Known Unknowns

"There are known knowns; there are things we know we know. We also know there are known unknowns," Donald Rumsfeld

 

Most VC’s have a hard time passing on a deal or giving a “firm no”. Instead, startup entrepreneurs are often told “you're too early for us now, but call us when you get some traction.” As a seed-stage investor that’s not a line I can use.  Many of the deals we see are for a pre-launch companies with incomplete teams, unproven technology, and unknown/evolving business models, etc.

 

One of the most common mistakes founders make at this stage is to assume that investors expect them to have all the answers. When asked about their advertising sales projections, the founder often launches into a five minute explanation as to why their numbers are conservative – when the real answer should be I "don’t know what the sales numbers will be, but here were the assumptions I used.”

 

Rather than have a founder defend every assumption to the death, I’ve often found that my most productive sessions with entrepreneurs occur when, together, we try understand the different risks facing the business. While Donald Rumsfeld has been criticized for his comment about “known knowns”, I actually think he was onto something. When I review a new opportunity, I like to divide the risks into three categories:

 
Known Knowns
These are the assumptions that have some proof or external validation. For example, if your customer acquisition model is based on customer acquisition using paid search, I’ve found that spending $200 on Google Adwords could provide you with some real-world data on your cost to acquire a customer. If you’re trying to build a subscriber base and you have a beta site operational, you might be able to get some real world conversion data to use in your model.  The known knowns are easy to model.

 
Known Unknowns
These are the assumptions that we don’t have actual data on.  Say your business plan has an assumption that there will be a viral element to your customer acquisition strategy but you don’t have any hard data to base your model on.  In this case, I often like to see if we can get any third-party data to use for comparison purposes. While you might not know what your viral customer acquisition model is, can you get data from analysts, public company statements or similar sites?  If not, I like to see entrepreneurs build a financial model that includes a sensitivity analysis.  This allows you to take a variable (say cost-per-acquisition) and see how it impacts your financial model with different assumptions.

 
Unknown Unknowns
These are risks that we don’t even know exist – typically the only way we learn about them is after an issue has raised its ugly head. These issues often result from an unanticipated consequence of an internal decision, unanticipated moves by a competitor, economic shifts, etc. While you try your best to anticipate all eventualities, these are the risks that you often can’t control or plan for.  This is one area, however, where having an experienced VC/mentor/advisor could really add value – by helping to build a variety of companies, they can take advantage of “pattern recognition”.

Before you go out to raise money, make sure you know what you don't know...

Thanks to my friend Ed Watkeys for reminding me of the Rumsfeld quote!