Why You Should Not Ask Startups About ROI?

Most of us have experienced one of these two very familiar scenarios:

1. We were young, with a lot of ideas and thinking about making changes in the world, we sat behind our laptops and started coding. After some time, I started seeking investment. We have approached VCs, and if we were lucky we pitched our idea in front of an investment committee only to be faced with questions such as: “What is your rate of ROI?”, “When will you break even?” and “What is your exit strategy?” trying to answer these questions that we have never faced yet in the realy, only to prove we are born ready, we say some random numbers. After several “no” answers from investors, we thought: “Well! Why not say the numbers they like to hear!” Therefore, our break even is a very short time (but not too short, because we are not stupid) and the rate of return on investment is so big to the extent that it covers any investment risks, and about the exit strategy, well, we don’t have it at the moment because we are focused on making this business successful. Then we created an Excel file with several sheets and dozens of colorful tables and formulas and presented it to investors to convince them to give us their money and finance our project.
2. We have worked in a company and we were tired of our pointless daily 9 to 5 hussle. We have sought to improve the processes, services, and products, but we have been told many times: “Do your job, we have a lot to do, and there is no time for your ideas’’ or “You are paid good money to do your job, and not more.” However, if we’re not disappointed, we’ve climbed the organizational ladder and presented our idea to every manager along the way. If we are very, very lucky, our idea will be discussed among one or two managers. A meeting has been held and all the managers with their innate skepticism have asked us the same questions: “How much is your Return On Investment?” And we probably replied with some shiny numbers they wanted to hear. In fact, we have participated in an innovation theater and we have tried to play our role very well not to embarrass ourselves and our immediate manager in front of the senior managers of the organization.

In both of these scenarios, an important question has been asked: “What is the ROI?” In simple terms, it means that how much profit are you going to make for us later if we give you X dollars today?

Why is it wrong to ask a startup about the ROI?

This is not a wrong question, but the important thing is that it is the wrong time to ask this question. Asking this question in an innovation project is a fatal mistake. Because:

1. The ROI can be predicted ahead of starting well-known projects and business models such as construction, buying properties and stocks. Because we have enough financial data to make a relatively accurate prediction of the future. But we don’t have such data on innovation projects where we don’t know if a new buisness model is going to be validated.
2. Asking these questions from an startup founder or intrapreneur, when they present their idea, at the beginning of their entrepreneurial journey, forces them to produce some fale prediction when they have the least amount of data.
3. The ROI in every industry has a certain range, and those who have worked in those markets know that a certain business models can not make more profit than a certain number in its best case. But in innovation projects, whether it is a corporate innovation or a startup, the range of return on investment can be from zero to tens of times. Anyone who claims that they can predict the correct number in such projects either does not know what innovation is about or thinks that they know Excel very well!

Why are these questions asked?

In most of idea pitch meetings, people ask about ROI only for this reason that it is a familiar metric that has been used for years in the corporate financial systems as a measure to evaluate investment performance. That is the only hammer they have in their hands.

If the only tool you have is a hammer, you tend to see everything as a nail.”

- Abraham Maslow

The familiarity with such information systems and metrics (corporate accounting) forces managers to ask intrapreneurs and startups founders a familiar question: “What is your ROI?”

How to measure success of Investment in a Startup or Innovation project?

We need a new tool that can properly calculate the progress and success of innovation. Unfortunately, there are no such tools in the structure of corporate finance and accounting.

One of the most important concepts in the Lean Startup movement is “Validated Learning”. This concept was proposed by Eric Reiss, the author of Lean Startup. According to him, validated learning is a measure of progress and describes the amount of learning obtained from the result of testing an idea and then measuring its impacts on customers. Each test is a single iteration of a continues process that involves many iterations where everytime we learn something new about the market and apply these learnings to improve the product.

Importantly, validated learning must be quantifiable, based on data such as revenue, customer engagement, and customer feedback. The result is evidence-based, hands-on learning that leads to real product improvement with each iteration. Therefore, using the concept of validated learning in innovation projects and startups as a metric and a unit-of-progress can be a way forward.

It’s best not to make any big investment decisions until we’ve got fairly good data. Let the startup go ahead with smaller amounts of money and step by step in each iteration of learning from market’s reaction to the product, we will get more information to decide on investing of larger amounts of money (and time, and mental energy).