July 31, 2023


Developing Financial Products - Develop your thesis, product and investment criteria

Happy Sunday, friends.  Today we’re diving into the next step in developing a financial product and getting it to market. You can see the first step (Identifying a market need) in our previous installment here.

Developing a thesis is critical to being able to build a financial product. You can substitute lots of words for thesis (call it concept, sketch, anything). What I mean here is now that you understand what the market needs…and why…you can use that understanding to rough out what your product really is.

Note that this is quite different from developing a product and taking it to market without knowing what, if any, needs it fulfills. Cautionary note: don’t do that.

Developing a thesis is simple:

  1. Synthesize your understanding of market needs into a series of features that solve the problem you’re attacking. These could be:

       a. Structure (cap table impact, capital stack position, repayment terms, etc.)

         b. Cost

             c. Conversion features

             d. Duration

             e. Speed to answer at various stages

             f. Sizing

             g. Value-add features

2. Turn that list of features into a product outline and document it. You might include:

             a. Broad terms

             b. Duration/Maturity

             c. Repayment structure and frequency, if applicable

             d. Downside protection you would include

             e. How you would approach sizing

             f. How the product works in terms of repayment, cap table or lien impact, etc.

3. Document, and test in the market. Gather feedback from as many entrepreneurs as you can (I’d recommend at least 20) and incorporate that feedback into your product concept.

4. Once you have a product concept that entrepreneurs agree they’d be willing to use, you can call that v1 of your product. Oila!

Now it’s time to figure out which businesses will qualify for your product; that is, you need to develop your investment criteria. This is tricky, and I waited until this point in the process to avoid getting hung up on trying to solve this problem before you really know who your customers are. The previous steps will really help you refine your target, but now it’s time to qualify customers. This is a critical step, and I think you can approach it in two ways, but in both cases, it requires financial modeling and some sample data.

On one hand, you can cast a wide net, and narrow it as you go. On the other hand, you can start with what your perfect customer’s attributes are, the customer you’d always fund, and then build a wider net from there. Either way, you’ll want to model:

  1. Revenue and growth requirements

  2. Sizing calculations

  3. The key metrics you believe signal (a) a company’s health and (b) the health of your deal given how your financial product works

  4. The key risks you believe are most important and how they impact the health of any deal you might do

  5. Other things you think drive value or contribute to risk

You thought I forgot about selling this to investors too? I didn’t. Now is when I suggest you factor that in. Based on your product criteria, you can (and should) model what a portfolio of these deals would look like under various scenarios. We always think that things will go the way we expect them to. They won’t. Model a portfolio under stress — it will turn out that you will need to understand how that works. Here’s how I suggest approaching it:

  1. Model one investment that works, one that fails spectacularly, and one that succeeds spectacularly. These are your three basic scenarios.

  2. Build a model portfolio at different ratios of each scenario.

  3. Build in fees or costs investors and your fund will bear.

  4. How do gross and net returns look based on various scenarios? If it has to be wildly successful in order to deliver any returns at all, it’s not going to work. Your product might not be ready for investors.

  5. If your gross and net returns are in-market given comparables (which you also have to define), then you might have a decent chance at raising money.

Note: This portfolio model is what you can use to raise money later. I’ll share a process for raising money in another series. That’s a whole different topic!

Now you’ve finished step 2: You have a thesis, a tested product concept, your investment criteria, and portfolio model. You’re ready to develop your diligence process and refine your risk profile, which we’ll discuss in our next newsletter.

I hope that was helpful — feel free to reply with comments or questions!