You’ve probably heard the wise-guy crack “Well you know what happens when we ASSUME…” unusually chirped with a “gotcha” smirk and a slight head-tilt “It makes an ASS of U and ME.” While Mr Punny is usually right with half of his statement, the phrase itself is interesting because assumptions are part of almost every decision we make in life.
Finance is no different, and unlike that annoying guy at the bar, ignoring assumptions won’t make them go away. Reviewing a business’s growth plan and pondering an investment is prime time assumption assessment.
Assumptions are all those little (and BIG) things we expect to be true in the future around our business, its market, or the customers we’re trying to serve. Since no one can predict the future without these assumptions, we would all be paralyzed and unable to build any businesses.
A few key assumptions to consider when looking to invest in a business:
There are enough customers
Are there enough people to buy this product? This is where TAM (Total addressable market) comes in. We could look at SAM and SOM if you want to get technical, but they all come down to 1 thing – can this business realistically (realistic is up for interpretation) access enough customers to make their model work?
There is product-market fit / aka the product is something that people want
This is where you’ll want to see how they’ve gone about gauging market interest. The most common approach here is to look at current metrics for people buying similar products. As a business, if you’re creating a product that meets the same need or solves the same problem in a better way, there’s a logical assumption that people might want your product instead.
They make enough money (specifically profit)
In short, are you charging enough to make the numbers work? Also, how do your costs scale over time? Economies of scale might make some costs drop over time, but other costs might increase as you add layers of sales and marketing, operations, and customer support. Let’s not forget legal and accounting either.
They have enough money
Does the capital they’re raising (and have already) give the business enough runway? Running out of cash is one of the top reasons cited when startups and small businesses go under. The best way to prevent this is making sure the business is getting enough on the front end to execute on their plan for the future.
The teamwork makes the dream work
Does the business have the right people in place to make the plan work? Investors almost always bet on people over plan. Why? Every business is built on assumptions. If all else fails, it’s up to the people to shift, adapt, and ultimately make the business work, saving everyone involved from ending up as an ass.