It’s All Been Done Before

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Whenever I start a new project, it always starts with excitement. New ideas are always exciting because, as ideas, they seem perfect and carry with them the promise of learning new things. That excitement lasts right up until I finish the first working prototype and have enjoyed the glow of having built something new. Then, reality sets in and I do a Google search for similar projects only to find…

It’s already been done before.

Or, at least something very similar. Seeing that my idea was not, in fact, novel is always disappointing. Worse, to see that others have not only had the same idea but spent much more time working on it is even more disheartening. This cycle repeats for literally every project I’ve ever done, yet I keep working on these projects and also having new ideas and starting new projects. Why?

Everything has been done before.

It’s true that there are some areas of physics where new things are being done. There are biologists who discover new species and new archaeological sites unearthed. But these are at the cutting edge of science today and happen very rarely. In the world of product development, there are few unique ideas. Even if your idea is novel, it is likely that someone, somewhere else has the same idea. That should not stop you, however.

What matters is not the idea but the execution.

Anything can be improved upon, and that’s your opening. Google did not invent the search engine, they made it better. Facebook did not invent the social network, they made it better. Uber did not invent the car service, they made it better. For each of those companies, not only did they not invent a new kind of product, they were not the only ones trying to improve on existing products at the time they got started. What they did was act on the idea better than anyone else.

While others may have the same idea, can they match your focus? Can they match your passion? Can they match your work ethic? Having an idea is cheap, what you do with your idea is what gives it value. If you believe in your idea, make it impossible for others with the same idea to compete with you by being the best at turning that idea into reality.

So, who cares if everything has been done before? Anything can be improved. That’s where you come in.

 

 

The Profitability Challenge

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Here’s a fun weekend experiment for you, something I call the $20 Weekend Challenge: Take a $20 bill out of your wallet on Friday. You task for the weekend is to turn that $20 into $40 by Monday, doubling your money. You are welcome to use any legal means at your disposal, but heading into a casino or buying lottery tickets doesn’t count. You have to turn that $20 into $40 without gambling. It sounds hard, but it is worth it, I promise.

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So, what does this have to do with building a business?

Cash and Business

A common refrain in business is that “cash is king”. Most people say that to mean your company does not exist if you don’t have enough cash to pay your bills, but it is also true that your business is designed to take in some cash and output more cash. You are trying to build something impossible in the world of physics: something that produces more than it consumes.

This is much harder than it sounds, as you likely know if you tried the $20 Weekend Challenge. If you are accustomed to working for a salary, you are used to exchanging your time for money which is very different from building a business. Having a job requires little thought on your part since your salary is (usually) guaranteed and your time has flexible value. Building a business, however, requires a lot of thought.

Let’s do a simple thought experiment to prove that point. Your typical employee at a high tech start up company costs between $100,000 and $150,000 depending on your location so let us assume $125,000. No, that’s not all salary, it includes benefits, payroll taxes, accounting costs, etc. (as a business, the salary can be only half the cost of an employee).

Depending on your business model, let’s see how many customers you would need to pay for that employee.

Business Model: Advertising

In advertising you are paid per every 1,000 ad impressions you show (CPM). CPMs vary wildly so let’s assume you make a $2 CPM (which is not bad). Assuming that 20% of your users are active on any given day and those active users generate 2 ad impressions, you would need 286,200 active users every day to support the cost of one employee.

Business Model: Subscription

In a subscription model, you make money through the monthly fee you can charge active customers. Let’s assume, your product costs $50/month to maintain a subscription. That means you need 210 paying customers every month to support the cost of one employee.

Business Model: Selling Products

When you are selling products, you get a one-time fee for the cost of the product. Let’s assume you sell your product for $100 and it costs you $90 to make it, leaving $10 in net profit per sale. You would need to sell 240 units every week to support the cost of one employee.

And remember, all of that only covers one employee.

The $20 Weekend Challenge

When thinking in these terms, I hope the value of the $20 Weekend Challenge becomes clear. In order to pay for a single employee, you have to have a lot of customers. To pay for your entire team, you need a large number of customers. To pay for your team, your offices, your lawyers and eventually make a profit? You need to have all the customers.

You need to take your money and almost double it to simply pay your bills.

Building a profitable business is hard because the cost structure that goes along with companies is high. Some companies claim they are profitable when they achieve Ramen Profitability, but that is really a false milestone. If you can’t afford to pay yourself a living wage, you are not really profitable.

If this makes starting a business intimidating, good. It should be intimidating. It should seem almost impossible. However, I bet when you first started thinking about the $20 Weekend Challenge it seemed pretty hard too. The only way to see if you can do it is to give it a try.

The Run Rate Trap

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One of the best ways to think you are the only company not doing well is to go to a networking event and ask other founders about their “run rate”. You’ll hear that 6 month old companies are on a $50M run rate or that a three person startup is on a $100M run rate. Clearly there is a magic bean stalk that everyone else knows about except for you.

In finance, a run rate is an estimate for the full year value of a financial metric (e.g revenues) which is made by extrapolating from a shorter period of time (e.g. a few months). For example, you can use a run rate to estimate the annual revenues for a store by taking the first three months of the year and multiplying it by four to get the revenues for all twelve months. However, that assumes the rate of growth of store sales stays flat and if the business is growing, it’s better to assume the rate of growth, say 10% month to month, stays the same and estimating annual sales from that. It’s a quick way to understand the annual size of a business based on a snapshot of data.

Unfortunately, run rates are as error prone as they are simple. The faster your growth rate and the more volatile your finances, the less accurate a run rate estimate will be. When we extrapolated the annual revenues for a store from the first three months of the year we did not take into account the Christmas rush in December which can generate 50% of a store’s revenue.  If that was the case with this store we would have underestimated the annual revenue of the store by 50%.

If you take too small of a snapshot of data, or worse you cherry pick the data, your run rate estimate can be wildly inaccurate. Estimating the annual revenue for a store from only one day is impossible, and if that one day is Black Friday then your run rate estimate will be orders of magnitude higher than reality.

Which is exactly what your friends at the networking event were doing. The pressure to succeed is strong and it is tempting to bend the truth to make things sound good. Cherry picking a few good weeks or months of revenue and calculating your run rate from that is one way to bend the rules. Yes, it is technically possible that you will make $50M this year but that is hard to tell from the $3.5M you made in the first quarter even if you are growing 25% month over month. More than likely you will hit some bumps in the road and not quite get to $50M this year.

Not everyone uses their run rate to mislead you purposely, but in the world of fast growing companies the run rate is very often misleading anyway. Use it with care or at least with a dose of skepticism. So, the next time you hear someone’s run rate is an order of magnitude higher than yours don’t worry. They might just been telling you what they want you to hear.

Reverse Pitching

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Recently, I have been helping  a lot of companies by pitching their 7184240743_a9fc6fbaca_zbusiness back to them in a process I call Reverse Pitching. I put together a investment or sales presentation of the company, from scratch, and present it to the founding team of the company. They act as the customer and I act as the company, trying to sell them on the vision and the business.

Wait, why would I want you to pitch me my own company?

Well, before I explain why it’s useful let’s cover what Reverse Pitching is not:

  1. It is not trying to show the company how to pitch themselves. I could never recreate the passion and vision that drive the founders to build the business from the ground up. If you are pitching your company, it should come from your heart in your own voice.
  2. It is not an attempt to convince the company they should change their business. It would be amazing arrogant to assume that I know their business better than they do and hence can improve their business through a simple pitch.
  3. It is not practice for raising investment. If you want to get ready to raise investment, you should practice your own pitch on a test audience as much as possible. Having me pitch your company back to you will not help.

Okay, so then what is the point of Reverse Pitching?

The goal of having someone else pitch your company back to you is to hear about the business from a fresh perspective. I am never as familiar with the industry as the team, nor do I understand the nuance of how the business operates. However, that naiveté means that the pitch they hear from me is very different than the pitch they would present themselves. It gets the team thinking in new ways about how to move forward.

Reverse Pitching is a great antidote for developing tunnel vision, which is common during the product development stage of your company. Nothing shocks a team out of their comfort zone more than hearing someone else talk about what they are doing in a new way. It opens their eyes and introduces new ideas, even if they disagree with everything in the Reverse Pitch.

I find that Reverse Pitching becomes useful whenever a company is preparing to make some large strategic decisions. Those decisions might be fundraising, product launches, rebranding efforts or new growth efforts. At those points it can be useful to ensure that you are not just making decisions based on momentum, but that you have thought about how your strategy is viewed by others.

If you are currently building a company, I encourage you to ask one of your advisors or investors to do a Reverse Pitch. If they aren’t willing to, drop me a note as I’d love to help.

Image courtesy of Erik Anestad on Flickr, made available via Creative Commons.

Who is in charge?

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In the early days of starting Flurry, my co-founders and I made all of our decisions by  consensus. It wasn’t hard, since we had similar opinions and were spending all of our time in development which we knew very well. The camaraderie of working together late nights and building something new fueled the excitement we had about our new path of entrepreneurship.

After about six months, we had a working product and were thinking of raising our first angel funding. One of our friends, a venture capitalist, offered to listen to our pitch as practice before we presented to potential investors. We spent a long time putting together the perfect pitch for our business and practiced it until it was second nature. When we pitched our friend the VC, he listened to the pitch, asked questions along the way and seemed generally impressed. Until, at the end, he derailed our entire company with a single question.

“So, who is the CEO?”

That question hit at our biggest weakness which we shared with most first time entrepreneurial teams. But before we talk about why, let’s talk about making decisions.

Democracy vs. Dictatorship

Democracy and Dictatorship are both ways of making decisions for groups of people. Democracy requires a majority to agree before a decision can be made which means a democracy makes fewer decisions, but will avoid making very bad decisions. In contrast, a dictatorship consolidates all decision making power in a single person allowing it to make many decisions very quickly, but with a higher chance of very bad decisions.

For a government, avoiding very bad decisions is the primary concern and the cost of not making any decision at all is often low so democracy thrives. However, in the military where there is a premium on making decisions quickly and it is dangerous to make no decision at all,  dictatorship is used. The decision making framework needs to match the needs of the organization making decisions.

Companies are much like armies, where the premium is on making decisions quickly. You have limited time to execute your plan before you run out of funds, your competition picks up or the market moves. Making a decision quickly and doing something, instead of endlessly debating, is critical to your success.

Companies need CEOs

When we were getting started in those early days, we put off the decision about who was in charge because we were friends first and co-workers second. While I carried the CEO title, I did not act like the CEO nor did everyone treat me like a CEO. This was a dangerous thing to do, as I have seen teams fall apart after 6-9 months fighting about who should be the CEO and I am glad we survived.

Had we been clear about the CEO authority day one we could have set up the right decision making frameworks from the beginning, and avoided any chance of decision paralysis if the team disagreed on what to do. As it was, we had to change the way we made decisions which slowed us down during a critical period of the company.

Note that just because the CEO has ultimate decision making power does not mean they make all the decisions. A good CEO delegates decision making to his team as much as possible, and the best CEOs make sure their teams feel ownership of all decisions even if they don’t make themselves. Still, it is not always possible to make everyone happy with every decision which is the hardest part about being a startup CEO.

Who is the CEO?

I am glad that our friend asked “Who is the CEO?” because it forced us to confront the question of authority very early in the life of our company. It was also a wake up call to me, as the CEO, to step up as the leader I should have been all along. The team also needed me to become that leader, as it allowed us to move more quickly and overcome some of the challenges we had faced.

And it prepared us for the even harder journey ahead.

This post originally appeared on the FounderDating blog as a guest post.

 

Location, Location, Location

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It amazes me how many people cling to the romantic notion of starting a new business in their garage. Garages are typically full of stuff (including your car), poorly lit, and cold due to a lack of insulation. Your garage is also attached to your home which means you’ve chosen a location for your business based on where you live right now.

That a dangerous mistake.

Even if you are not starting a retail store or a restaurant, location is an important factor in the success of your business. It might not seem so at first when it is just you, your laptop and a phone working from a coffee shop. However, if you are successful and need to grow then you want to make sure you are in a city that facilitates your growth. Just like natural resources fuel economic growth, your company will need business resources to grow.

Three common business resources that depend on your location are: Employees, Financing and Customers.

Location Based Employees

Assuming your business takes off, you will want to grow your team quickly. This might mean hiring engineers, artists, sales people or simple manual labor. Whatever kinds of employees your business calls for, you want to make sure you have a ready supply of candidates in your area to fill those positions.

It is not a coincidence that you find many companies in the same industry gravitating to the same city. Companies in the same industry hire the same kinds of people, and often away from each other. This creates a liquid workforce where you can quickly scale up when you are successful by drawing from employees at larger companies in the same industry.

The major drawback to being in close vicinity to many other companies in the same industry is that your employees are more likely to be poached by those companies. Ideally, you want to find somewhere with enough density to make hiring easy but not so dense that employees will switch jobs every six months.

Location Based Financing

At some point your company will require outside capital to continue to grow. Despite the global nature of business these days, most early ventures are initially funded by local investors. There is so much risk in early ventures that investors focus on the people more than the business and to do that they need to meet you in person. Of course, to be funded by locals there need to be locals that invest in your kind of business. While there may be investors in your city, if they don’t typically invest in your kind of business you will have an uphill battle to raise money.

Put simply, you want to be in a business that your city is in already. It’s easiest to raise money for a high tech company in San Francisco and for a new hedge fund in New York City but if you need to finance a new farm both places will prove difficult.

You want to be in a business that your city is in already.

The good news is that if you’ve already chosen a place with a large pool of potential employees, chances are that they work for competitors and those competitors have raised financing already. That means you might already have an educated investor community.

Location Based Customers

While you can reach customers by email, phone and even video these days there is no replacement for meeting your customers in person. Sales is still a very human activity and your ability to sit down with potential customers and understand their needs will be critical to your success. While you can’t work in the same city as all of your customers, you want to be close to enough of them to fuel your early sales and product development.

Another added benefit of being close to your customers is that other companies who service the same customers will be there as well. This means you will have more opportunities to develop partnerships (and potentially be acquired).

Moving On

The reality is that any location you choose will never be perfect. Whether to move your business, or even your home, somewhere new is a decision that you will need to make after weighing the facts. It is possible that the potential of easier financing is outweighed by your desire to be near your family, which is a very logical decision. However, realizing that limitation up front means that you can plan ahead and work harder to overcome it.

Thanks to Evan Cooke for inspiring this post. He promised me a job cleaning his yacht in exchange for covering the topic. 

Photo made available via Creative Commons by Jim Trodel on Flickr. 

That’s Just a Feature

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Stop me if you’ve heard this before:

It’s just a feature, not a product.

It is a popular refrain from skeptics who want to sound intelligent about a new innovation, product or company. On the surface it sounds insightful because it draws a line between a product that stands on its own (“product”) and something that solves a small problem and cannot stand on its own (“feature”). It is hard to refute as it is a subjective statement and easy to justify.

It is also meaningless.

Dismissing something new as a “feature” ignores the fact that every product starts by solving a small problem. When you are starting from scratch, you don’t have the time or the resources to build a perfect product that solves a big problem so you carve out a small part of that problem to solve. Whether you follow the Lean methodology and build a Minimum Viable Product or simply suffer from the resource scarcity that follows starting a company, your initial product will be simple and basic. That is a good thing.

Many successful companies follow a common progression during their growth:

Feature -> Product -> Platform

If your business has potential (see Are You Solving a Problem), you should be able to prove it by starting with a feature. From that feature you can build a complete product which, if also successful, will form the basis for a platform on which additional products can be built. Companies like Facebook, Google and Sony have all been built this way.

So if you find a skeptic that dismisses your idea as a feature instead of a product, don’t let that get you down. Instead, explain to that person the bigger problem you are tackling. If they still don’t understand, then I suggest ignoring their opinion. Life is too short.

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Illustration made available via Public Domain. 

Recruiting is a form of Sales

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Starting on the first day of your new company, 3118776394_d88167cc3eone of your most important jobs will be recruiting a team around you. That includes co-founders, employees and even your supporting cast like lawyers and accountants. Anyone that works on behalf of your company is someone you will need to recruit as the best people always have many options available to them.

Many people think of recruiting as interviewing. The traditional model for recruiting is to write a job description, field resumes and then interview candidates who need to prove you to that they deserve the job. If someone does, you offer them the job and they accept it. It is a very self-centric way to think about recruiting because you focus on your own need instead of the needs of the candidate. It is also a great way to fail.

Recruiting is a two way street. You need to make sure that the candidate can do the job but you must also make sure they want the job. It is critical that you make your recruiting process equal parts evaluation and selling so that you maximize the chances of closing the best people. The best way to think about recruiting is that every single candidate that talks with you, whether you hire them or not, should walk out of your interviews wanting to work for your company.

Every single candidate that talks with you, whether you hire them or not, should walk out of your interviews wanting to work for your company.

So, how do you sell your company during an interview?

Selling your company to candidates takes practice and the successful sales pitch will vary depending on the candidate. Note that selling your company is not the same as allowing the candidate to ask you questions. Selling is proactive. Sales people exist specifically because you cannot expect customers to just throw their money at you, in the same way you can’t expect candidates to magically want to work for you.

Here are some ways to make sure you make the case for your company:

  • Ask the candidate what criteria they are using to select their next job and take the time to understand them. Then go through that criteria one by one to show how your company not only meets the criteria but well exceeds it. Listening to the candidate and understanding their perspective is always better than just tossing around the same talking points.
  • Emphasize what makes your company unique, something they can’t get anywhere else. Is it the culture, the technology, the customers? Whatever it is, make sure the candidate has a strong association between your company and your unique characteristics.
  • Give anecdotes about why other people (including you) have chosen your company, and what their life has been like after joining. People love to hear that others who made the same decision worked on cool projects, got promoted quickly or were able to do things they have never done before.
  • Make it personal for them. Talk about how their background makes them the perfect fit for your company and how they will make your company more successful. Candidates that feel like you know them and value them will build a more personal connection.

When making the case for your company, remember that repetition is the key to marketing. If you feel that something is really important for them to consider in their decision, don’t be afraid to bring it up a few times.

It should go without saying, but it is more important to be honest than persuasive. If you lie to a candidate, and tell them what they want to hear, it will inevitably come out and cause more harm than good. Most candidates would prefer to hear the honest story of your company, both good and bad, instead of only the good or lying about the bad. You will be surprised how persuasive the truth can become.

Square Peg, Round Hole 

Even after making your case effectively, you still might not be able to convince an amazing candidate to join your company. Often, this is because the job you have is not exactly what they are look for in their next job. This is where selling becomes front and center in your process because a sales person never goes into a customer with only a single product to sell them. Being flexible and adapting to customer challenges is what makes effective sales people.

If you are faced with an amazing person who you want on your team, you should not be afraid to change the job or create a new job that better matches what they want to do. If the person is an engineer who wants to do product management, and you think they can, create a hybrid product/engineering position. If the person is in sales but wants to do marketing, create a customer development job where they can do both. Truly amazing people are few and far between, so if you find one you want them on your team in whatever form that might take.

Recruiting is a team sport

In the end, candidates will meet some if not all of your team as part of the recruiting process. If you are the only one selling, then your chances of closing a great person are low. Everyone on your team should be following these same guidelines and making the case for your company at every step of the process.

Go through your own recruiting process yourself so you see it from the candidate’s perspective.

Don’t assume that people on your team know how to effectively interview and recruit, be sure to train them and help them practice before talking to candidates. One great way to do that is to go through your own recruiting process yourself so you see it from the candidate’s perspective.

There is no substitute for a great team. More than anything else you do in starting your company, recruiting your team will have the biggest impact on your future success. If you are successful in building an amazing team and make sure they are happy in what they do, your company will start to attract more amazing people who want to be part of a great team. When that happens, you have made your team a competitive advantage – one that will pay huge dividends down the line.

Image made available via Creative Commons by BFI Business Furniture, Inc.

Your Three Types of Customers

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When you design the user experience for your products, it is important to remember that every product actually has three different 6774634275_73b52d6267_zuser experiences. These three experiences exist because you have three types of customers and each of them will use your product in different ways. The three types of customers are:

  • Newbies: People who are using your product for the first time, right now.
  • Students: People how have used your product a few times and have mastered the basics but have not yet decided if they will be dedicated customers.
  • Experts: People who use your product as frequently as possible, ideally part of their daily routine.

Each type of customer has different needs, different expectations and requires different strategies to win them over. Let us review them one at a time.

Newbies: Winning on Day Zero

Day zero begins the first moment that a new customer touches your product. You should assume that, on day zero, Newbies know nothing about your product or what it is supposed to do. Hence, your challenge is to simultaneously educate them about the product while demonstrating how useful the product will be once they master it.

Your primary goal with Newbies is to get them to come back a second time. Customers that only try a product once are lost and almost impossible to recover. You want to find a way to bring them back often enough to increase the chance you convert them to a loyal customer.

To win over the Newbies, there are some key things you need to provide as part of your Day Zero experience:

  • The Wow Factor. Newbies need to see something exciting and memorable during their first time using the product, without requiring them to do a lot of work. Something that is so impressive that they will have an incentive to learn more and put up with the natural frustration that exists when learning something new. This initial payoff will set the tone for their interaction with the product.
  • Goals over Tools. Many products have their interface built around capabilities of the product, exposing everything the product can do. Newbies don’t yet speak the language of your product so they won’t know how to translate their goals into the features and tools you provide. You should focus instead on the goals of a first time user and map those into features for them. It gives you a great chance to demonstrate the power of the product, while helping a customer achieve a goal during their first time using the produce.
  • Limit Choices. While it might be great that your product can do a lot of things, you don’t want to expose these all at once to a new user. Instead, you are best to reveal only the minimum necessary to use the product and reveal additional complexity later. Providing too many options and too many paths will only serve to confuse.

Remember, your goal with a Newbie is not to turn them into an expert but to get them to come back again. If you are successful, your Newbies will become Students.

Students: Getting Over the Hump

Student customers are already familiar with your product and have used it a few times, so hopefully they have experienced the Wow Factor and have achieved at least a few of their goals using the product. You managed to convince them to come back multiple times, now your challenge is converting them into an Expert.

Getting over this hump, and turning them into loyal customers, will define how quickly your business will grow. Some common ways to help turn Students into Experts:

  • Always show them something new. Don’t overwhelm customers with power tools all at once, but encourage them to explore something new every time they come back. If you see them attempting to achieve goals, you can coach them with better or faster ways to achieve the same goal. You can also introduce features and tools they haven’t used before to expose them to everything the product has to offer. Constantly being exposed to new things will give them a strong incentive to keep coming back and learning more.
  • Watch out for warning signs. If customers show signs of frustration or lack of engagement, proactively engage with them. For example, if they try the same action multiple times with no success, you can prompt them with help on how to achieve their goal. These friction points also become the top priority for you to improve in the user experience.

Make sure that you are closely tracking your Students because they will be at risk of loss until they become Experts.

Experts: Rewarding Your Evangelists

Experts are the most active customers you have. They use the product constantly, hopefully everyday, and know all of the features inside and out. Since they are already as active as possible, your challenge is to keep them that way and not lose them.

The best way to keep them engage is to stay ahead of any reason they might have to leave. While you can’t force someone to be happy, you can remove reasons for them to be unhappy. Anticipating reasons they might depart and removing them ahead of time is hard but there are some general ways to do this:

  • Constant Improvement. Constant and consistent improvement to the product is critical. It provides customers with a sense that the product is always getting better, which will translate into patience when they encounter things they don’t like. If they get frustrated and feel that the product is stale they are more likely to give up and walk away.
  • Open lines of communication. Solicit and listen to feedback from these customers, giving them a feeling of ownership in the product. You should have special lines of communication available to Professional users which will make them feel valued. It will also allow you to prioritize their concerns and improvement requests.

You will lose customers, even Experts, that is a fact of life. However, minimizing that loss is critical for maintaining your business. It is significantly cheaper to retain an existing customer than to acquire a new one.

Conclusion: The Perfect Product

There is no such thing as a perfect user experience, as it is difficult to balance the needs and interests of all three types of customers at the same time. Some products are very simple to pick up and use the first time but are not useful for experts. Other products are powerful for experts but very difficult for first time users to learn. You cannot make everyone happy at the same time, but you can alleviate as many problems as possible. Just because there is no such thing as a perfect product does not mean you should not aspire to create one.

By taking all three customer types into account when designing your user experience you will get as close as possible to your ideal product.

Photo made available via Creative Commons by Flickr user Henriksent.

What Investors See When They Look At You

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If you’ve gotten far enough in building your mirror business to think about raising investment, then you’ve worked very hard and survived some near-death experiences. It’s been a tough road and you should be proud of the progress you have made. Well done!

However, when you sit down to talk to a venture investor about your business you need to put all of that aside. When a venture investor looks at your company they don’t see it as it is today, they are trying to envision what it might look like in 5-10 years.

Wait, let’s take a step back: How do VCs work?

If you’re not familiar with how venture capital funds work, they are easy to explain. A group of partners (known as the general partners) form an LLC to act as an investment fund. They then raise capital for the fund from large institutions like pension funds, endowments and other funds (known as limited partners).  The size of venture funds varies wildly from $20M to $1B, but almost all venture funds have a 10 year lifespan. For the first 3-4 years of the fund, the general partners are making investments in new companies and the remaining 6-7 years is spent managing those investments and making follow-on investments in the same companies. At the end of 10 years, the fund is closed and, assuming there was a positive return, the limited partners get their rewards. (For a much deeper explanation of venture funds, read Venture Deals).

Keeping that in mind, the primary motivation of a venture investor is to produce returns on their fund in 10 years. Considering the high failure rate of start up companies, out of a portfolio of investments in 10 companies they can expect 7 to go out of business, 2 to be moderately successful and one to be hugely successful. In order to produce a return on the entire fund, they need those successes to be huge (return 20+ times the money invested).

Okay, so how does that affect how they see me?

Venture investors, because of how their funds are set up, are constantly looking for companies who have the potential to produce a 20x return on investment. That is very difficult to achieve and not many companies will have that kind of potential. A neighborhood grocery store will never produce that kind of return, nor will your local bookstore.

Not only do venture investors need a 20x return, they need it within 10 years. There are businesses you can grow slowly over 20 or 30 years to produce those returns, but to do it in less than 10 years means that your business needs to grow extremely quickly. To grow that quickly, you need a quickly growing market, a well thought out plan, some critical strategic advantage and the right team to execute your plan.

So, when you sit down with a venture investor, they are looking for signs that your business can produce 20x returns within 10 years.

Ah, that makes sense. So what does that mean for me?

The most important thing for you to convey to venture investors is the potential of the problem you are solving and how large the market is that has that problem. You cannot produce a 20x return on $10M of investment if your market size is only $50M, but you can if your market size is $1B. If the venture investor can envision your company in 10 years operating at that scale, you will get their attention.

After you convince them that your problem/market is big enough, it is time to convince them that you can make that happen. It is very hard to convince anyone what will happen in 10 years, especially investors that hear similar things everyday, but there are some keys to doing it well:

  • Present a plan. Your plan might change, but you need to have a credible long-term plan for getting to the large outcome. If you can’t build a credible plan at the beginning, it’s unlikely you will be able to come up with a new one as the market changes. The plan you present will also serve to identify the key risk factors that your business will face as it grows.
  • Show you mean it. You have already been following your plan in building your business, so show off how well you have executed. Remember, your progress so far is not why they will invest in you, but your progress so far is proof that your plan is credible and that you can execute against plans you create.
  • Sell the team. 10 years is a long time. If your company is going to be very successful, it will be a long and difficult road. Your team is critical because it is those people who will steer the company through those hard times and the venture investor needs faith that you can do it. In the end they are investing in you.
  • Don’t play fair. If you really have found a big opportunity that can product 20x returns, it is likely that many others have as well. You need to show a distinct competitive advantage that will allow you to win when faced with dozens of competitors going after the same goal.

Hopefully, at this point you are starting to realize why many companies struggle to ever raise venture funding at all. It is great that you have 5 paying customers today, but can you convince an investor that you will get to 5,000? You have 2 brilliant developers writing code, but who is going to sell your product to Fortune 500 companies? You have a great plan and team, but without any customers how can you be sure your product will work in the market?

Time to Focus

The good news is that, assuming you’ve followed at least some of the advice on this blog, you have already built the foundation for a great company that can produce the kinds of returns that venture investors want. In order to successfully raise investment, you just need to make sure to present your company in the way the potential investors need to see it. Focusing on where you can go, and not on where you’ve been, will go a long way towards that goal.

Besides, after all the hard work you’ve put in, it’s fun to think about how successful you can be in 10 years.

Thanks to Leo and Beth for reading a draft of this post. Image copyright Graham Hogg and made available via Creative Commons.