The Onion of RiskI am developing a new product...that means that I am trying to innovate rather than optimize. I am plopping down in an area of solution space where I don’t know how to move in order to succeed. There’s a ton of risk and tons of ways this could fail. It’s not only not guaranteed to succeed - it is highly probabilistic that it will fail...at least looking at a standard distribution based on historical data.
I have built stuff and exited (succeeded) and built stuff and crashed + burned (failed). In both cases I had episodic periods of failure inside the macro outcome. I didn't discover the "Onion of Risk" from Marc Andreessen until after I was failing but the mental model actually took to my mind far more because of the moment.
What you want to do is systemize your risks, and attack them one by one. To do that, use the onion. Even though it is written from the Investor perspective, it is actually really great to think about from the Founder side in respect to both the idea that you are pursuing and the business structure that you create around the idea. It is also adjacent to Charlie Munger's concept of Inversion.
Marc Andreessen (click here to see the full PDF) says he got it from Andy Rachleff.
If you’re an investor, you look at the risk around an investment as if it’s an onion. Just like you peel an onion and remove each layer in turn, risk in a startup investment comes in layers that get peeled away — reduced — one by one.
Here are the risks Andreessen lists in the thesis:
Founder risk — does the startup have the right founding team? A common founding team might include a great technologist, plus someone who can run the company, at least to start. Is the technologist really all that? Is the business person capable of running the company? Is the business person missing from the team altogether? Is it a business person or business people with no technologist, and therefore virtually unfundable?
Market risk — is there a market for the product (using the term product and service interchangeably)? Will anyone want it? Will they pay for it? How much will they pay? How do we know?
Competition risk — are there too many other startups already doing this? Is this startup sufficiently differentiated from the other startups, and also differentiated from any large incumbents?
Timing risk — is it too early? Is it too late?
Financing risk — after we invest in this round, how many additional rounds of financing will be required for the company to become profitable, and what will the dollar total be? How certain are we about these estimates? How do we know?
Marketing risk — will this startup be able to cut through the noise? How much will marketing cost? Do the economics of customer acquisition — the cost to acquire a customer, and the revenue that customer will generate — work?
Distribution risk — does this startup need certain distribution partners to succeed? Will it be able to get them? How? (For example, this is a common problem with mobile startups that need deals with major mobile carriers to succeed.)
Technology risk — can the product be built? Does it involve rocket science — or an equivalent, like artificial intelligence or natural language processing? Are there fundamental breakthroughs that need to happen? If so, how certain are we that they will happen, or that this team will be able to make them?
Product risk — even assuming the product can in theory be built, can this team build it?
Hiring risk — what positions does the startup need to hire for in order to execute its plan? E.g. a startup planning to build a high-scale web service will need a VP of Operations — will the founding team be able to hire a good one?
Location risk — where is the startup located? Can it hire the right talent in that location? And will I as the VC need to drive more than 20 minutes in my Mercedes SLR McLaren to get there?