Entrepreneurs must validate the market for their product or service (published in January of 2010 in the SB News Press)

Entrepreneurs with startup businesses and those with new products or services must validate the market for their products and services before they attempt to raise funds or commit capital.  In this week’s column, I will interview Bill Benjamin, a successful entrepreneur and senior author of the new book, “SUCCESSFUL STARTUPS,” which identifies the critical venture development milestones necessary for a successful startup.  (www.venturecritical.com

According to Benjamin, many would-be entrepreneurs skip the most important step in testing the market for a new business idea.  Called opportunity analysis, it is obviously necessary but rarely practiced with firm diligence at the point of business model conception.  Venture opportunity analysis consists of three important steps involving in-depth primary research into (1) concept testing by market experts; (2) self-testing of entrepreneurial capabilities, and (3) an in-depth analysis of industry receptivity.

Market Expert Opinion:  The entrepreneur must submit his or her concept (existing difficult problem and perfect solution) to at least three different types of experts who, together, represent their target market.  These are prospective customers who will go on record stating their absolute need to purchase and use the proposed solution (product or service); technology experts who know intimately the problem to be solved and that can judge the technical or financial merits of the solution, and the initial investor expected to finance the startup or expansion.  If the new product or service passes muster with all three experts, it is safe to take the following next step.  

Self-testing Your Capabilities:  The entrepreneur with a startup enterprise must determine, with the assistance of outside venture development experts, whether he or she has sufficient expertise and experience to pull off one of the most challenging endeavors—a business venture startup.  At a minimum, one needs five years of experience developing and selling products and solutions in the same industry as the proposed new venture.  The entrepreneur also needs to understand financial management and corporate governance, and have the persuasive genius of a born salesman.  And, contrary to common belief, he or she will need access to about $75,000 of their own funds in order to jump-start a venture with the potential to attract outside investors.  

Market Segment Analysis:  Finally, the entrepreneur must establish, beyond a doubt, the viability of the industry segment in which he or she will operate.  This segment must be large and growing, open to new solutions, and currently controlled by very few competitors—each with a large share of the market the entrepreneur can systematically begin to focus upon, and capture. The entrepreneur must also prove that he or she can penetrate and use existing distribution channels.

To insist that all ventures and venture founders must go through these rigorous steps in opportunity analysis before writing their business plan is a heavy imposition.  But, too many entrepreneurs get carried away with their concept and forget to check reality with the really important players in venture development—customers, investors and owners of distribution channels.

Opportunity Analysis is the first step in the market validation process.  Once opportunity analysis has been completed, and if the results are favorable, additional work must be done, including surveying actual potential customers to gauge market acceptance and demand for the product or service (this is where the $75,000 gets spent).
Many entrepreneurs, either due to a lack of funds or simply to save money, cut corners, skipping market validation, and even failing to write a quality business plan altogether.  This is a mistake; plain and simple.  Lenders and investors are extremely unlikely in any economic environment, and especially given the current Great Recession, to provide funding to someone without a specific, well-developed financial plan as to how they are going to execute their business model and either repay the loan, or deliver attractive investment returns for investors.

In my interview this week with Eloy Ortega, CEO of Bank of Santa Barbara, on AM 1290, I asked him what entrepreneurs need to do to get a loan.  He stated that, if the business owner walks into his bank, “with hat in hand,” and asks for a loan without a clear plan for how they will repay the loan, and without a “plan B,” in case their primary plan doesn’t work, they are simply not going to get a loan.  For startups, personal assets, income, good credit, etc., are a must to successfully secure a loan, especially in today’s lending environment.
Market validation is an essential part of a well-conceived and well written business plan, and can make the difference between a lender or angel/venture capital investor funding a business, and filing the business plan in the circular file. 

If the entrepreneur does not have the money to undertake a comprehensive market validation, there are ways to provide at least some basic information that will help the lender or investor develop a level of comfort with the venture.  First, the Internet is a wonderful source of information one can access to obtain general information about the market for products or services, competitors—market share, similar products or services offered, markets of focus, customers, pricing, profitability, domestic or international, if international, which countries of focus, intellectual property, patents, etc., etc.  One can also access information about the industry as a whole, including the overall size of the industry, in terms of total sales by units, revenues, growth rates, number of competitors, etc. 

There are also a number of companies that offer advanced research and data for a fee, such as IBISWorld, Hoover’s, Factiva, as well as industry-specific organizations that specialize in data for their respective industry.  These services typically offer either a per-report charge, or monthly/quarterly memberships for an ongoing fee.

There are also firms that specialize in market validation that can build a customized market validation package, which will typically include all three steps outlined above by Benjamin, with custom-built customer surveys and statistical analysis of the results to determine the quality of the data.

When I write a business plan, I ask the client for any market validation information they may have, including interviews with experts, survey results, product/service reviews, etc.  I will typically take a top-down approach, (from general, big picture, to specific), starting with general industry information, and moving down to competitors, products/services, and finally the specific market validation information provided by the client.  If the client does not have any market validation information, I can perform some of the research work to obtain relevant validation information (for a fee).  If the client does not want (or cannot afford) to undertake the market validation process, I will provide as much of the other relevant information available through other sources. 

While it is certainly possible to obtain a loan or an equity investment without market validation, it is more difficult.  Also, the larger the amount required, the more important market validation becomes. 

A well-written business plan, with or without a comprehensive market validation section will contain a complete set of financials, which represent a five-year forecast.  These financials should include the expected source of funding—loan balances and payments, if using a loan; an equity investment if using an investor.  This way, the lender or investor can get a true sense of potential profitability, and in the case of a lender, the ability of the business to generate enough cash flow to repay the loan. 

Entrepreneurs should seriously consider the three steps to market validation outlined above.  In today’s environment with high competition for funding, a weak economy, and tight lending standards, entrepreneurs must do everything possible to at least meet and hopefully exceed lender and/or investor expectations.  A well-written business plan with a detailed market validation section along with complete financials is absolutely essential to meeting lender and investor expectations.  Those who cut corners here will likely not achieve the desired result of venture funding.

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