As a VC and five-time entrepreneur, David Skok frequently sees two common mistakes being made by startups:
1. Companies spend too much attempting to grow the business when it’s not ready for such growth; or
2. Companies don’t spend enough money when the business is ready to scale.
It’s, therefore, a CEO’s responsibility to decide when to hit the startup accelerator pedal. There are times when it makes sense to step on the gas and invest aggressively, but there also times when it’s smart to keep your company’s burn rate as low as possible.
Frequently, a startup CEO is new to the job and doesn’t have enough experience to understand what level of investment is appropriate at what time. Founder optimism makes them want to spend to grow the business as quickly as possible. The VCs on the board, whose role should be to help guide the fiscal decisions, often contribute to the problem, making the mistake of trying to spend their way out of problems like poor product/market fit or bad market timing.
According to David Skok, to get the spending right, a CEO needs to understand the three different startup phases:
1. Finding product/market fit
2. Finding a scalable and repeatable sales model
3. Scaling the business
A company’s behavior needs to be dramatically different in each phase. David will explain how and why in this three-part series.
The three critical phases of a startup.
What is product/market fit?
In the beginning, the entrepreneurs should be obsessively focused on finding a product/market fit, and conserving cash to allow them as much roadway as possible. Mark Andreessen describes product/market fit as “the only thing that matters,” but what is it?
Basically, according to David Skok, a startup has product/market fit when it has:
• A set of customers excited enough about your product to pay for it. Usually, that payment is cash, but sometimes it’s time. As Facebook, Twitter and Google have proven, if you can get enough customers spending time with your product, there’s usually a way to monetize it.
• A customer base large enough to create a viable business.
[Y]ou can always feel product/market fit when it’s happening. The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers ….
You can always feel when product/market fit isn’t happening. The customers aren’t quite getting value out of the product, word of mouth isn’t spreading, usage isn’t growing that fast, press reviews are kind of ‘blah,’ the sales cycle takes too long, and lots of deals never close.
If your startup hasn’t reached product/market fit, you should obsessively focus on finding it and adjust your burn rate downwards to give yourself as much time as you need to get there.
The best way to find product/market fit is to get in front of customers and validate your assertions. Start early, and validate before you build anything. Use wireframes of the product to walk customers through your vision, then keep validating throughout product development.
Develop objective listening skills, and don’t get caught up in selling too hard. Often entrepreneurs only hear what they want to hear, a trait sometimes referred to as “happy ears.” When a customer disagrees, you’ll often hear these entrepreneurs say: “They just don’t get it.” This is a good indication the entrepreneur isn’t listening.
Also, ask yourself two questions about each of your assertions:
1. Is the problem you’re tackling important to the customer? Too often, companies chase problems that just aren’t important enough to spend money or time to solve. If the problem isn’t important enough, be prepared to drop the idea you’re currently working on and pivot to something different.
2. Do your solutions really solve the problem? Present the solution to the client, and ask them tougher questions such as:
•“Is this a must-have, or a nice-to-have?”
•“Would you commit to purchasing at this price if we build it?”
•“Where does this fall on your list of priorities on which you’d spend money?”
At my fourth startup, Watermark Software, we got a great response when we showed our software to potential customers; our launch went well; and even the New York Times was excited enough to dedicate a half page to covering us. But while it was cool, it wasn’t a must-have, and we struggled to sell it. After two more years of hard work, we found the vertical applications that were a better fit for our product and pivoted the product into a full solution for those verticals. The business took off.
We wasted a ton of money in those two years. Had we done a better job of customer validation up front, we could have avoided that waste. I made the mistake of listening with “happy ears” instead of being objective.
No one can predict how long it will take to find product/market fit. To give yourself the greatest chance of success, you need your funds to last as long as possible. In other words, you need to set your burn rate as low as possible.
The ideal startup team should be the founders, the product development team, and one or two sales people to get the founders in front of customers. That’s it. The founders are the people best suited to interacting with customers to figure out if the experiments are working and to learn from the failures. This work is the key job of the entrepreneur, and cannot easily be delegated to others.
It may also be tempting to hire a large R&D team to get to market quickly. Recognize that few products are immediately ready for broad adoption, and you’ll likely need to go through a few revisions to get to product/market fit. Set your burn rate for a marathon, not a sprint.
There can be exceptions to this spending rule when you can find things that will clearly shorten your time to product/market fit: for example, a new hire that brings in a missing but much-needed skill.
Once you have evidence of product/market fit, you can then find a repeatable and scalable sales model, which I’ll address in my next post.
David Skok has been a General Partner at Matrix Partners since 2001. He founded his first company when he was 22, and since then, founded three companies, including SilverStream Software, and done one turnaround. Skok specializes in SaaS, enterprise software and cloud computing, and blogs at forEntrepreneurs.com.