The Five Questions Large Companies Ask When Evaluating Startups

I get contacted regularly by startups looking to partner with large, global companies who can give them scale. My work over the years has shown me a number of these deals from both sides of the table. While almost all of these relationships make some logical sense on paper, in reality they are way more difficult to implement than founders initially think.

On the surface, the logic for these relationships is straightforward – one party has a unique technology or product that can improve things for end users while the other party has global distribution and scale. What’s not to love? But there are several other factors that go into the decision making process for large companies which founders often fail to consider.

Question #1: Does this innovation align with where we think the future is headed?

While no one can tell the future with any sense of certainty, large companies almost always have a hypothesis for what the future of their industry and business will look like. Despite the fact that these hypotheses are often wrong (again, because no one knows the future), decision-making in the organization will be strongly influenced by them.

For example, if a large company strongly believes that the future of their brands is direct-to-consumer and you have an innovation that will help them sell better at big box retailers, they may not be interested in engaging. This may happen in spite of your innovation making a meaningful impact on their business today.

The reason for this is that bringing any innovation to market requires a lot of string pulling and political will inside of an organization. Without aligning with the company’s long-term vision, there’s simply no way your internal champion will have the political capital to get a deal done.

Question #2: Will the innovation work in real life?

Many times, new innovations and inventions have proven efficacy in a controlled or lab setting. But companies don’t care about controlled settings. They care about how something performs out in the wild jungle that we call “the marketplace”. And without any solid proof that something performs in the wild, you’re going to have difficulty convincing a corporate partner to work with you. Which brings us to our next point…

Question #3: Do customers care?

The easiest and most convincing way to show a potential corporate partner that there is a legitimate market opportunity is to have customer traction. If customers care about what you’ve created, it’s much easier for a corporate partner to believe they have something to gain by working with you.

This is where I see a lot of startups get tripped up. Founders, especially technical founders, often focus on building and perfecting the product. While the product is obviously incredibly important, on its own, it doesn’t do much to convince a potential corporate partner.

When a founder sets out to create a “great” product, they are building something that they personally feel is great. But a corporate partner is going to judge a great product by the feedback its getting in the marketplace. Qualitative feedback, like reviews and social credibility, are certainly valuable but the most credible feedback is dollars. Nothing speaks to a potential corporate partner more clearly than repeat paying customers. C.R.E.A.M.

Question #4: How does this innovation meaningfully improve our business?

The immense size of large companies is a double-edged sword, and ignoring it is a common mistake among startups pitching large companies. For example, generating $1 million in new revenue sounds fantastic. But if you’re pitching Walmart, which did $514 billion in revenue in 2019, an increase of $1 million represents a 0.0002% improvement. Even calling that a drop in the bucket is a vast exaggeration.

So when a startup founder views a partnership or acquisition as inevitable because of the potential to generate an extra $1, $10, or even $100 million for their corporate partner, they are sadly mistaken. This doesn’t mean the partnership or acquisition can’t happen (indeed, many acquisitions happen with much less) but it is going to take the right narrative to get a deal across the finish line.

The right narrative is about creating a meaningful impact on the corporate partner’s business. This can leverage a variety of factors but the most common are: future technology trends, risk mitigation, growing emerging sales channels, and reaching tangential markets.

A prospective corporate partner is going to need both the right narrative and evidence (that’s where your revenue comes in handy) to close a deal with your startup.

Question #5: What needs to be done to get this innovation to market?

I’m going to use a chemistry term to explain a commonly misunderstood concept in corporate-startup deals. Bear with me.

In chemistry, there’s a term known as activation energy, which is basically the amount of energy a system of potential chemical reactants needs to make a reaction occur. Catalysts are used to reduce the activation energy needed for a reaction.

For our purposes, the product of the reaction is the market impact we are hoping to make and a catalyst can be thought of as the startup-corporate partnership which will (hopefully) make the market impact easier to reach. Activation energy is the amount of resources required (money, manpower, political capital, etc) to generate the desired market impact.

While the partnership will ideally reduce the activation energy required, the cost may still not be worth it. To illustrate this with numbers, imagine a potential market impact of $100M/year. For a large company to do this on their own, they expect a cost of $2 billion. By acquiring your startup for $1 billion and adding $500M of their own resources, they bring the cost down to $1.5 billion, which saves them $500M. But with a cost of $1.5 billion, it will take them 15 years to breakeven, which may be unacceptable but also depends on what the corporation’s future vision is (see Factor #1 above).

The point here is that the cost to bring something to market, or to scale, is an important part of the equation large companies are using to evaluate whether they want to proceed with a partnership or acquisition. Sometimes the cost of acquisition can be a rounding error but the cost of bringing that acquisition to appropriate scale will be insurmountable. The opposite can also be true – buying your startup will cost them $$$ but scaling it will cost virtually nothing. That’s definitely the preferable position.

Final Note: Large companies are NOT transparent about these questions

When you’re interacting with a large company, it’s extremely unlikely that they will share their thinking around the questions above. You’ll have to learn how to read between the lines.

On a related note, it’s fairly common for decision-makers at large companies to not even explicitly ask all of these questions. Sometimes the concerns will be felt on a more qualitative level. The reason for this, like many things in startup world, is that there simply isn’t enough data to know any of the important numbers with certainty. Who is to say whether a given market opportunity is $200M or $500M? This uncertainty means that companies are often evaluated from an order of magnitude or qualitative perspective, rather than with explicit numbers.

Finally, it’s important to remember that large companies are conservative by default. They are (usually) profitable, and have been so for many years. To get them to take a risk, there has to be some driving factor. That factor can be market trends, emerging technologies, or even a competitor being interested in your startup. But it’s very difficult to generate the momentum needed for an acquisition or major partnership without some external, driving factor. But when that factor does arrive, the best founders know how to exploit it.

My book, The Startup Gold Mine, helps you navigate these questions and much more. If you need personalized help navigating a particular deal or simply have a question, you can reach me here.

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