Lind Ventures

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

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.

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.

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.

I urge you to read this article by Ben Kaufman:

http://www.quirky.com/blog/post/2012/09/what-raising-money-means-to-me/

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.