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Building a Business is Hard Work, Make Sure You Are Getting Credit
One area that seed investors can be really helpful to founders is around setting milestones to optimize for future funding rounds. Assuming that you are building a business that will require more capital, using your limited resources against the highest priority activities can make a big difference.
The frustrating thing I notice is that many activities that go into building a seed-stage startup don’t get full “credit” from the external funding market. They may be necessary, but they don’t really create a step-function increase in the appeal of your company to a new investor. In general, I call these under-valued activities things that are “difficult, but inevitable”. These are activities that make take a lot of work and effort, but that future investors will unfortunately take for granted. Instead, most of the credit goes towards things that are “difficult and uncertain”, with that uncertainty being from the perspective of an outsider.
Here are a couple examples and a bit of commentary on each.
Building Foundational Tech or Building Supply
Whenever I work with a marketplace or commerce business, there is some version of this discussion that goes something like “will investors value all the work that we’ve put into building supply?” Similarly, if a company is more software and product centric, the question is whether investors will value the time and effort that has gone into building the foundational technology.
The unfortunate answer in almost all cases is “no”.
For consumer transactional businesses, building supply is usually in the difficult but inevitable camp. Most marketplaces fail because they are demand constrained. Supply becomes a constraint only if PMF is achieved, and is actually a wonderful problem to be dealing with when you are speaking to investors about your next round.
For software businesses, unless you are building fairly groundbreaking technology, the work you do to build the foundation of your products will be considered hard but inevitable. Even in our portfolio companies that are building groundbreaking tech, we’ve seen the biggest step-function increase in external investor interest when there are at least some signs of market demand, either through pre-orders, escalating customers pilots, winning TechCrunch Disrupt, etc.
In practice, it takes a lot of work to build core technology or to build up initial supply. And not all supply and tech building are created equal. The quality and scalability of the efforts will matter. But this is the classic case of a challenge that the market will tend to undervalue unless it is coupled with signals of demand.
Every investor is looking to invest in a high-caliber founding team. Part of being high-caliber is the ability to attract excellent people. So unfortunately, I find that building a strong team usually fits in the “difficult but inevitable” category. This doesn’t mean that team building isn’t critical. It just means that doing this doesn’t get an investor over the hump, it just allows them to not disqualify you out of the gate.
The exception is when you make one or two hires that seem like total game-changers. These tend to either be A) team members that plug a very critical gap in the founding team from a skill-set or domain perspective, or B) a team member who’s seniority, experience, pedigree, or other other attributes are easily perceived to be a notch above what other companies like yours are able to attract. I find that these types of hires cross into the “difficult and uncertain” category of achievement and can make a big difference, especially for less experienced or first time founders.
Highly Engaged Happy Users
In the quest for product-market fit, intense usage and very happy customers is the holy grail. Everyone knows that companies that drive growth but don’t have products that actually delight customers will eventually collapse. So companies are right to focus fairly narrowly on finding and cultivating 1000 true fans of their product.
But if this is true and generally accepted, why are early stage investors still so enamored with growth and vanity metrics? There are three reasons for this.
The first is that it takes a lot of time and work to really understand and calibrate user engagement. Unless an investor is very deep in your sector and type of business, it will be hard for them to really appreciate that something special is happening with a small group of users. It would take time and some diligent effort to really understand what’s going on, and many investors may just decide that they are better off spending their time elsewhere.
The second is that seed stage companies often run into a question of market size. If you start out by building a narrow wedge, one may wonder whether your early success will translate to other segments of the market. Can your company actually be “big enough”? Are you early, satisfied customers representative of mainstream demand? I find that most investors are more easily won over by growth vs. engagement when it comes to the “can this be big enough?” question.
The third is that growth does end up being a by-product of highly satisfied customers. Products that are loved do tend to spread organically, and good product teams are good at capitalizing on this momentum. My suggestion is that as a founder, the best way to prove PMF is by showing viral or organic growth vs. deep user engagement.
There are other examples of work that is hard but ends up getting undervalued by investors. My point here is not that you should ignore these kinds of activities. They are often an absolute necessity in building a successful company. But it is usually the effects of these activities that create a step-function increase in value that the market will reward. And these effects usually do manifest in the form of customers, traction, and growth.
As a founder, it means that you probably want to make sure that you approach investors when there has been time for the effects of your efforts to take hold. Even if you are completely right about the trajectory of your business, there is always a lag between what a founder feels in their bones and what the external market will recognize.
Founders should also be pretty merciless when all their efforts don’t result in demonstrable growth. The hard but inevitable things are often the necessary inputs that are in the founder’s control. But the market will evaluate you on the outcomes. Ultimately, the most important hard and uncertain thing about every startup is finding great product market fit. The more convincingly you can demonstrate that, the more credit you are going for all the work before it.