How can investors use first principles to assess the reasonableness of a startup's valuation?

Good question, it's not as mysterious as it sounds. "First Principles," simply put, means stripping away all the concepts, labels, and narratives that everyone else is echoing, to see what the business fundamentally is at its core. Then, starting from the most basic common sense and logic, you do your own calculations.

Let's not talk about "SaaS," "Web3," or "Metaverse." Let's just treat it like a street-side fruit stand.

You want to invest in this fruit stand, and the owner tells you it's worth a million. How do you use "First Principles" to determine if he's bluffing?

Step One: What "real" problem does this stand solve?

Is it solving the problem of "white-collar workers in nearby office buildings not having time to buy fruit, wanting healthy snacks," or is it solving the problem of "the owner wanting something to do"?
The former is a real demand; the latter is self-indulgence. The "rigidity" of the demand determines how solid your business foundation is. Is it "can't do without you," or "can do with you"? That's a huge difference.

Step Two: What's the "ceiling" for this business?

In the most ideal scenario, how big can this fruit stand get?
First, calculate how many potential customers are nearby (total number of people in office buildings)? How often do they buy fruit (consumption frequency)? How much do they spend each time (average transaction value)?
Potential Customers x Consumption Frequency x Average Transaction Value = Total Addressable Market (TAM).
For example, if there are 5,000 people nearby, they buy twice a week on average, spending 20 yuan each time. Then, theoretically, this market has a potential of 5,000 x 2 x 20 = 200,000 yuan per week. This is the ceiling; your imagination cannot exceed this number. A market that can only generate 200,000 yuan in business, valuing it at 1 million, is clearly unreasonable.

Step Three: How can it win business? (Moat)

The market is for everyone; why should he be the one making money?
Is it because his fruit is exceptionally fresh, sourced through exclusive channels (supply chain advantage)? Or because his fruit salads are particularly delicious, and others can't replicate them (product/technology barrier)? Or because he has strong relationships with the property management of all buildings, preventing others from entering (channel/license barrier)?
If his core advantage is merely "cheap prices," then if someone cheaper comes along tomorrow, he's finished. A business without a "moat" carries high risk, so valuation must be cautious.

Step Four: Can the business itself make money? (Unit Economics)

Don't listen to the owner's stories; get down to the detailed numbers.
Selling a 20-yuan fruit item, what's the cost of the fruit? How much does the packaging cost? How much does the delivery person's labor cost per order? How much does the stall rent cost per order?
Revenue - Variable Costs = Gross Profit. If each order loses money, hoping to profit later when the scale grows, then a big question mark arises: can costs really come down with scale? Why? Often, this is just a beautiful fantasy.
A healthy business should be profitable at its smallest unit.

Step Five: Why is "he" the one to do this? (Team)

Finally, and most importantly, look at the person.
What did this owner do before? Does he understand fruit? Does he understand retail? Can he do accounting? Is he hardworking? Is the team configuration reasonable?
A good idea, executed by an unreliable person, will likely fail. An ordinary idea, executed by a capable person, might even turn into something extraordinary. The ability, determination, and integrity of the founding team are the foundation for all future possibilities.

In summary:

Investors applying First Principles break down a complex company into these five fundamental questions:

Is the demand real?
Is the market big enough?
Is the advantage strong enough?
Can the books balance?
Is the team reliable?

Once you've thought these questions through, you'll naturally have a clear judgment. The valuation is based on the discounted value of future potential earnings. If, through the above analysis, you find that it's highly likely to become a "fruit king" with tens of millions in annual profit, then a 1 million valuation today might even be cheap. But if you find it's just a small stand that could collapse at any moment, then 100,000 is too much.

This is far more reliable than listening to others say, "This is the next XX company," or "The XX sector is very hot right now."