Product Risk
(and how to mitigate it)

How Venture Services can reduce your risk profile and increase your valuation in the eyes of investors.
A company's valuation is based on its ideal outcome, weighed by the likelihood of overcoming all of its risks. The biggest way to grow the valuation is to mitigate the biggest risks.
— Leo Polovets, Susa Ventures
When pitching to investors, it's common for founders and CEOs to focus on market size, opportunities and exit scenarios. Whilst these aspects are critical to attract interest, it's easy to overlook the role risk plays in influencing investment decisions. Whilst looking to maximize upside potential, investors are also looking to protect against downsides.

Investors evaluate companies across a variety of different risk categories. Redpoint's Thomas Tunguz cited 11 types of risk that VC's evaluate for, whilst Leo Polovets from Susa Ventures has outlined nine. These include Product/Market Fit Risk, Product Quality Risk, Sales Risk and Funding Risk.

RiskLightspeed's Alex Taussig helpfully developed this framework to separate risks inherent in a typical venture deal.
In Polovets' analysis, investors apply a a 'risk multiplier' between 0.0 and 1.0 in order to reach a valuation. The more risk there is in a category, the lower the multiplier and the lower the expected value of a company.

Risks cannot be avoided, but they can be managed. If they can be defined, they can be limited. For any founder or CEO looking to attract investment, it's worthwhile conducting a detailed analysis of the probability and potential impact for each risk category. This process of identification and classification is the first step on the path towards risk reduction.

The more you reduce the perceived risk inside your company, the greater your valuation. Even small adjustments can have dramatic effects. Moving a risk multiplier from 0.75 to 0.90 improves your expected value by 20%, but moving a risk multiplier from 0.05 to 0.25 can improve your expected value by 400%.

As a founder or CEO, if you're not technical, then you are particularly vulnerable to two forms of risk. These are Product/Market Fit Risk and Product Quality Risk, described in Taussig's grid as "Do we have Product/Market fit?" and "Does the tech work?"

If you've never shipped software before, investors will be questioning whether or not you can build a product that delivers your vision at the speed and quality you need. And, as an entrepreneur seeking to raise capital, it's vital you have a plan for mitigating these areas of risk.
So, what are your options?

Orthodox advice would always be to find and recruit a 'rock star' CTO or technical co-founder and rely on them to build your product (and your Product Team). Less orthodox, although equally common, is to find a 3rd party (ie a development shop or contract developer) to manage your technology. Both routes have their benefits but each carry their own inherent risk.

Capable and committed CTOs are increasingly hard to recruit if your finances are limited and your business isn't at technology's leading edge. The services of contractors and development shops are easier to secure but are aligned against your pay check, not your outcomes.

For founders and CEOs looking for a 'middle way', Venture Services (a new form of early-stage investment) is emerging to solve both digital and capital requirements. By providing the CTO and Product Team they need on a co-investment basis, venture services firms can reduce not only Product/Market Fit Risk and Product Quality Risk but Team Risk and Recruiting Risk as well.

In the eyes of an investor, having a digital partner in your pitch deck, one who has the technical and product experience you need and whose incentives are aligned with yours, can de-risk your profile across a number of categories.

And, the further you move from 'high risk' to 'low risk' in an investor's calculations, the stronger your valuation, perceived progress, and likelihood of success.
Castle Digital Partners
Castle is a digital partner for management teams of software-driven businesses. We team with management to envision, design, develop and operate digital platforms, products and services that drive growth, market differentiation — and ultimately enterprise value.

We are a venture services firm operating as a true partner and investor in our portfolio businesses. We focus on software-as-a-service, digital commerce, and tech-enabled services companies that have strong management, solid business traction, and a clear opportunity for digital product creation or transformation. We then partner on the execution of the digital thesis with creative deal structures involving equity investment and/or fees.

To date, we have executed over 50 digital platform programs and invested in 18 of these companies.