The document introduces the Critical Factor Assessment (CFA) and Critical Factor Assessment Snapshot (CFA Snapshot) tools. The CFA is a diagnostic tool that identifies 42 critical risks that could lead to business failure. The CFA Snapshot analyzes these 42 factors according to 8 underlying risk categories. Both tools help entrepreneurs identify high risks and develop mitigation strategies to improve chances of success or decide not to proceed.
A new business is challenged to persuade existing competitors’ customers to switch to those offered by the new company. If there is no current competitor, then the challenge is to persuade the customer of the benefits of purchasing a product or service at all. Changing potential customer behaviors is one of the biggest challenges faced by a new venture, and requires the new venture to provide evidence of significant benefits over current solutions or non-consumption. Evidence is required that product or service features offer significant benefits over currently available products or services, sufficient to make people change their current product use, either by switching from non-consumption, or away from a current supplier. It is important that the entrepreneur can actually provide some evidence of customer demand, and that identical features are not readily available from the main competitor. In some cases, product features are intertwined with a new business model that can foster a truly disruptive company, alternatively, the development of a novel business model can create a competitive advantage that better meets customer requirements and offers a substantive value proposition to a potential customer. Without the ability to offer something novel and unique, that the customer cannot readily obtain elsewhere, the venture should be rated as a red light (C).
Launching a new product or service has inherent technology risk related to performance of the product/service and the supply chain. At the point that an idea moves from a research project to a venture, the entrepreneur must provide evidence that the product or service is “market ready”. Evidence that most of the technology risks, associated with product development, manufacturability or technology implementation have been addressed, is required. Evidence that these risks have been addresses can be seen if the technology is used in another application, the use of a reliable technology supplier, or evidence of third party or expert technology performance. Alternatively, there may be evidence that the path to addressing identified technology risks is well known to the entrepreneur, or evidence that the proposed technology risk mitigation strategies are likely to be successful. Confidence in the reduction of technology risk in a new venture can be seen in the form of working prototypes, strategic partnerships with competent suppliers, or third party performance evidence. If technology risks are still seen as high, or are not properly identified, then this factor should be rated as a red light (C).
A new product or service has to have a sustainable competitive advantage otherwise existing or new competitors will subsequently enter the new venture’s market and drive down price and service, reducing long-term profitability. There are many ways in which a company can create a sustainable barrier to entry, that makes it much more difficult for competitors, but without one, the long-term profitability of the new business will reduce to zero. Perhaps most misunderstood or risk factor is the requirement for the entrepreneur to demonstrate a sustainable ‘barrier to entry’. If a business does not have a ‘barrier to entry’ then potential competitors can easily replicate the proposed product or service, making it difficult for the venture to sustain a continued profit. One common barrier to entry is the filing of a patent application (but there are times when this route is not preferred – due to the cost, time delays, disclosure requirements and uncertainties of the patent process. Other barriers to entry include: being first to market, developing a strategic marketing partner, licensing/developing a brand, having a supplier or cost advantage, or capturing a critical first customer, dominating a particular channel or receiving endorsement from well-known people or organizations. If the company can not show that it has the capability to perform in the marketplace in a manner that can not be easily replicated by a competitor, then this factor should be rated as a red light (C).
It must be easy for first customers to adopt the product, without needing to fundamentally change how or why they buy the product. Alternatively a compelling value proposition motivates change. Evidence of adoption requires customer validation as potential stakeholders are unable to predict market reaction, requiring evidence of 3rd party product or service validation. Evidence of customer adoption requires the entrepreneur to show that a potential customer will change their current behavior and buy the proposed product or service. Assessment requires a skeptical perspective and the need to see critical evidence of adoption, and that if necessary customers will start to use a product, where in the past they were non-consumers, alternatively that customers will modify their current processes to use the new product or services. A lack of evidence, in the form of third party validation, endorsement or conditional orders, will lead to a red light (C).
Channel partners are often essential in getting a new product or service to mainstream customers, yet potential partners have different motivations and skills than those of new ventures. A new venture must show it has a good understanding of what it takes to get the product or service to market, and qualified partners that can implement this strategy. Evidence of a viable channel to market is often one of the least considered factors, as entrepreneurs often believe that if they develop a product or service that meets a market need, finding a channel to market will not be a challenge. However, in reality, finding distributors or OEMs can be the biggest challenge, as rather than convincing customers of the benefits of a product or service, a larger partner has to be persuaded to divert resources from current activities to support the new venture. In addition to the challenges of getting the attention of the distributor or OEM, the choice of partner requires evidence that the partner can perform, and has the required skills and willingness to commit them. A retail product without a retail partner, or an OEM product without an identified and committed partner, stands a real chance of failure. The distributor is often the most crucial component of the implementation plan and the assessor must to be convinced that identified distributors/partners can and will do a good job. Without evidence of this this factor should be rated as a red light (C).
A viable business must be able to earn sufficient profit to provide a financial return for its founders, and if required, its investors. Bottom line profit is a function of top-line sales, which are a function of market share and market size. Creating a new venture is only cost-effective if the market dynamic and opportunity is sufficient to allow required returns to be achieved. In the case of ventures seeking equity investment, this requirement is amplified by the need to achieve an exit.. Evidence of market size requires the entrepreneur to provide insights into the dynamics of the market, the size of the market, and the nature of competition. Strong evidence is presented if the entrepreneur shows an understanding of the number of potential customers and how they will compete. Lack of evidence of a viable market, unrealistic market share calculations, underestimating competitors or small market size forecasts are reasons for this factor to be rated as a red light (C).
There is a direct link between the likelihood of venture success and the combined experience of the venture founders, advisors and management team. Evidence of relevant experience in some team members increases the likelihood that the company will be able to anticipate and manage risk. Evidence of reduced management risk is primarily based on the history of performance, although there are often times when an early stage entrepreneur simply does not have a track record of performance that can reduce concerns about management risk. In this case, the entrepreneur must show that they understand their own limitations, and are willing to work with individuals who have the requisite experience of the market, technology or challenges of implementing the business plan. Required resources to fill gaps identified in the management team may be hired, or join the venture as: mentors, advisers, or board members, however without recognition of potential gaps in the management team, and the identification of individuals who can compliment identified weaknesses, the management risks are likely to be excessive and the venture should be rated as a red light (C).
The most common reason for venture failure is running out of cash, this can be due to the fact that the company raises insufficient cash in advance to fund the negative cash flow ahead of revenues, that there is a high risk or negative cash flows associated with cost overruns or time delays, or the gross margins don’t support the cash flow required for operations. The final factor examined in CFA snapshot is the runway - that is the amount of money the company can obtain in the short term, before it is able to raise further rounds of money. Given that the single most common reason for a venture to fail is that it runs out of cash, this factor looks at cash flow projections, to see if they are realistic, to see if the company is likely to be able to raise sufficient cash in the short term to fund negative cash flow, and to determine that the company is likely to be able to attract further cash if required, often as it reaches valuation milestones in the venture creation process. In combination, if the entrepreneur does not show a clear understanding of the initial cash required, does not have a clear path to obtain this funding, or is unlikely to be able to raise additional funds before it runs out of cash, the venture should be rated as a red light (C).