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. Jet.com 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 lindventures.com/blog

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!

The One-Person Product

Today I read a great article written by Marco Arment who was the second employee at Tumblr then left to found Instapaper. Read the article here, it is brilliant.

What I love about David’s story is his stubbornness to focus on product over profits, for a long time. This is a common trait of the best entreprnuers. Founders like Steve Jobs, David Karp and Jeff Bezos think long term and strive for product perfection before profits.  It takes balls and belief to keep your investors, employees and financial stakeholders at bay, even if you have 100m users on your platform.

What is great about the acquisition is that David can now keep doing what he loves. This is the dream of any product focussed entrepreneur  Let someone else worry about the business so you can focus on product. He can keep making great product. He can leave the boring stuff to the leadership team at Yahoo. He can forget about making money as he’s made enough for himself and the original investors. He can leave that stuff up to Yahoo to figure out, if he lets them.

Well played David.

Raising money

I have to admit that I’ve been a bit behind on my blogging lately. Since November I’ve been pretty flat our closing an investment round for BuyReply.

Last week we announced that BuyReply had closed a $1m seed round from a consortium of Australian and US investors led by Adrian MacKenzie and Square Peg Ventures with participation from Valar Ventures in San Francisio which is Peter Thiel’s international fund. Additionally we bought in 6 local angels to make up the rest of the round.

BuyReply was covered by the Wall Street Journal, Tech Crunch, AFR and a bunch of other outlets around the world.

It was my first time raising funds having bootstrapped my first company, Lind Golf so it’s fair to say it was a new experience.

I though I’d to share a few of the lessons that I learn’t along the way. To seasoned entrepreneurs they might see naive however if you’ve never raised money before, you might find these points helpful.

1. Back yourself before you ask others to back you

I invested a considerable amount of my own money and time in BuyReply before I looked for outside funding. Doing this will give you a better chance of receiving a healthy valuation and it will also align you with your investors as they can see you have skin in the game and are committed to the business.

Depending how far you get with your own money, you’ll be able to demonstrate your resourcefulness. How far can you get with very little resource? We were able to build a fully working product and run three meaningful proof of concepts before we asked for money.

A note on founder vesting: My view is that this should be inversely proportionate to the amount of cash the founder(s) personally invests. Some investors will want all your shares to vest over 4 years however if you’ve already taken a huge risk financially, why should you have to earn your company twice? Negotiate hard here if you can!

2. Your pitch deck should be a product not a PowerPoint

When we originally met with Valar we had a pitch deck and an idea. We were told to come back with a product and a customer. When I met with Adrian I had a working product and a proof of concept business deal in the pipeline so the conversation was very different.

You are doing yourself a disservice by trying to raise funds from a PowerPoint presentation. In the lucky chance that you do get funded, you’ll get a terrible valuation.

Investors want to see a working version of your idea. This demonstrates that you can transform ideas into products. It shows that you can manager a team and attract the right resources. It shows that you truly believe in what you are doing because you’ve jumped off the cliff before you’ve found funding so to speak.

Most importantly it gives your investors something to see, touch, feel and play with. At the seed stage they are investing in people and ideas and they need to be convinced of both.

Anyone can build an impressive PowerPoint presentation. It takes more than that to execute.

3. You can’t fake an orgasm

Passion sells. When an investor backs an entrepreneur they need to be convinced that the founder is 100% committed and passionate about their business and vision. You need to sell the dream and take your investors on a journey which they want to be a part of. You need to convince them without an inch of doubt that you are whole heartedly committed, and that is something that cannot be faked.

4. Tell a compelling story

Raising money is not just about having an impressive product. It’s about having a story as to why your idea is novel, unique and worth backing. It’s about knowing where you want to be in 1, 3 and 5 years time and taking your investors to that place in the future. You need to sell your vision and your ability to execute to get to that position.

5. The entrepreneur runs the process

I thought that investors run the investment process and entrepreneurs build the business. I was wrong. In our case myself and one other ran the entire process. Once we had a term sheet, I engaged the lawyers, negotiated the deal, bought in other investors and drove the deal over the line. In some cases the investors might run the process however in this case, it was run by myself and our team.

6. Don’t use corporate lawyers or private equity lawyers. Use startup lawyers.

Startup financing is a very specific skillet and it needs to be done at a low cost. While it sounds good to use the biggest most well known firm in town, chances are they don’t have the specific skills needed to close a venture round in a reasonable time frame at a reasonable cost. We had to incorporate in Delaware, flip our AU entity into a US entity, establish a share plan for employees, set up license agreements and do it as cost effectively as possible.

If you want to keep costs low and do it the right way, make sure you engage a firm who specialises in this. The documents and work required is very specific and can be turned around quickly and affordably if you use the right people. We used Richard Horton and his team who are probably the best guys in the business for Australian –> US venture financings. They did an incredible job and moved fast.

7. Momentum matters

Raising money has a domino effect. If you can convince one or two influential investors to back you, the rest of the process becomes significantly easier. Some investors like to be the first money in and some prefer to be the last. Once we had the first two investors committed, the rest of the round filled up pretty quickly on the back of that momentum. You need to capitalise on early momentum and move quickly. Try to get the big names in first for as much as they are willing to commit then leverage that to bring in others who were already interested.

The trick here is to approach investors very early on. You don’t want to be selling the story at the 11th hour. Have conversations 6 months out and inform potential investors about your startup. Tell them you are raising money but don’t come across as desperate. Once these people hear you have interest from a couple of lead investors, it takes just one call to ask if they are in or out. Do the story telling before the momentum builds so that you don’t need to sell the story at the 11th hour.

Additionally, investors like to see good management capabilities. If you can convince a credible executive to join your board during the investment process it will show investors that you can attract the right people and increase their confidence in your abilities.

8. For founders, venture money is better than strategic money.

We had three interested parties who were strategic investors. As an entrepreneur it might make sense in your mind to bring in a customer as an investor however customers are only interested in using your product for their own benefit whereas investors need to make a return on their equity. So if investors make a return on their equity, then as a founder, so do you!

Furthermore, if a customer is interested enough to invest, chances are they will become a user of your product in any case. Try get venture money not strategic money if you can.

9. Don’t accept unfair terms

When you need money it can be tempting to accept any term sheet you receive however if you truly believe you have a great product, team and vision, then you deserve to receive a fair deal. Seasoned investors understand they are taking a 1 in 10 chance and should give the entrepreneur a fair deal. That means a priced round at a healthy valuation without any tricky terms.

If your investors are trying to shaft you from day-1, find someone else who really believes in you. You’re in it for the long run.

Don’t be afraid to walk. I walked away from two term sheets before I got what I wanted.

10. Investors need you more than you need them, but remain humble

There is no chicken or egg scenario when it comes to raising capital. Investors need something to invest in, I.e. businesses and founders, and while this might seem arrogant or naive, you need to maintain a demeanour that reflects a sense of confidence and belief that the “train has left the station”. Investors will flock to a founder that has confidence and conviction, and a great idea, however confidence and conviction are vastly difference characteristics to arrogance and ignorance.

Finally, be patient and DFTBA . It took almost 10 months from our first investor meeting to close the round.

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.

TimeToCall

A good friend of mine @hiltmon has recently launched a new app called TimeToCall. If you are anything like me, working out time differences when making international calls is a struggle.

World clocks sometimes help but if its 4pm and you want to know what the time will be in New York when it’s 9am the next day, you need to do some thinking.

This is where TimeToCall comes in. You enter the location you are calling from then add destination locations. You can then use the slider to change the time to the time of your call and the clocks below update automatically to the correct time.

Here is a screenshot:

It’s a simple solution to a common problem and often those are the best ideas, and it’s just 99c on the App Store.

Best of all, Hilton has documented his journey of creating TimeToCall. It’s recommended reading for anyone thinking of making an app. There are 10 parts to it and this post contains links to all of them.

So if you frequently need to calculate times for overseas calls, go ahead and download TimeToCall.

Well done Hiltmon!

Technical Luck

When building products for the Internet, no-one builds ‘everything’ from scratch. Web services are almost always a mashup of existing technologies and third party services that come together to form a product. Entrepreneurs use API’s, SDK’s and hardware from a range of vendors to create their products. This might be as simple as using an existing open source software stack to launch a WordPress blog, hosted by Go Daddy. The end goal for the user is to create a blog, but they don’t want to be concerned with developing a platform to do this, or configuring servers. They just want to be able to write and publish their thoughts.

I often think about start-ups and the timing of their success with regard to the technical capabilities the preceded their services and whether or not their business could have existed 6, 12, or 24 months ago. The ability to leverage an existing technology and build something valuable on top of this, is what I refer to as ‘Technical Luck’.

A good example of this is Square. Square is a payments platform that is currently valued at $4bn. What would have happend if Apple did not allow for the headphone socket on the iPhone to work as a microphone? If this was the case, Square would not exist because they could not process payments via the Square card reader that plugs into this port. This tiny feature enabled Square to build a $4bn business.

Another example is Instagram. If Amazon Web Services did not exist, Instagram would never have been able to scale to meet demand with just 3 or 4 staff. It could have been a disaster.

There are services out there that let you leverage incredibly powerful and scalable features that make it possible for Entrepreneurs to move swiftly.

These examples of ‘technical luck’ make breakthrough products and services possible simply because of a some pre-existing features or services that can be leveraged in a few lines of code.

The Team & Hiring

As a startup CEO when investors ask you how you intend to spend their money, your answer is most likely going to be people. Startups are not capital intensive businesses which is why investors love them. A very small but talented team (think Instagram) can go a long way due to the scalability of the internet and web applications.

Give or take some money for rent, marketing, and hosting, 80% or more of your investment are going to be in people.

When you raise funds you need to make sure that your money is going to get you the traction you need to either become cashflow positive or to build the business to a level where you have enough traction to justify a higher valuation. In order to do this you need people who are going to help make this happen. This means identifying your weaknesses and hiring staff who make up for what your founding team lacks.

You can broadly break down your company into these skill sets:

  • Sales/Marketing
  • Technology/Engineering/Design
  • Strategy/Administration/Finance

Startups often begin with a heavy focus on engineering and strategy. After all, before you can sell something you need a product to sell, and that requires engineers and product people. Only once you have a product can you start marketing and selling it.

After your product is built, the next hires should be people that can help you generate cashflow and/or traction. That means sales people, community managers or online marketers. They should be relentlessly focused on communicating with your target market in every way shape and form, driving traffic and getting your company heard across the web and real world.

Often in the early stages you don’t need much more than a designer, a couple of engineers, some marketing/sales people and a couple of admin/support staff. As the company scales these skills are amplified by growing each respective skill set to support the initial team.

Hiring is probably the hardest thing you’ll do as an entrepreneur. If you interview two engineers they might both want the same wage, but ask them to code and one might be good, but the other one might be off the charts good. How do you know this up front? Well thats the hard part. Until you put people to the test you never really know how good they are. My advice here is to be brutally honest with every hire you make. When they sit down for the interview you need to explain that you are building a team of world class players and that their first 3 months of your employment is a probationary period. If they are A-players, this shouldn’t worry them. If you set these expectations upfront there will be no surprises down the track.

The last thing you want to do is turn around staff often. It takes time and costs money to hire and educate then on your product and once your cash is burnt, thats it. If you don’t use your funding on the best talent you can find, your chances of getting to the next stage of growth are much lower. In addition to this it is important to incentivise the right staff with stock options. This aligns your team with the company. Just like hiring, you need to ensure your equity is protected against bad decisions. To protect yourself against bad hires, its common practice to make stock options vest over 3 or 4 years with a one year cliff. This cliff provides you with 12 months of time to get to know the hire and ensure they are the right fit. If a staff member is terminated during this time, none of their options vest.

Good luck building your team. Its a challenging task but very rewarding when you get it right. The difference between a good and great team is almost always the difference between a good and great company!

 

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 lindgolf.com. 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:

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.