of primary decisions already made. Sometimes we need to step back and realize that the decisions we are struggling with today could become irrelevent and timewasting if we revisited the primary decisions that justified this allocation of secondary decision making effort.

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