When investors talk about product, they’re often not just talking about the details of the thing a company builds or delivers – be it software, a physical product, or a service.
Investors also consider a number of factors, including the quality of the product or service a company offers, the business model behind that product, and whether the product matches a market need.
Often the first step investors follow in evaluating a product is determining if there is anyone who actually wants the product. This is referred to as “product-market fit”.
“The term product/market fit describes ‘the moment when a startup finally finds a widespread set of customers that resonate with its product" – Eric Ries
Many startups fail before they find product-market fit – or because of lack of it. Examining the product-market fit is about validating the value hypothesis – or the underlying assumption the company and founders have made. After all, without the ability to meet a pressing need, both the short- and long-term prospects of a company are fairly dismal.
“If you address a market that really wants your product — if the dogs are eating the dog food — then you can screw up almost everything in the company and you will succeed. Conversely, if you’re really good at execution but the dogs don’t want to eat the dog food, you have no chance of winning.” – Andy Rachleff
For more notes on Product-Market Fit, see this blog from Andreessen Horowitz.
In this day and age, there are very few financial barriers to creating prototypes. All companies pitching investors should have at least a prototype.
The answer that a prototype is "coming soon", or "almost complete" is not an acceptable answer. Even hardware companies, through the use of cheap prototyping tools and with the help of platforms like Kickstarter, can create initial products prior to raising any venture capital. And service businesses should be able to show that they’ve run significant trials of their service.
The only real exception to this is companies with a founding team that has an exceptionally strong track record of creating great products. In those cases, investors will sometimes trust the founders have the ability to create a high-quality product.
The quality of a company’s sales website, pitch deck and other materials presented throughout the pitch process can also be great indicators of a team’s ability to deliver on the product.
Once a product passes an investor’s initial screening, technical due diligence into a product may be conducted. If an investor is not technical themselves, or are investing in an area outside their domain, they will often have someone that is technical and who has a solid understanding of the particular technologies and industry look at the deal. The investor may have this expert, someone they trust, talk to the founder or CTO or try the product to give them an opinion on the product.
An investor may choose not to invest if the company is purely technical and outside their area of expertise. However, there are some cases where a lack of personal technical understanding won't hamper an investor's ability to make a sound investment decision. In the case of a company where the technology is only an enabler to the end product, or in a domain where an investor has experience, they may be able to make a decision without a complete understanding of the technical nuances.
Ultimately, investors aren’t just evaluating the thing a company builds or delivers. They’re evaluating the quality of the product or service the company offers, and whether it matches a market need.