A freight train without a track ahead is just 200 tons of metal. Until a new Venture has distribution channels and a robust pipeline, it’s basically the same.
One important aspect to determine when evaluating the future prospects of a company (and the investment you are considering) is whether the company has “laid the track” for current and future sales.
Actively managing a sales pipeline is critical to any business, particularly at earlier stages. Until the company has a track record, steady revenues, and regular, recurring customers, its products are “sold” to customers, not “bought” by them. The sales closure rate starts low, and the sales cycle takes longer when a company is just breaking into a market. Most successful entrepreneurs aren’t just visionaries or strong managers, they are also effective salesmen who are myopically focused on “closure.” So, gauge whether the entrepreneur has ever managed a pipeline before, and ask whether there is a process in place for following up with the leads. A robust pipeline is a positive sign, but they can’t cash it in to pay their employees…
In addition, finding “natural” allies to distribute product, a.k.a. distributors, is an effective means of quickly expanding the company’s customer base. However, experienced investors will recognize the following obstacles that forced two company entrepreneurs to pivot.
One, not atypical, example is an entrepreneur that has, arguably, the best products on the market (locomotive), and he had multiple distribution channels in place, which, on the face of it, is always good. Unfortunately, after analyzing the company’s prospects to decide whether to help the company raise capital, Carofin realized that the company was losing money in several channels, and the company was starved for operating income. At some point, these channels might have become effective. But, as a condition of our engagement, the entrepreneur focused his considerable talents and efforts on the remaining channels, generating more immediate positive net revenues.
The second company had developed a product that aligned perfectly with a department within a large home improvement chain store. It would help increase the department’s sales, give the chain store a competitive edge over its closest rivals, and would not add significantly to the chain store’s product cost to the consumer.
However, after testing the product for several months, projected revenues simply didn’t materialize. What the store and the entrepreneur realized was that the chain store’s sales force wasn’t being adequately incentivized to learn how to sell the benefits of the add-on product. Without that motivation, a sales channel may languish.
Here’s a tip for the careful investor: When reviewing the pipeline that lists potential customers and sales channels (like retailers for a consumer product) — every business plan should include one — the pipeline should specify the sales potential while “risk weighting” the likelihood of realizing those sales. As a rule of thumb, if the visible pipeline of risk-weighted sales isn’t at least 2 times the projected sales (more is better!), sales projections will probably fall short. Entrepreneurs are inherently optimistic — most customers aren’t.
How deep is their sales pipeline by channel? Can they forecast (likely) sales beyond six months? How long does it take to close a sale, what is the customer acquisition cost, and how long before they capture revenues?
Ask how direct sales compare to channel partner sales. Is that balance changing, and have they considered ways to increase direct sales (assuming a greater profit margin and greater control)?
Are sales conducted online, or are other, more effective, traditional distribution channels — brick and mortar, events and conventions, distribution agents, etc.? Are those scalable?
While a locomotive can be an attractive piece of machinery, issuers need to lay the track ahead to improve their chances of success. The discussion above is part of a series of questions that we encourage investors in venture-stage companies to consider. You can find the comprehensive list in our white paper, “Nine Leaps of Faith – 9 Key Questions for Evaluating Venture Stage Investments.”