Should you include risk factors in an early-stage pitch deck?

When writing your pitch deck, should you include the risk factors in your startup? This is a question a founder asked me. To me, it is a pretty simple answer, but we’re going to dig in so you understand what risk factors are and why I don’t put them in a pitch deck.

In this blog, there is also a free PowerPoint template slide you can use for your deck on risk factors.

What are risk factors?

Firstly, since I’m educating you, let’s talk about what risk factors are in the first place!

When you are a public company in the USA you will file an S-1 to go public and then will file 10Qs and 10Ks, which are long-ass documents. They state the risk factors in the investment so investors know what the risks are in the investment. This is an SEC requirement to basically look after the little guy (AKA dumb money, AKA easy pickings).

To give you a startupy example, you ‘could’ have a risk agreement with investors who do a convertible note with you. Here is an example of what that might look like (Abridged, because you don’t really want to read the whole thing)

STATEMENT OF RISK FACTORS

THIS STATEMENT OF RISK FACTORS (the “Risk Factors”) is provided on this ___________, 20__, by and between XYZ Corporation, an <State> corporation (the “Company”), and _______________________ (the “Investor”).

RECITALS:

The Investor and the Company have entered into a Convertible Note Purchase Agreement of event date herewith. The Company has identified certain risks which the Investor should be apprised of which it desires to disclose to the Investor as a part of the note purchase transaction.

– STATEMENT OF RISK FACTORS –

Investing in the Securities involves a high degree of risk. The risk factors and all other information disclosed in the Convertible Promissory Note transaction must be carefully considered before making an investment decision regarding the Securities. One or more of these risk factors could cause a loss of part or all funds invested in the Securities.

The Company may not be able to create the products or produce the inventory is estimates it will need to launch the business with Seed Capital to prove its business concept.

The Company may not be able to create the products or produce the inventory necessary to prove its business concept and in turn to make its Series A offering. In such a case, the expected conversion of the Investors’ debt into an equity security would not take place and the anticipated benefit of equity ownership would not occur.

The Company may not raise sufficient funds to close the Series A offering and the investor may not be able to convert its debt to equity.

The Company may not raise funds sufficient to close the Series A Round. If sufficient funds are not raised to close the Series A Round, the Investors’ only recourse may be to secure the repayment of the principal and interest of their loans from the Company.

The Company is recently formed and has not operating history and no revenues.

The Company was only recently formed and has no operating history and has generated no revenues. There is no assurance that the Company can generate revenues or sell any of its products in the marketplace, and even if revenues are generated there is no assurance that the Company can earn a profit, in which case the Investors’ notes may not be repaid

But these agreements are not normal so who cares, the point is that you understand what examples of risk factors are in principle now.

All those examples are very boilerplate legal stuff. When investors think about your startup’s risk factors they are thinking more pragmatically about your business model and the market.

The common startup risks (from Marc Andreessen) include:

1. Founder risk (right combo of business development, technology, and fundable, scaleable leadership)
   1. 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?
2. Market risk (monetization)
   1. 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?
3. Competition (differentiation)
   1. 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?
4. Timing (why now)
   1. Is it too early? Is it too late?
5. Future financing needs (when, how much and how long to profits)
   1. 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?
6. Marketing (cost of customer acquisition)
   1. 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?
7. Distribution (partnership needs)
   1. 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.)
8. Technology (breakthrough needs)
   1. 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?
9. Product (nailing market fit)
   1. Even assuming the product can in theory be built, can this team build it?
10. Hiring (who’s needed)
    1. 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?
11. Location (does it fit within the investors’ value add network)
    1. 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?

You know, when you stack up all these layers and look at the full onion, you realize it’s amazing that any venture investments ever get made.

What you need to do is take a hard-headed look at each of these risks — and any others that are specific to your startup and its category — and put yourself in the VC’s shoes: what could this startup do to minimize or eliminate enough of these risks to make the company fundable?

Then do those things.

This isn’t very much fun, since it will probably involve making significant changes to your plan, but look on the bright side: it’s excellent practice for when your company ultimately goes public and has to file an S1 registration statement with the SEC, in which you have to itemize in huge detail every conceivable risk and bad thing that could ever possibly happen to you, up to and including global warming.

For a real example of including a risk factors slides is from eShares’ $7 m Series-A round led by USV. Page 29 is the risk factors slide. Here it is in all the glory:

Some of these risk factors may read boilerplate at first blush, but eShares is highly leveraged to the tech startup market. Their risk factors are real.

What would make this slide far better is if they explained how they plan on mitigating these risks.

Update: I found a deck that added a risk factors page with how they mitigate it. It’s from Cabify and their $3m seed raise.

 

Why you might include risk factors in your pitch deck

My fellow Top Writer on Quora Brett fox wrote his views on why you should have a risk factors slide in your deck:

A big thumbs up yes! It may seem counterintuitive if you’ve never raised money before, but there’s huge value in explaining the risks in your venture.

The reason you should absolutely tell your investors about the risks (competition, technical, and go to market risks) is that your potential investors are going to try and come up with what they feel the risks are. You get a chance to do two very important things by explaining the risks in your venture:

A. You get to frame the discussion by presenting the risks.

Framing the risks gives you the control of the story. You get to explain what the risks are, and, just as importantly, you get to explain how you are going to deal with these risks.

Second…

B. You build trust and confidence with your investors.

Every business has risks. Every business has competition.

Admitting the risks and explaining who the competitors are builds a tremendous amount of trust between you and your potential investors. One word of caution here: Just because you explain what the risks are doesn’t give you a free pass.

You have to explain how you are going to deal with the risks. And you have to do a good job explaining your strategy.

What Brett wrote is absolutely spot on and makes sense. I, however, disagree about timing. We’ll get into why now.

Why I don’t include a risk factors slide in a pitch deck

My view is that you absolutely don’t include a risk factors slide.. in your pitch deck! This is important. I’m not saying you should send or hand a slide with risk factors (and how you are going to manage them), I’m saying you don’t include them in your pitch deck – the one you send them in order to ascertain initial interest.

The goal of your (first) pitch deck is to get a meeting.

You don’t need to get into this level of detail yet. Investors just need to like the sector, market size, approach to a real problem and the team to care to learn more to continue a process with you.

As an investor, you get so many decks you need to triage for what you are interested in. As a founder, you need to balance getting read now with a response “I’d like to know more” not “I’ll save that to read it later” (ie never), and providing all the relevant information they will like to know.

Escalate commitment and provision of information

In your 2/3/4+ meetings you can and will get into all manners of pertinent topics.

You start with the basics and then you give more as investors care.

I tell people who have done a lot of work to have another deck called an information deck. In that, you can give them the kitchen sink. I also have other documents you can make to make the process more expedient (e.g. business model deck, metrics deck).

Name your monsters

Brett Fox is absolutely right that you should know the risk factors and be able to talk about them.

I have a draft for a blog talking about “naming your monsters” I haven’t shipped yet. Investors believe there are monsters under the bed, so say Rumpelstiltskin. Name the monsters so they are not so scared of them, as they for sure are going to invent monsters for you.

The thing about investing is you have two main emotions:

• Fear (FOLS – fear of looking stupid)
• Greed (FOMO – fear of missing out)

Before you can get over the crocodile brain and your fear, you can’t think about getting greedy.

Once an investor has had a meeting with you, you might have another with the investor and get into the risk factors and say something like:

“Great, it seems like you like our business model? Ok, well let’s talk about the key drivers of our business and the things that could go wrong. We’ve figured out a lot already, but there is a reason we are raising $5m now, not $100m There are things we need to figure out with this round to be able to scale at our next round”

Control the narrative and what they think

As Brett said you want to control the narrative as much as possible. Investors are going to ask you all sorts of ‘scary questions’. That’s actually a good sign- they’re trying to get comfortable.

If you have a solid and thoughtful answer to all their questions, you build a lot of confidence. They’re not asking questions to be dicks to you, they’re figuring out if you know how to build your company and what you are going to do when inevitably things are going to go wrong, and they always do.

The danger of you not answering questions or preempting what investors are thinking is that investors can choose what to think, and that may not be what you want them to think, or what they think is actually incorrect/malformed.

You want to control what investors think. The best way to do that is to raise answers to questions before they even ask them.

“No, that’s the investor’s job to figure out.”

Some people might say regarding risk factors “No, that’s the investor’s job to figure out.” That’s insanely naive. You want to make it as easy as possible for an investor to invest in you. VCs need to convince their partners to OK a deal and they need to then explain themselves to their investors (limited partners).

Anything you can do to ‘feed’ them smart answers to the questions they have will enable them to be able to pitch you better when they are asked the same questions (and they will).

You can take that attitude when you are hot shite, but even then it’s better to stay humble.

Wondering what questions investors might ask you?

Here are some Q&A with investors:

• Fundraising deal questions
• Fundraising exit strategy questions
• Fundraising financial questions
• Fundraising sales questions:

But… Reid Hoffman said you should include risk factors

Yes, on slide 13 Reid adds a comment that his deck missed risk factors, but, come on, Reid had a 43 slide deck for LinkedIn’s pitch deck, with an appendix!

This is what he wrote:

Advice
One ingredient this pitch lacks, which I now think is essential to modern pitches, is our risk factors. Experienced investors know there are always risks. If they ask you about your risk factors and you can’t answer, you’ve lost all credibility because they assume you are either dishonest or dumb.

Dishonest if you’ve thought about the risk factors but choose not to share them, which is a bad way to build trust and a partnership. Dumb if you aren’t smart enough to understand that all projects have risk factors — including yours.

Explicitly identify the risks that could thwart your success and how you will mitigate them. And instead of waiting until investors ask about your risks, share them proactively so you build trust.

Again, I don’t disagree at all. You just don’t need them in the initial phases of engaging an investor.

Free risk factors template

I’ve never seen a risk factor slide myself, other than the example from eShares.

My bet is you haven’t either 😉

So to make life easier for you, I’ve made a perfectly formatted template you can use yourself. Here it is:

You can download it here. Pop in your email and it will be emailed to you.

Download:

Conclusion

Risk factors are important to investors. You should know what they are and how you are going to manage them.

So do this:

1. Prepare what your risk factors are and how you are going to manage them. Make a slide for these.
2. Practice how you are going to respond to a question on these, or script how you are going to proactively bring them into a discussion (better)
3. Don’t have a slide in your main pitch deck.
4. If you make an ‘information deck’ then add in a slide on your risk factors

As Marc Andreessen states:

Your challenge as an entrepreneur trying to raise venture capital is to keep peeling layers of risk off of your particular onion until the VCs say “yes” — until the risk in your startup is reduced to the point where investing in your startup doesn’t look terrifying and merely looks risky.

By knowing your risk factors and communicating them smartly, you will increase your likelihood of getting funded.

Keep hustlin’.