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How “Clustering Illusion” Stalls More #startups Than Any Other Bias

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Clustering Illusion

When you are doing your initial customer development, by talking to many potential users, there are many cognitive biases you need to be aware of.

Cognitive biases are tendencies to think in certain ways that can lead to systematic deviations from a standard of rationality or good judgment.

Usually most founders tend to solve problems they have exposure to or those they are aware of, or those they believe to be one that’s a large market. This stems from the “scratch your own itch” phenomenon.

I had a conversation with a founder who is building a consumer internet company, where viral effects of her product determine the growth trajectory more than any other metric. Or so, she had learned from many other founders experiences – both by talking to them and investors in the space.

After 3 months of building her mobile eCommerce product, she and her cofounder launched it in the marketplace. Initial traction was good and trending ahead of their expectations. Many of the early users were impressed with their product selection and merchandise.

Growth after the 4th month though, stalled as they were on the road trying to raise their initial funding. Most every entrepreneur knows that fund raising can be a full time job. In fact I have mentioned several times that fundraising is a poker game more than chess.

When they were trying to show their initial user growth, many investors had the same problem – was their product a trendy, 3-month-uptick or a sustainable-fast-growth business?

After hearing this from the 5th seed investor, they determined that they need to look closer at their numbers, their repeat purchase behavior and address the issue before they were going to raise any funding.

Looking at the initial numbers suggested their they had many buyers who got to know about them through word-of-mouth, and the repeat purchase was high.

She and her cofounder determined that they had to improve their virality coefficient.

This is the bias I see most often: clustering illusion.

The clustering illusion is the tendency to erroneously consider the inevitable “streaks” or “clusters” arising in small samples from random distributions to be statistically significant.

When you have very little data, you have very little data. That’s it.

Don’t make assumptions about the overall market based on very little data.

There are times when you have 60% of the data and you have to make a decision. There are times when you have 30% data and you have to make a decision.

The difference between 30% and 60% is a lot. In fact, most entrepreneurs I deal with confuse having 3% of data with 30% of data.

To reduce clustering illusion the only remedy is to get more data. You will have to run more, smaller, experiments, over smaller periods of time and do it consistently. Make your assumptions, document your hypothesis, but continue to work on getting more data.

Turns out the real problem for our entrepreneur was that the overall market was much smaller, and they found it after 1 year of trying to increase their virality coefficient. They did raise their initial funding, but have since pivoted to expand their merchandise offerings to cater to a larger market.

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Is The Opposite Of Winning And Success, Learning And Not Losing Or Failure?

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Learning

I was reminded of this yesterday when a friend, Rajesh Setty eloquently put it in an email signature to me.

The opposite of winning is learning.

Which should technically mean that the opposite of learning is winning, but that’s not true. You do learn when you win, The mystery of success and the articulation of failure is a big problem overall.

I have found that when you dont know what made you successful, you make new mistakes.

So my question is, f you keep having multiple “failures” and end up learning a lot, how can you incorporate learning into your learning. Meta Cognition is an important field of science I am paying some attention to.

Metacognition refers to higher order thinking which involves active control over the cognitive processes engaged in learning. Activities such as planning how to approach a given learning task, monitoring comprehension, and evaluating progress toward the completion of a task are metacognitive in nature.

Simply put, learning how you learn is an important skill for most people.

Self awareness, (not nirvana or even self realization, in a spiritual sense) or understanding what makes you as an individual tick is important for entrepreneurs.

That’s another skill I seek to understand about entrepreneurs.

How do they learn? Do they know how they learn? This is less about how coach-able they are, but more about how they go about learning things they dont know much about.

When you get started, there are many things you dont know about the market, customers, adoption, sales, etc.

How you go about prioritizing what’s important to learn and how you learn them is critical to what is called “Execution”.

The ability to understand that is driven, I believe by 3 questions:

  1. How do you learn best? – By reading, but observing, by being tutored, by seeking advice, by doing it yourself, etc.
  2. How quickly can you incorporate the learning into your plans and execute them?
  3. How do you monitor and observe what the results were so you can continue to learn?

So, back to the question – Is the opposite of winning – learning?

And not losing? Similarly

Is the opposite of success, learning as well and not failure?

Also Read: New Ipo Filing – Remitly #Fintech Global Money Transfer Company, Previously Valued At $15.B In Jul 2020

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New Ipo Filing – Remitly #fintech Global Money Transfer Company, Previously Valued At $15.b In Jul 2020

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Remitly

Remitly, a Seattle startup that helps immigrants in developed countries send money home to family and friends in developing nations has filed confidentially for an IPO. Pricing and terms will be known by early July.

Remitly CEO Matt Oppenheimer

Remitly competes with Western Union, Transfer Wise, Money Gram, Xoom and others in the $550B remittances market.

Remitly competitor TransferWise has also seen its valuation rise, with investors recently pegging its worth at $5 billion during a secondary share sale in July 2020.

Matt Oppenheimer, started Remitly in 2011 after running internet and mobile banking at Barclays in Kenya with Shivaas Gulati and Josh Hug, as cofounders.

Remitly eliminates forms, codes, agents, and other fees typically associated with the international money transfer process. 

Send money to M. Lhuillier with Remitly

Remitly started with the Philippines market, but today lets over 4M consumers ship money to 50 countries, worldwide.

Remitly Review 2021: Low-Cost Platform to Transfer Money Abroad

It owns no retail outlets. Customers can only initiate a transfer digitally, although on the receiving end in developing countries, Remitly partners with cash-pickup locations.

On average, money transfer agents charge a 13% fee on remittance transactions.  For those sending money home, the appeal of faster and less expensive money transfers is obvious.

HOW REMITLY WORKS WITH GCASH? |Tesha EK - YouTube

Remitly makes money by charging transaction fees and marking up foreign exchange rates. Fees vary widely by country, but on average, Remitly charges about 1.5% for a transfer.

Western Union, which owns many brick-and-mortar locations and brought in $852 million in profit last year, charges roughly 5%.

Remitly expands coverage for mobile remittance program to 40 countries,  nears 1K employee mark - GeekWire

Remitly has grown revenue nearly 100% annually over the past five years, reaching an estimated $80M in 2018 and over $250M by 2020.

Remitly customer growth increased by 200% in 2020, compared to a year ago, with 3 million customers served in aggregate spread evenly across the 17 send-from markets and the 57 send-to countries.

Remitly | Impact 20 | Fortune

Remitly has over 1000 employees has raised over $400M in funding so far, with over $80M in debt alone. It last raised money from Visa in March 2021, and previously $85M at $1.5B in valuation on July 2020. It is seeking $4 – $5B valuation.

Remitly will use the IPO funds to invest in PassBook, a banking and debit card product aimed at multinational workers, who frequently face hurdles when trying to set up bank accounts.

Jeff Bezos-backed Remitly announces free money transfers to the Philippines  - GeekWire

Remitly has acquired 2 startups – Symphoni, an AI Product in the #Fintech space and Wire, a mobile messaging app.

Valuation

At $4B valuation and about $220M in revenue, (estimated), 18X last twelve months valuation is rich in the #fintech space but in line with $AFRM at 24X P/S. Given the rapid growth in customers this may be justified, but until we know the final valuation sought and the revenue growth this seems rich.

Analysis

With over 500 IPOs in the last 6 months, the pickings are great. Remitly will do very well during IPO time if the market conditions are good.

I do think however, that I am going to wait to see their final numbers and decide if they will be in the top 1% of IPOs that I will invest in.

What we still need to review:

  1. Revenue, customer growth in 2020 and expected projections
  2. Gross Margins (estimated at 30 – 40%)
  3. Average $ per transaction and average take rate
  4. Repeat customer usage of platform – do customers like using it or are they very price conscious and use the platform with lowest fees each time?

Also Read: How Can You Tell If An Angel Investor Is “Real” Or “Fake”?

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How Can You Tell If An Angel Investor Is “real” Or “fake”?

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Angel Investor

It has become quite fashionable to be an angel investor. The last 5 years has seen an increase in the number of registered angel investors on various platforms – from a mere 3000, we are at over 25K in the US alone. That begs the question – do we have more people who have become angel investors now, or are people richer, or did we always have them and we just found out about them now?

Many high net worth individuals would like to be angel investors, but just don’t have the inclination to do the heavy lifting that it requires to help entrepreneurs, source deals and find follow on investing. Most are also fairly conservative, especially if they have made money at a larger company and not been an entrepreneur before.

Here are key “leading indicator” questions that I ask before I try and syndicate deals with other angel investors, which might be useful for you to consider. YMMV.

  1. Have they invested before in a startup? The best indicator of an investor is if they have invested before. The time to make the first investment for a newly minted rich individual is close to 21 months. So, if in your discussions with a potential investor, they have never invested before, it is highly unlikely they will. Angel list is a good source, but not comprehensive. I would simply ask them this question. Or ask them for their previous investments? What companies have they invested in before?
  2. Do they come referred as an investor? The best network is still word-of-mouth. They best referrals for angel investors is typically not other investors, but entrepreneurs is what I have noticed. Even if an investor “passes” on an entrepreneur’s idea, I have found that if they have been respectful, consistent and fast in their communication, the entrepreneur will refer “relevant” deals to them.
  3. Are they accredited? When an investor has over $1 Million in investment capital (exclude the capital in their primary residence), or if they can show they have over $250K in annual income, they can be accredited. I have found the best way to determine this is ask the investor for who their financial consultant or tax consultant is. People who have that much money have a person for both or either. If they don’t, the signal I get is they are rather unsophisticated in their approach to investing.
  4. Are they involved and connected with the local startup ecosystem? Most interested angel investors are either mentors or advisers at local entrepreneur’s hot spots such as accelerators or co-working spaces. If they are not connected, it is likely they are not going to invest, since they don’t value the experience.
  5. Do they understand key terms and nuances? An experienced or willing angel investor understand convertible notes, equity rounds, key milestones and other “insider” terms well enough to not have you explain it to them. If you are educating the investor about angel investing, you are better of looking for someone else to do that, while you focus on your company.

What other questions would you use to differentiate between a “real” and “wannabe” investor?

Also Read: The Perfect Startup Team: Asterix And Obelix

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