Product Market Fit

There is little else that matters to a start-up than product market fit.

Actually… If you are a seed stage company, nothing else matters.

It is so important, that I want to write a blog post dedicated entirely to Product Market Fit.

For those who have never heard of this term, it refers to determining whether there is actually a market for whatever it is a start-up is building — i.e. Is there a market for your product?

I have made the mistake before of building a product with little product market fit (ShopReply). I have also built a start-up that had instant product market fit (Lind Golf). I have also pivoted from a start-up without much product market fit, to a concept that has a lot more* product market fit (CalReply).

Notice I said “a lot more”. I did not imply that CalReply has product market fit. That is because I don’t believe product market fit is not something you either have, or you don’t have. Product market fit is a relative and elastic concept since the extent to which you might have product market fit will vary in accordance to the size of the market you are addressing, and the pain factor of the solution you are solving.

My “back of the napkin” definition of product market fit is:

A product with 10 or more non-related customers that generates $1.5m in annual recurring revenue with 10% annual churn or less, where there is a foreseeable path to $10m in revenue in the next 24 months by scaling andrepeating what got to you to the first $1.5m in revenue.

This will vary depending on your business model, but I’m talking about a B2B SaaS product here. Having a great product and lots of users is not enough. Revenue, or a clear path to revenue is what matters.

Another important factor of product market fit comes down to your expectations as a founder, the expectations of your investors and the type of company you want to build.

You might create a product that solves a problem for a relative niche, however investors are not interested in niches. They want $100m plus valuations post Series A, and the potential for $1bn valuations later.

That said you, as a founder, might be happy serving this niche and building a lifestyle business that generates $1–2m a year in ARR. So in your mind you might have product market fit. If you ask for investment with this mindset, investors will push you to think bigger… 50 x bigger.

So while you might think you have product market fit, investors look at companies like Airbnb, Uber, Google, Amazon and benchmark product market fit based on their products, and the size of the market that these companies address. They want to invest in the next unicorn.

Lets take Twitter as an example. If you started Twitter you’d be pretty sure you had product market fit after the first few million users started using the service on a monthly basis. That is a great achievement… A few million monthly active users. A fraction of start-ups ever achieve this level of traction. Twitter definitely had product market fit at this stage. Fast forward 6 or 7 years, and Twitter is a publicly listed company being compared to Facebook. They have ~300 million active users, however they also have 800 million inactive users. These are people who signed up to Twitter, tried the service, never to return. Twitter is also a public company under a lot of scrutiny

So, does Twitter have product market fit? Of course they do, however what I’m trying to demonstrate here is that product market fit is in the eye of the beholder. The average person doesn’t identify with Twitter like they do with Facebook. Furthermore, Wall St expects the company to live up to its valuation so in Wall St’s mind, perhaps the product is broken if they are meant to be a mass market consumer social network, but there are so many inactive users. This is why I believe there is no “one size fits all” for product market fit.

The more cash you raise, the higher your valuation, the more will be expected of you to deliver deeper, wider and more sustainable levels of product market fit, and ultimately revenue growth.

How do you know if you have product market fit?

The thing with product market fit, is that it can be elusive. You might think you have product market fit but you might be solving a really painful problem in a market that is not sufficiently large enough to ever become huge. This is the elusive part… As a start-up you think you are doing great when you hit $1m in year one, however you now need to get to $10m in the next 24–36 months. There need to be a lot more customers left in the market that got you to the first $1m in ARR. Then you need to get to $20m, $50m etc.

How to get to product market fit

Here are four rules you can follow to help get to product market fit:

1. Money cannot not buy product market fit

One of the biggest misconceptions of start-ups, is the correlation between money raised and future success. Raising a lot of money very early on has almost no correlation to future success. At the seed stage it simply means you are a good sales person, have convinced investors to write a cheque, and have something sufficiently interesting. It does not mean that anyone in the big wide world actually cares about what it is you intend to bring to market.

Many companies have failed raising too much, too soon. Two examples that come to mind are Color and Clinkle. seems like they could be on a similar path, however I don’t know any details and am just speculating since they have raised A LOT of money, are far from lean.

I would argue that companies who raise smaller amounts of seed capital actually have a better chance of success because it forces discipline. If forces you to build essential features, get out of the office and make your time count. You don’t have time to get comfortable. You need to figure out if your hypothesis is right and start bringing dollars in. An endless cheque book will only prolong the inevitable if you are on the wrong track.

Remember, Google was profitable on $8m in funding.

What will get you to product market fit is having a visionary open-mindedness around your offering, as well as a product that can be tweaked slightly to open itself up to new markets and verticals if your original ideas don’t stick.

So what does money do for seed stage companies?

Money buys time. In addition to a visionary open-mindedness, time is what you need to get to product market fit. You need time to meet with potential customers and validate your idea. You need time to iterate and change your product and business model based on feedback from customers.

When we raised our $1m seed round for ShopReply we had a couple of customers who used our product but it become obvious very quickly that generating revenue would depend on the platform processing very large amounts of gross merchandise volume. At the time it was tough to admit, however I was realistic with myself and knew that this would be incredibly difficult given the transaction volumes we were seeing from early customers. At that point in time we were still very lean with only three people. To cut a long story short (I’ll save it for another post) we decided to pivot to CalReply.

Because we ran lean, we had sufficient funding left over to have a real crack at an entirely new product. Where we were fortunate, is that it only took three weeks to add support for calendars to our platform so we did not have to start from zero on the product side. We did have to start from zero on the customer/sales side. I decided to go all-in on CalReply and within a few months got very lucky (I’ll leave that story for another post).

The lesson here, is that you need to be very conservative during your seed round because it takes time to prove product market fit. Chances are it will take a lot longer than you think so if you don’t listen carefully to market feedback and iterate on your product quickly (or pivot entirely), you will run out of money and die in the trough of sorrow.

In addition to all of this, you need an insanely committed team, a visionary founder, excellent engineers, a heap of luck and excellent timing. So there are about 5 or 6 key variables that are working against you at all times when you are at the seed stage. It’s not easy. Most start-ups fail.

2. Stay Lean

The most important thing you can do in the search for product market fit, is stay lean. When you raise $1m or $2m in your seed round, it is too easy to think you need to create a culture defined by ping pong tables, nice offices, stand-up desks and a large team.

The truth is that you need to keep the team tight, save every penny and be as scrappy as hell.

Here is why…

Lets say you raise $1m in seed funding and you have a team of 4 people (1 founder, 3 product/engineering people) on average salaries of $120k each, fully loaded at $150k each. You will be burning around $650k/yr when you add a few travel expenses, hosting and other costs to the mix. With this money, you need to build the first version of the product, find product market fit AND get to initial traction.

Lets say it takes 9 months to get version 1 out the door (9 months is relatively quick by the way — only a team that has experience in start-ups, is sufficiently product minded, and has strong engineers and designers can do it this quickly). This means you get to the starting line after about 9 months. Once you are at the starting line, your product is ready for paying customers. Over the next 3 months you might be lucky if you meet with 10 customers where your business has a high probability of product market fit. By now it is a year in and you’ve spent $650k. You now have $350k left in the bank.

With the remaining $350k you need to:

  • Continue to improve your product
  • Get initial traction so you can raise more money!

Now lets assume 3 of the 10 customers love your product, and want to buy it. They ask for pricing and an insertion order. By the time these customers sign off on the terms, you’re probably looking at another 2 months of money burnt. You now have $120k left in the bank. Now lets assume each deal is worth $25k/year and you sign three of these, you’re back to $195k.

You now have three customers who you have convinced to give you some money, however you are still far from initial traction which is around $1.5m ARR run-rate.

The lesson here is that even with a sizeable seed round, start-up economics are stacked against you. You need to be lean, while ensuring you have enough money to find product market fit, and get to initial traction.

3. Don’t get emotionally attached to your product or offering

If your customers are not emotionally attached to your product, you should not be either.

Think long and hard about what you are trying to achieve:

  • Do you want the freedom of running your own company?
  • Do you enjoy the creative process of going from Zero to One?
  • Do you love hustling or coding or selling?
  • Do you want to make a lot of money?
  • Do you want to build a great culture and team?

All of these desires can be fulfilled with any product even if its totally different to your original vision. If you start selling eCommerce software but end up building a SaaS calendar platform, so be it. What is important is that you end up with something people want and are willing to pay for, while having fun and enjoying the journey.

Not being emotionally attached can be tough. You need to dig deep and be very real with yourself if its not working out.

4. Keep your product simple

I am extremely proud of the ShopReply product, and while nobody uses it today for commerce, it is an insanely awesome platform that became the foundation of CalReply. We built a ton of great features that we thoughtwould get us customers. In hindsight we made it too complex and spent a lot of time on features that were never used. Luckily there were only two salaries being funded at that stage, which goes back to being lean.

The reality is that many of the best platforms such as YouTube, Soundcloud, Airbnb, Instagram, and Twitter are fundamentally simple products. Complexity does not make your product better. It probably makes it worse. So figure out what your core value proposition is and deliver a great experience around that but don’t try and be all things to all people. You shouldn’t have to. Your core offering should offer enough functionality to provide significant value.

How do you know if you have product market fit?

Here are some signs that you might have product market fit:

  • You can explain what you do in 30 seconds and pitch your entire product from 1 slide. I can pitch CalReply to any customer from a single slide if I have to (I don’t do this, but I could). It’s a simple product that solves a real problem that is easy to understand.
  • Customers that you are pitching for the first time tend to ask for pricing on the first meeting or call. This is a great sign.
  • You have 10 or more unrelated customers buy your product for meaningful sums of money — e.g. $15k/yr+
  • You’ve closed 10 or more sales where all customers are using the exact same feature set and you did not have to add new features or customize the platform for each new customer
  • You can pitch your product via a web-ex demo and sign up a customer who can start using your product almost instantly (I plan to talk about the importance of “instant utility” in a future post)
  • You know who your ideal buyer is, whether it’s the CMO, CEO, CFO, social media lead etc
  • You confidently believe there are thousands of other companies or customers that would also pay similar amounts of money to use your product
  • Customers are responsive to your follow-up emails and don’t disappear after the first meeting

This blog was cross posted to

Learning the difference between graphite and steel

Having started two businesses in the last 6 years, I’ve noticed a pattern that has taken place in the formative year or two of both companies. In both cases the businesses I went into were in industries relatively foreign to me. My first company, Lind Golf, was a golf equipment manufacturing business while my second company, ShopReply, is an eCommerce platform targeted at media and retail.

When I started Lind Golf I had never played golf before (I still don’t play golf). I found replica putters on Alibaba which cost $250 in store and bought 50 of them for $11 each then listed them on eBay. I saw a gap in the market and went for it. I bought rolls of cardboard from a packaging company, cornered off a section of my parents garage, and started listing the putters for sale on eBay. I ended up selling 50 putters in two weeks, reinvested the profits and ordered 100 more shortly after. That is how I got going. For two years I repeated this process. Every night I’d stay up until midnight packaging clubs and the next day I’d deliver them to the post office in my car. My father would help package clubs at night and would eventually  become our club builder until the business could afford to employ someone full time.

The putters were selling well so I decided to expand our range as I figured golfers need more than just a putter to get around the course. I liked the idea of selling drivers – the large 460cc clubs that made that ‘ping’ sound when hit in the sweet spot, so I ordered some titanium drivers from China and put them onto eBay and they started to move. Soon enough it was time to expand the range again. The next logical step was to order Iron sets. I only began to sell iron sets about 8 months into the business as putters and drivers were doing well. I requested pricing from my agent in Taiwan and she emailed me some images and costs. There were two options:

  1. Iron sets with graphite shafts
  2. Irons sets with steel shafts

The sets in graphite were 2-3x more expensive than the iron sets in steel. Since I was not a golfer, my immediate reaction was that since graphite sets are more expensive than steel, they must perform better. Furthemore everyone uses graphite shafts in their woods these days, so I immediately thought graphite was better than steel. Makes sense right? So I ordered 50 sets and put them online… and then I waited… and waited. Two months later we still had 41 graphite iron sets in stock so I thought something was not right. I decided to go to a golf store and look around. For every set of graphite clubs there were about 30 sets of iron clubs on display. I asked the shop attendant why there were so few sets fitted with graphite shafts available and he responded by advising me that the only golfers who use graphite shafts in their irons are ladies and senior golfers!

I took this advice on board and ordered 50 sets of irons in steel. I put them up online and ended up selling 20 sets in the first week. In start-up lingo this is called ‘product-market fit’ however in plain english it means learning what your customers want and giving it to them so they give you money in return.

When I started ShopReply I knew I was entering an industry I did not know that much about – media. Media is a compliated beast. It looks simple enough when you watch TV or read the paper however behind the scenes there are layers of decisions makers, egos, relationships and processes to understand and contend with. When I started I thought it was simple enough to partner with a TV network and they would broadcast something on TV. I thought that the outdoor media companies that sold ad space, had relationships with brands who bought their space. It turns out I had a lot to learn, like the difference between graphite and steel, media is not that simple. There are brands, marketing agencies, media planners, media buyers, TV producers, executive producers, editorial teams, advertising teams, production companies, digital strategists, eCommerce directors, social media managers, stylists and many more roles and responsibilities that come together make up the media landscape that we sell our product into.

It helps to have the right advisors around you who can try to teach you these differences and nuances however the reality is that for the first year (or more) it can be a painful and unproductive process as you begin the journey of understanding what your value proposition is, who your customer is and how to position your products so that customers pay for your product or services. What I’ve come to realise is that this learning curve is part of the process and part of the fun of starting companies. It’s often the naivety of not knowing all this which causes you to take the leap in the first place!


Lately I’ve been reading up about Tesla Motors, the automotive company founded by PayPal Co-Founder, Elon Musk.

I’ve been thinking about the automotive industry over the last 12 months and I’m convinced it’s an antiquated industry. Being in the tech business I am fortunate enough to make it my job to learn as much as I can about the future of software, technology and the connected world. Every day I see software entrepreneurs and inventors progress in leaps and bounds however when I get into my car I feel like I’ve gone back in time. My car is not an old car. I bought it in 2008 and I have all the gizmo’s such as bluetooth, reverse sensors, GPS, hands free, voice activated dialing and so forth, however I still feel that my car is antiquated compared to my computer or iPad.

Given the advancements in the world of software and “the internet of things” I am blown away that only one car manufacturer has been able to use software to make the automotive experience significantly better. That company, of course is Tesla Motors.

What Tesla has done is nothing short of astonishing.

  1. They have built a car that is 100% electric (no fuel at all)
  2. They have build an ‘operating system’ that is used to control every facet of their vehicles from a touch screen
  3. They are rolling out charging stations across the US and Canada creating a huge barrier to entry

Every few years an incredible company is born that ends up changing our world. Microsoft and Netscape did this in the mid 90′s. Google did it in early 2000. Amazon did it to books and retail, and later AWS. RIM followed shortly after, then Apple came along and blew RIM out of the water.

Tesla is one of these transformative companies.

Not only are their cars electric, they are also controlled entirely by an API. The 17″ touch screen in the dashboard sends API commands to a computer within the vehicle that triggers events to ‘do stuff’. Unlike my car where I flick a mechanical switch and push a button to turn on the airconditioner, the Tesla has a touch screen. For example if you want to open the sunroof, you ‘drag’ the sunroof open on the touch screen and the roof begins to open above your head. The electric engine is cool, but so is the thinking that has gone into reinventing the car.

If I was the CEO of Mercedes-Benz (or Ford, or any other automotive company) I’d spend $50m on an ‘acqui-hire’ tomorrow to snap up a hot shot software team in Silicon Valley capable of creating an operating system which could be used to control their vehicles.

Within the next 5 years, every car should have a ‘Tesla” style 17 inch internet connected touch screen embedded in their dashboards. We should be able to download apps to install them in our cars, and all components should be controlled via an API. This will sell more cars than larger engines.

Click to enlarge this image of the Tesla dash:

Network effects

Tesla also has network effects. Tesla is currently installing charging stations across America and Canada to enable customers to ‘Super Charge’ or ‘quick charge’ their cars on busy routes across these countries. Tesla charging stations could well become the new ‘petrol station’ and once enough of these exist, it becomes very difficult for other car manufacturers to roll out their own versions of these proprietary charging systems. As Tesla’s technology improves and prices drop (which they will), consumers that want to save on gasoline (who doesn’t?) may be forced to buy Tesla cars as Tesla would have the most mature charging network of any car manufacturer. I can envisage a world where we are all eventually driving Tesla’s because its the only electric car manufacturer that has a pervasive network recharge stations. The result is a Tesla ‘eco-system’ which I’m confident has the potential to do what Apple did to mobile phones, to cars.

Silicon Valley

The innovation that has come out of Tesla could only have been executed by a Silicon Valley entreprenuer.

An Israel company named Better Place tried to invent the electric car. They did this in conjunction with Nissan however after billions of dollars of investment the venture has yet to amount to anything of significance. I’m not 100% sure why it has not worked out, however I suspect that one of their problems would have to do with their decision to partner with an existing automotive manufacturer. In order to innovate on the combustion engine you need original thinking. The engine was invented over 100 years ago and radical change requires someone who is able to challenge the status quo.

Unfortunately, Nissan was an incumbent trying to be something they are not. We’ve all seen this one before in that Sony did not have the foresight to create the iPod, and if they did, their brand did not have the cult status of Apple.

It took someone from the outside world of music, movies and cellular phones, to change the industry and Elon Musk is the guy that is doing this in automotive.


What Elon Musk is doing to the car is what Steve Jobs did to the phone. Jobs used ‘software’ to reinvent the phone. He built an operating system for the device (iOS), added some sensors, then opened up its capabilities via a set of APIs.

Here are two examples that show you how a Tesla vehicle can be controlled via the command line of a MacBook:

Tesla is an amazing company which is just getting started and I can’t wait to see where they are in 20 or 30 years time!

Earning equity

When founding a startup there are hundreds of decisions to be made during the course of the founding years that can significantly impact your business.

One of the most impactful decisions you’ll make will be how, and who you choose to grant equity to.

If you are taking outside funding and hiring employees you’ll need to make these decisions pretty early on and you’ll need to live with them for the life of the business.

When you have something hot, everyone wants a piece of it. People will try and convince you as to why they are worthy of being a founding employee, how they can add value during the early days when you need help getting established. It is very easy to give in to requests by colleagues friends/associates who might not have what it takes to be a founding employee. When you have 5 staff chances are you need 2 or 3 engineer type people and 2 business/marketing/sales people however if you have a technology product then they should all have a level of technical competence. Finding people that satisfy this mix of skills is not easy.

During the early days you need to be tough and true to yourself as to who is worthy of equity. You need to listen to your instincts. Chances are your mate who can code or sell is not the right fit. Recruiting the right hires is a process in itself and needs to be done thoroughly, and equity must be granted deservingly.

With his in mind, I am of the opinion that there are only three ways to receive equity:

  1. Be a founder – This means being the one who incorporated the entity and started with 100% of it. This is the highest risk, but highest return way to own a piece of the action.
  2. Earn it – This means working for the business over a period of time so that you earn shares that ‘vest’ according to the option pool, usually a 4 year vest with a 1 year cliff.
  3. Pay for it – The other way is via an investment in the company at a valuation that is fair to the founders and fair to the investors and leaves  enough skin in the game for the founders to be incentivized and raise additional funding if needed.

In my opinion there is no other way to get equity. At the very early stages when it’s just the founders and no investors, it’s very easy to part with equity however at this stage it’s unlikely you’ve worked with these people before and therefore it’s risky to just give them something without being able to work together to see if they are the right fit. You need to date before you get married. The same applies in startups.

My advice here is not to part with equity (outside of the founders) to anyone until you’ve got a formal investment in place, and as part of the term sheet insist that all employees, directors and advisors be a party to the option plan and its associated vesting terms. This means that the CFO or the whiz executive you’ve just found has to earn their right to own a piece of the business.

As the founder you can play man in the middle between the option plan terms and your stakeholders by advising them that all stakeholders, including director grants, are subject to vesting. This removes the need to have those uncomfortable conversation around equity. My key point is to try and get your vesting terms in place prior to granting equity to anyone (during you Seed round), otherwise you’ll end up making promised you can’t keep.

Oh… and as a founder, don’t ever forget the risks and sacrifices you’ve made to get to where you are today. Chances are those people asking for equity are just seeing the tip of the iceberg, but with this is mind, A player employees are always worthy of generous equity grants. You can’t do it alone.

Be your own bitch

This week we saw the relationship between Zynga and Facebook change. You can read the SEC filings here. Starting in May next year Facebook will be able to create their own games and market them directly while at the same time Zynga will be able to accept payment off of the social network and make games that are currently only available through Facebook available directly via their website.

What this means for Facebook is that their share of game credits will be fragmented and that users will be able to play games without being logged into Facebook. On the flip side Facebook can make their own games if they wish and make a direct margin on credits.

There are a coupe of lessons here as I see it. The positive for Zynga is that they were able to quickly build a business off the back of a huge user base due to some exclusive privileges negotiated between themselves and Facebook. The problem however is that the party is now over and Facebook have decided to treat with Zynga as a standard developer is treated. What’s more is that Facebook have cleverly included this provision:

Zynga’s right to cross-promote any games that are off of the Facebook web site from Zynga services that use Facebook data and to use e-mail addresses obtained from Facebook, will be limited by Facebook’s standard terms of service, subject to certain exceptions.

What this means is that Zynga can’t use data collected from on Facebook to convince users to move across to Zyngas proprietary versions of the games.

When I started Lind Golf we built a database of customers from sales on eBay then over time we ended up starting our own website and used that database to launch what is now In Zynga’s situation they are prohibited from marketing to the email addresses collected via Facebook.

The reality Is that anyone who builds a platform on another proprietary platform runs the risk of the rules changing down the track.

Zynga isn’t the only company that’s been castrated by a proprietary platform. Jodee Rich’s latest venture was recently cut off from the Twitter firehose. You can read about this here. He is now taking legal action against them (perhaps he should just become a lawyer, he seems to like the court).

The lessons here are that you need to control you own destiny. Good examples of this are open source software platforms where there is not proprietary body. The Internet is built upon these standards. Standards like HTML, email, TCP/IP etc are non proprietary standards. It’s why Steve Jobs didn’t include support for Flash in iOS. He didn’t want to be at the mercy of a middleman.

As for Zynga, their stock chart says it all:

The importance of physical proximity

I often hear from other entrepreneurs its important to operate out of Silicon Valley, or that you need to be in New York if you are serious about your business. Entrepreneurs often say that you are at an unfair advantage if you are in physical proximity of your customers, partners and investors however I never bought that. I thought that it was enough to have a good product and build relationships over time that would grow the business globally.

I’m writing this blog from New York having just spent the last few days in the city doing business. I am convinced now that in order to be a player, you need to have a presence where your target market is because if you do, things can happen really quickly.

In the last few days we’ve bounced between some of the largest corporations in the US, all of which are in a radius of 1km. We had two meetings with two different companies in the same building yesterday. When someone e-mails you for a meeting, you can be in the lobby of their building within 10 minutes. When they call you back for a second meeting, they know you cannot be that far away.

The pace that you can execute when you are on the ground in New York is something I’ve never thought about in the past, but have just experienced. If you are in technology, the same can be said about Silicon Valley (our next stop), and if you are in media or finance, the same can be said about New York.

Even though we build things on the internet, the reality is we still need to do business in the real world and thats all about meeting with people and making things happen. Once you have critical mass, you can put your office on Mars and it won’t make a difference but until you get there, you need to be able to hustle in person.

I’ve been to New York many times in my life but this is the first time I’ve experienced the convenience of physically proximity first hand. It can make a huge difference.

Strategic Investment

Entrepreneurs often fall into the trap of chasing after VC funding while failing to explore the strategic options that might be available to them. We have become accustomed to reading the fantasy stories posted on Tech Crunch so it’s become commonplace to believe that raising from a brand name VC is the right thing to do. The reality is that VC’s exist to provide rocket fuel when needed and their early stage funds often exist to enable their late and growth stage funds to ‘see the flop’ when more funding is needed as start-ups mature.

For all the noise around capital raising, I’m surprised how few entrepreneurs raise money from strategic sources during the early stages of their business.

Strategic sources are investments where your investor is able to benefit themselves from the products or services you create. In other words, they double up as an investor and a customer. If you were a manufacturer of tyres, would you rather Mercedes-Benz invest in your business, or a bank invest in your business? Taking investment from a source that doubles as a customer provides you with some important benefits:

  1. Feedback - There is no faster way to find product market fit than to have your investor be your customer as well. The feedback loop is fast and transparent as both companies have an alignment of interests.
  2. Credibility – If your investor is your customer and they happen to be a large trusted company or corporation, this can often bring significant credibility to your offering as larger competitors are likely to trust your product if they see their counterparts using it as well.
  3. Speed to market – If your investor doubles as your customer you can often gain traction quicker than competitors who raise funds then have to find customers.
  4. Income – If your business is going to help your investor/customer generate revenue or reduce costs, then you can generate income from your investor. If you raise from a VC this wouldn’t be possible.

Furthermore the job of an investor is to generate returns for their shareholders. Corporations often have different goals and agendas and will often take a more strategic approach to investments rather than viewing them from a purely financial perspective.

Sometimes the best scenario is raising funding from sources that are strategic as well as financial. You might want to raise from a strategic source, get product market fit, then raise from a VC. There is no right or a wrong, all I’m saying is that you should think outside the box when considering your source of capital.

Convertible notes Vs Priced rounds

There has been some debate lately about two forms of investment structure used by VCs, namely “priced rounds” and “convertible notes”. Fred Wilson first posted about it on Saturday here then Dave McClure chimed in, followed by Mark Suster via another blog post.

At its simplest, in a “priced round”, each investor in a funding round is told the price per share and is issued shares at that price. Meanwhile, a convertible note is a type of loan that converts to equity when the next round of funding is closed, usually with some form of discount.

I found this conversation interesting as it provided insight into how these experienced VC’s structure their investments. I wasn’t sure how many deals were based on notes versus how many were priced. When Fred said he had never invested via a convertible note I felt very reassured as I recently declined such a deal. The reason I don’t like convertible notes is because they do not align entrepreneur and investor. There a tension that one side might end up better off than the other and the note incentivises you to make short term decisions to bolster valuations for the next round which might not be the right strategy for the business over the long term.

We recently received a term sheet from an investor which proposed a convertible note. As an entrepreneur it is difficult to be aligned with an investor on such terms that could result in losing vast amounts of equity if things take longer than expected. While founders will have their own views, I value alignment over valuation. Convertible notes with ratchets don’t represent an alignment of interests. If you want to build a billion dollar valuation over the long term, founders and investors need to see eye to eye. My view is that a priced round is the only way to achieve alignment if the founder prefers this.

To quote Fred in point #2

“I don’t understand why folks don’t understand it.”.

The excuse that investors use is that ‘it is hard to value a startup, so lets leave this to the next round once you’ve got some traction’ however startups are not mean’t to be valued traditionally as there are usually little or no cashflows from the outset.

Investors need to back the idea, the market, the vision and the team and figure out what funding is needed to realise this vision. If the opportunity ticks the right boxes then the next step is to work out how much is needed, how much the founders are prepared to part with, set a 1x liquidation pref, and get started. The valuation should be based on what the founder needs, and how much they are prepared to part with.

I wouldn’t sleep as well at night knowing that I might end up parting with 40, 50, 60 or 70% of the company if we don’t reach specific milestones quickly. If I was on the other side of the table as Fred is, I’d rather the founders I invest in focus on product and the business rather than have the stress of knowing they could lose equity over the long term. The reality is that businesses are not built overnight and that many of the consumer internet business that are worth billions today never had a revenue model when they started out – Google, Twitter, Facebook etc.

A convertible note with a ratchet is nothing but a ticking time bomb especially if you don’t yet have a revenue model. Founders need the breathing room to figure things out and the right investor will appreciate this. Our business does have a revenue model but its still a new product and we need to market it and get it out there and that can and will take time. I’d rather build the business without a ticking time bomb under my seat and with the peace of mind that I know where I stand, and that means an equity deal.

Startups should not be about financial engineering.

They should be about software engineering and marketing. Founders deserve to have the peace of mind that they can get on and build their product and business and in my view, the only way to ensure the founders full attention is focussed on building company value is by pricing the equity up front if thats what a founder wants.

The truth about raising money

I urge you to read this article by Ben Kaufman:

Ben writes what raising money means to him. Last week Ben raised $68m from Andreessen Horowitz and KPCB. This brings Quirky’s fund raising to $97m. I saw Ben in action last year while I was in New York and he is an incredible entrepreneur so I wasn’t completely surprised when I read about this round. While I’m not a fan of his business model (product manufacturing) he now has a war chest behind him to make it work. Another thing about Ben is that he is just 24 years old!

I was going to describe which parts of the article resonated with me but I ended up copying and pasting most of it, so I recommend you read the whole thing.

My favorite line was this:

Congratulating an entrepreneur for raising money is like congratulating a chef for buying the ingredients.

The future of media

I just read an awesome blog post written by Albert Wenger from Union Square Ventures. Albert has financed some of the largest consumer internet franchises on the web including Twitter, Zynga, Foursquare, Kickstarter and Tumblr. He know’s what is what!

A while back I wrote a post called “The future of eCommerce” which outlined my vision as to where I see online commerce going. His recent post has an uncanny resemblance to what I described back then.

I explained that the future of eCommerce is going to be driven by the following three factors:

  1. Mobile
  2. Frictionless payments
  3. Social platforms

Alberts blog is titled “Attention Scarcity, Transactions and Native (Mobile) Monetization”

  1. Attention Scarcity = Frictionless payments
  2. Native (Mobile) = Mobile (twitter, SMS and email – the lowest common denominator of technologies on smartphones)
  3. His use case is an example of buying via Twitter = Social platforms

What Albert is saying is that we need to capture consumers when their purchase intent is at its highest while they are engaged with their medium of choice, whilst making it easy for them to pay.

Marketing 101 is all about endorsing a celebrity with a brand (think Nike + Roger Federer), putting the celebrity on TV, broadcasting them to a large and engaged audience, and creating an emotional connection with the viewer. This is how brands are built. Almost all established brands have been built this way. It is what they teach you in marketing kindergarden.

As a cyclist I watch the Tour de France every year. I see these guys pumping up Alpe d’Huez with sweat beading from their foreheads. They are my hero for that moment and I watch in awe taking into consideration how gruelling the ride must be. If you are a soccer fan, you sit there glued to the TV watching your heros play the game. Every pass of the ball stikes an emotional cord. Fans want to be the players. Fans want to wear what they are wearing. This is why people pay $149 for a pair of Nike shoes that cost $15 to manufacture. This is why we shop at Nike Town not Joe’s Shoe Store.

The problem though, is that until now it has been impossible to turn purchase intent into a transaction at the moment where purchase intent is at its highest. In order to make a transaction, consumers have to move away from the medium they are engaged with, whether it be Twitter, TV, newspapers or magazines, and go to a store or web browser to buy. There is too much friction in this process.

Albert describes this here:

Because at the moment most routing is still of the disrupting and annoying kind that tries to take your attention and move it somewhere else altogether, such as a different web site altogether. The primary reason behind the need to disrupt and really move you elsewhere is that most web services have not yet found or deployed their native way of making money, which is largely due to the inability to transact within the services themselves.

According to Alberts example, he is saying that the consumer needs to be taken away from the Twitter stream and moved elsewhere on the web to a place with a low conversion funnel before they can buy. In reality, it is much worse than this. While watching the soccer, if I want to buy a Barcelona jersey, I have to leave the medium I’m engaged with (TV) leave my house, go find a store that stocks this product then buy it.

While my purchase intent is at its highest while watching TV, it diminishes over time, so the sooner I can capture a transaction, the higher the chance of a sale. 

As time goes on my circumstances change, I get distracted, my financial position might not afford a jersey, my wife might talk me out of it or Barcelona might lose the game – i.e. before half time I might have wanted to by the jersey badly enough to transact on the stop but at the end of the game I no longer want to. Had I been able to make that purchase instantly, before half time, I’d have done so.

In reality, the transaction point is not a website away (perhaps it is from Twitter) but if you take into consideration traditional marketing methods, the transaction point is miles away. If you see somethinig you like on TV, hear something on radio or see something in a magazine or catalogue, you still need to visit to a store. Even if you don’t need to visit a store, there is significant friction in buying online. You need to leave the couch, find a computer, search for the product, find a size, add it to cart, enter your payment details and so forth.

The opportunity therefore lies in bringing the transaction point to the medium – Twitter being one of those mediums.

  • What if you could bring the store to the TV?
  • What if you could transact within the Twitter stream?
  • What if you could buy off of the page of a magazine?
  • What if you could buy instantly while listening to radio?
Albert describes this here:
 The primary reason behind the need to disrupt and really move you elsewhere is that most web services have not yet found or deployed their native way of making money, which is largely due to the inability to transact within the services themselves.
It is not only web services that have not found a native way of transacting in stream. It is ALL offline mediums that don’t yet have a native way of transacting. This includes television, radio, magazines, catalogues etc. In order to transact we see something we like, then we go to a place where a transaction point can occur which is either in store or on the web, but what if the transaction could occur off the medium itself? What if I could buy Roger Federer’s shirt off his back while I’m watching the game in real-time using NATIVE technologies on my mobile phone (by native I am referring to technologies that dont require an App download). What if i could purchase when my purchase intent was at its highest via a single click payment mechanism? This is what Albert aludes to in his last paragraph when he talks about Facebook, Apple and Amazon storing credit cards.
FG says:

The platform we have created (BuyReply) solves this problem, and I look forward to sharing more with you shortly. We enable instant transactions from any online or offline medium including Twitter via a secure virtual wallet!