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Blog

When Revenue Isn’t The Answer

Raju Rishi

So you’re an enterprise startup. You have a solid founding team, you’ve raised a Seed Round to tackle a particular problem in your target market, and you’ve built and launched an MVP. Everyone said you need at least a million dollars of ARR and a dozen customers to raise a bona fide Series A, so you’ve chased the dollar and you’ve gotten there.

But one thing went wrong. You became so focused on closing deals and winning customers that you missed finding real product/ market fit. Only after you raised your Series A did you realize that velocity does not equal repeatability when it comes to enterprise sales, and that the latter means far more than the former. Suddenly you’re not scaling as fast as you’d expected and modeled. Welcome to the world of a bridge round.

How and why does this happen? And how can you avoid it? Let’s go back. An enterprise startup raises a Seed Round, develops a product, and introduces an MVP into the market. The next step is to see if anyone will buy the product, so the team focuses on getting pilots and deals in place and — hopefully — signing up one or two big customers. It works, and suddenly the company can boast modest recurring revenue.

Even for seasoned entrepreneurs, this initial taste of success can be intoxicating. The product works, and a few clients are signed up. Money — for the first time — is flowing in and not just out, and a decent sales pipeline seems ample evidence of product/market fit. That’s the good news. At the same time, you begin to feel the weight of competition both real and imagined. Existing investors are pressuring you to think about the next round. Now, you’re sure, is the moment to move swiftly forward.

But here’s the catch: Closed deals and sales velocity are not exclusive measures of product/ market fit. Maybe, among your first customers, there are wide variations in the core use cases for the product. Maybe your team is struggling with lengthy sales cycles. Maybe you find yourself significantly altering your pitch for different target customers and creating multiple marketing messages along the way.

While these can be typical growing pains for many young companies, they are also indicators which — if occurring consistently — might foreshadow difficulties for enterprise startups. The simple fact is that product/ market fit is not always obvious. And just because you’ve closed deals doesn’t mean you’ve found it.

How do you know if you’ve achieved real, meaningful, and differentiated product/ market fit? Here are a few key questions to test your thesis:

1. Do you know, at a granular level, which potential customers you should target?

2. Who are the influencers? Who are the buyers? Where does their budget come from?

3. What marketing channels should you use to target those customers?

4. Do you have a simple and — most importantly — single marketing message?

5. Do you know what your sales process is, and is it an easy process?

6. Do you have a clearly defined product roadmap that’s aligned to your target market?

7. Can you hire junior sales reps, ramp them quickly, and have them close deals with consistent results?

Product/ market fit is ultimately about repeatability. If you understand who your customers are, what causes them to buy your product, and how to make your solution their number one priority, then you’ve found product/ market fit. But if you haven’t, you need to make some hard choices and keep searching. While it can be deflating to give up revenue or a Series A check, attempting to scale in the absence of product/ market fit can — and often does — debilitate promising companies.

It’s a cruel irony that while early customers and revenue often feel like the lifeblood of your business, these things might actually be killing you. It’s not ultimately about selling to customers; it’s about fundamentally understanding what core functionality causes customers to buy. Allowing a few early customers to determine the trajectory of your business or product offering in exchange for a quick buck is a Faustian bargain, and the devil always collects.

Too frequently, entrepreneurs and investors alike believe that the goal of a Seed Round is to get a startup to the Series A. It’s not. Seed Rounds are the only time in the lifecycle of a startup where you are allowed, expected, even encouraged to test your product in search of real product/ market fit. That’s the ultimate goal of a Seed Round, and a hallmark of great teams is the discipline to move deliberately in the face of distracting opportunity.

Achieving product/ market fit is the transformative moment in the life of a startup. It is the moment of metamorphosis, where a company aligns messaging, marketing, target customers, sales methodology, product roadmap, and operating metrics. This moment cannot be bypassed, faked, overlooked, or ignored. So be disciplined. Slow down. Don’t get caught up in the expectations of customers, investors, or yourselves. For in the absence of product market fit, more money will yield nothing but more problems.

 

Navigating the Hype

Cooper Zelnick

In the final days and weeks of 2015, the velocity of venture deal flow increased dramatically. Startups and VC firms alike sought to close deals before the arrival of the New Year; excitement around imminently closing rounds reached a near fever pitch and opportunities to invest in the hottest startups—it seemed—were quickly evaporating.
 
I was introduced to one such company in mid-December. The founders had already met with several top-tier VC firms. Many investors were apparently enthusiastic about the opportunity. If RRE wanted to get in on the deal, then we would have to act fast. This deal—I was told—would close before the end of the year.
 
As a first-year analyst, I got excited. What if I had found the next billion-dollar company? What if this was the one? Infected by the thrill of a fleeting opportunity, I nearly overlooked one critical question: Do I really believe in this company?
 
When the dust settled on that particular deal (the clock ran out on 2015, the round has yet to close) I was struck by how easily I had been swept up by a false sense of urgency. Why, I wondered, do popular deals seem better irrespective of actual quality? Why is it that when one firm commits to funding a company, the rest of the round is soon filled?
 
At first, I attributed this state of affairs to the phenomenon of FOMO (fear of missing out) and the fact that VC is an insular community which can be somewhat prone to groupthink. Investors see their peers—whose judgment they respect—participating in a round, and don’t want to be left behind. But when I discussed this question to fellow RRE analyst Jason Black, he gave a more nuanced answer, which led us to this statement:
 
@itsjasonblack: “In VC popularity means scarcity. Scarcity too often conflated with value.”
 
The first part is fairly obvious. Only so many investors can participate in a single round of financing. There’s limited space to begin with, and popularity implies commitments from VC firms and angels alike. The more popular a deal, the less perceived availability there is for additional investors. The more firm commitments to participate, the less actual space, making FOMO a legitimate concern.
 
The other side of the FOMO coin is the problem of groupthink. If a fear of missing out is the stick that drives some VCs ever faster along the road to funding companies, then groupthink is the carrot. All too often, investors hear that top-tier firms or renowned angels are already in a deal and assume that it must be great. Allowing others to drive their diligence process, and ultimately their decision-making process, even the best investors can be tempted to follow the herd.
 
But if FOMO and groupthink account for the first part of Jason’s statement, the second part is somewhat more puzzling. Of course, there exists plenty of historical precedent for conflating scarcity with value, so I’ll start there. Many works of art, for example, fall into both categories; take the paintings of Vincent Van Gogh. 

The artist only created about 900 paintings in his lifetime, and today they are near universally praised and valued for a variety of reasons. In fact, one sold at auction this past November for over fifty-four million dollars. But the thing is, the scarcity of Van Gogh’s paintings is a necessary yet insufficient condition for their sustained value. While these works are inherently scarce, they have proven to be desirable independent of scarcity. 

To illustrate the point, consider the works of another artist: Me. If I were to create 900 paintings, and then to announce that I would never again pick up a brush, it is highly unlikely that Sotheby’s would want to auction any of my works. It is even more unlikely that anyone would bid on them, and it is nearly unimaginable that a patron would pay fifty-four dollars for one, let alone fifty-four million. I am not an artist, and my paintings would likely not be aesthetically pleasing or desirable to art collectors no matter how scarce they became. 

That’s an obvious example. But many things—the works of Van Gogh, for example—have so long fallen into both categories that it is now easy to forget that they are scarce and valuable for two different reasons. To some degree, I believe that the same thing has happened to startups. Decently promising early-stage companies are inherently scarce, and over the past decades there have been many highly publicized examples of these companies becoming exceedingly valuable. Somewhere along the line, scarcity was indeed conflated with value.
 
The issue, clearly, is that just as all paintings are not Van Goghs, all companies are not Facebooks. And moreover, scarcity doesn’t always yield value to begin with. History’s most famous and successful startups have proven valuable not because they were scarce, but because they were actually valuable. That they were also competitive deals to access for investors is—at best—a side note.
 
When meeting with the prospective portfolio company, I became convinced that the deal was scarce, and I accepted as an article of faith that the company would become valuable. I fell into the trap of forgetting that there exists a wide—if at times unseen—chasm between scarcity and value. 
 
Especially for a green VC Analyst, that is necessarily an occupational hazard. I fell into a classic trap of venture investing (and probably caught a bit of FOMO too). Only later did I regain the necessary perspective to formulate an independent opinion. For a moment, I found myself overwhelmed by the excitement of a new company and a hot deal.
 
Despite the perils and pitfalls, getting swept up in the hype can be irresistibly fun. After all, maybe, just maybe, a deal is highly sought after because it’s the real thing. The trick, I’m starting to think, is refusing to get swept up in the moment’s zeitgeist without becoming cynical or losing your sense of excitement about what the future might bring. For me at least, finding the space between those extremes is what makes this industry so alluring.

Raising the Bar: Managing and Hiring Talent in any Startup

Maria Palma

We recently had the chance to catch up with Peter Platzer, CEO of Spire. Spire is building a space-based constellation of small satellites to gather data about activities on Earth.  By providing unique data from any point on Earth, every hour, Spire offers a competitive advantage for organizations that require insight into areas such as global trade, weather, shipping and supply chain, illegal fishing, and maritime domain awareness.

Peter is renowned for having built an incredible team and for fostering an environment where employees grow and thrive. Becoming a Spire employee is harder than many Ivy League admissions programs; only 1 in every 130 interviewees getting hired.  They have yet to fire anyone and have nearly doubled in the past year so their process is definitely working for them. 

Here are some of his takeaways for managing and hiring talent in any startup organization:

•    As a CEO, you should be spending 50% of your time on people.  Between hiring, coaching & mentoring, promotions and other people matters, this is where a majority of my time goes.  Since people are the scarcest and most important resource to building an incredible company, it’s time well spent.

•    Hiring process matters.  Putting in time upfront to make sure you have a good hiring process pays off in dividends.  It’s important to provide a positive and consistent experience with the firm that is also respectful of everyone’s time. At Spire, we respond quickly to candidates, use a very quantitative assessment tool, and provide robust feedback to each person, regardless of the outcome. This has actually lead to a number of referrals from people that did not get an offer, but left feeling inspired about the work that we do. 

•    Employees need to feel like they are making progress, which is not defined by titles, but responsibilities.  At Spire, we don’t have traditional titles, organizational charts, and performance reviews.  We make sure people are challenged and progressing, but they are there to do what they love, not seek a title.  We provide career coaching based on what each employee feels intrinsically motivated by and what they want to develop.  This model has really worked for us.

•    Your first talent hire should be a sourcing professional who loves to source.  If I were ever in the business of hiring a sheepherder, I would hire the type of herder who just loved doing that so much that if they didn’t have a flock of sheep, they would start herding whatever else they could find. Just as a physicist loves solving complex physics problems and a sheepherder loves herding, you will get good people if you hire a sourcing professional that loves finding great people. 

•    Don’t wait too long to find this person. We hired our first talent employee when our company was ~30 people and we could have done it earlier.  Even though we are still less than 100 employees, almost 10% of our staff is dedicated to talent.

•    Keep raising the hiring bar as you go. After your employees have been at the company for more than two years, they should feel like they would no longer make it through the interview process.  You want to be continually raising the bar as you grow.

•    Relocation expenses can be the easiest money you’ve ever spent.  Sometimes startups are worried about paying relocation expenses, especially at the earlier stages of a company.  If you are already at the point of making someone an offer and they have met all of your other criteria, it’s worth spending a few thousand dollars to help them relocate effectively, if that is important for them.  The sheer cost and time it takes to find and retain good talent makes this a negligible amount.

Peter Platzer, CEO of Spire

Peter Platzer, CEO of Spire

Series A Investing is Not a Market Driven Pursuit

Stuart Ellman

“Is your fund crashing?” is the question my mother will ask after seeing the front page of Wednesday’s New York Times.  “Dizzying Ride May be Ending for Startups” is the name of the article. DropBox and Snapchat have both been marked down by mutual funds. Square is going public at a price significantly below the last private round.  Every banker pitchbook now has a page showing how late stage venture valuations are dropping. So, how does this affect Series A investors? My answer: Not as much as you think. 

At first glance this contention may seem counterintuitive. Of course there is a certain frothiness when the late stage markets are riding high. Boundless enthusiasm infects the venture community at large, and people assume that we too are swept up in the hype. The reverse is true as well. Tremors shaking the public markets yields a certain amount of fear throughout the ecosystem. But the truth is this: Series A investing is not a market driven profession, and late-stage pricing fluctuation doesn’t change how we run our business or how our portfolio companies run theirs.

At RRE, we are primarily Series A investors, which means that we lead the rounds after the Seed Round (which is the first money in a company).  Series A funding is usually raised once the product or service starts to ramp and show initial traction.  Usually, the valuation range is between $20mm and $50mm and the amount raised is between $5mm and $15mm.  

This is different from late stage investing in many ways. But one difference is critical when thinking about valuation. Series A rounds are priced up from what the company has achieved since it started (ground up approach) whereas late stage rounds are priced at a discount to what could be in the market (top down approach).  Series A gets a richer valuation, up to a limit, based on the quality and background of the CEO, the amount of traction the product or service has been able to achieve with the seed money, and the market opportunity. 

Late stage is done in reverse. Companies are valued at a discount to where they would be priced in the public markets.  If a company is expected to trade at $3 billion, a late stage round might price at a 15% to 20% discount to account for risk and illiquidity. 

The implication of this is obvious. The share prices of publicly traded companies are variable. Tremendous price fluctuations are common even in stable markets. If late stage venture valuations are based upon constantly shifting public company share prices, then one would expect pricing for late stage venture deals to be highly variable as well. 

Consider Box and Dropbox.  If Box is the publicly traded competitor to Dropbox, then similar multiples must be applied to both.  If Box drops by 30%, it would only make sense that the same should apply to the late stage rounds for Dropbox.

But here’s the thing--this is not true for Series A valuations. While there is certainly some upward price pressure when the markets are very high, as well as downward pressure in times of economic turmoil, we never price a $1mm revenue company off of a discount from public markets.  First of all, there is almost never a publicly traded direct competitor to a Series A company.  But moreover, it would (and does) seem ridiculous when a company says, “even though we have almost no revenues, assume we have $200mm in revenues and price us like our publicly traded competitors.”  It simply wouldn’t make sense.

When I make late stage investment decisions, I pay close attention to public market comparables. But when I do my bread and butter Series A investing, I remind myself that the company I am funding is 5 to 8 years away from a public offering. Rather than worry about the headlines, I focus on what each company has achieved and on what it has the ability to achieve. 

So, Mom, my fund is not crashing.  My job, first and foremost, is to find great entrepreneurs building exceptional companies, to fund them, and to help them grow. If I get that right, the rest will take care of itself. Great companies will cash out when the markets are ready to receive them. And while share prices of publicly traded securities are constantly moving, there will always be market appetite for great new companies.