“I need a favor,” I said to my friend, Nelson Chu, a highly-regarded VC in our Atlanta community.
We were attending the 2016 Venture Atlanta annual conference. It was the kick-off of the conference, and he asked me to join him for lunch.
“Tell me how I can help you,” he said.
Entrepreneur and the Idea
“I think you would be a great speaker for the next Angel Lounge at the ATDC. As you know, the purpose of the Angel Lounge is to help make our local angel investors better investors. We are all about learning from each other’s successes and mistakes.”
“What topic would you like me to speak on?” he asked.
“The two critical elements in screening a startup investment are the entrepreneur and the idea. Last month, we had Paul Iaffaldano speak on how he determines if an entrepreneur is investible. I would like you to speak on how you vet the idea,” I said.
“Hair on fire,” he said without pause.
“What?” I asked.
Definition of a Solvable Need
“For me it is simple. Is it clear the idea is addressing a “hair on fire” need in the market? In other words, do the people you intend to sell to have a desperate problem they need solved?” he explained.
Then other people at the table jumped in. They each had a story of a successful venture which solved a hair on fire market need. Every one of them. We started to talk about the deals which went to zero. Guess what they all had in common. No hair on fire.
“The concept is great, but do you have any criteria to determine hair on fire?” I queried.
He said, “I sure do.”
“Will you be the speaker next month?” I asked.
“Sure,” he said.
3 Hair on Fire Questions
Fast forward to the Angel Lounge meeting. We have over 25 active angels in attendance. I had no idea what Nelson was going to say. But with his 20 years of investing experience and having reviewed over 15,000 business plans, I was confident we would all learn.
Here are the three questions Nelson asks to determine if an idea is addressing a hair on fire market need.
1. Has the entrepreneur identified customers with hair on fire?
My most successful investment was in a company called TaxPartners. Robert Dumas, the founder, is an expert in sales tax for telecommunication companies. When I met him, I thought I understood sales tax preparation and filing. After two hours with him, I realized how uninformed I really was.
He told me all telecom companies with nationwide networks must file sales tax returns in over 4,000 jurisdictions every month. That is a very big problem with stiff penalties and huge potential liabilities.
Robert clearly had identified a market whose hair was on fire.
2. Do the customers know their hair is on fire?
The year was 1998. There was a new telecom company being birthed seemingly every day. They were raising a large amount of money from VCs for the huge capital expenditures of digging trenches and laying fiber.
The salesmen for TaxPartners would call these new companies. They would go right to the CFO and tell him, “We are an outsourced telecom service who prepares your sales tax returns and files them in all required jurisdictions. We are the experts in telecom sales tax.”
The CFO would say, “I know we need to file sales tax returns, but we’ll do it when we get around to it. It is just not a priority right now.”
“Really. Then you must be booking this liability on your balance sheet every month, including the penalties and interest,” the salesman would say.
“No. I’m not. I don’t think it is significant enough, and it is not a priority,” the CFO would say.
The salesman would reply, “Do you ever plan on selling this company you are building?”
“That’s why we are doing this,” the CFO would respond.
“Know this. The escrow holdback on a sale will be significant even though you think the liability is insignificant right now. If you contract with us, we will relieve you of this concern, keep you in compliance with all the jurisdictions and take on the liability. You’ll have a clean balance sheet from here on out,” he’d explain.
At this point, the CFO would realize his hair was on fire.
3. Does the customer have the ability to fix it?
Nelson explained the customer must have the political cover, authority, and budget to invest in his hair on fire problem.
This was the case for our customers at TaxPartners. In the first year, we closed eight six-figure deals. All because they had the ability to fix it.
Nelson went on to explain that without all three criteria met, “the startup should stay in the batting cage.”
He said, “They should stay quiet in the market until they see they have a one in five chance for a hit. Until they can realize this kind of close rate, they will spend a lot of money in search of the hair on fire.”
He summed it up by saying, “Unless someone is going to get fired, then you don’t have a hair on fire market issue identified. Go back to the drawing board until you find it.”
Nelson made a lot of money for his institutional investors over the years using this criterion to vet ideas. I made money in all the companies which satisfied the hair on fire criteria.