I just got back from SXSW 2019 in Austin TX early this morning and the experience provided me with yet another opportunity to reflect on how entrepreneurs view their businesses. It's funny because as an investor I'm always coaching entrepreneurs on how to "view the conversation from the other side of the table", and yet to be honest sometimes I forget to do that myself.
For 4 days straight we had back to back meetings with entrepreneurs in every tech industry imaginable and from all corners of the Globe. After the last conversation an important pattern jumped out at me that doesn't get talked about nearly enough, timing. Not just market timing, the importance of that has been talked about to death. I mean the timing of your business; an entrepreneur's ability to be very self aware and objective about what stage their business is at and what challenges lie ahead.
Unfortunately what triggered this revelation was the last meeting we had with a company I actually really liked and think has great potential. What's important to note is that they're about to close quite a nice size round at quite a high valuation cap and yet the company is essentially pre-revenue, has no clue what the best application is of their technology, and is dramatically underestimating how hard sales will be. The founders have mostly technical backgrounds and the one sales guy they have has primarily worked for much larger tech companies not startups. The combination of these factors means they have a very inflated idea of what stage the company is truly at.
I think the best signal for this was when we asked him about his plans after closing the current round. His answer was focused entirely on the tech development. He knew precisely what features he wanted to ad, bugs to fix, etc. but it was as if sales had not even crossed his mind.
So you'd be totally justified in asking, how then were they able to raise their current round? In the vast majority of cases, software startups can only ever get away with raising one round based purely on "the vision". This means you basically get one attempt at bat when you're pre-revenue and so the only thing investors have to go on is their confidence in the team and belief in potential size of the opportunity. After you raise that round the dynamic changes entirely to a traction based argument. If you don't hit certain KPI benchmarks or grow at the pace that's expected for the next round, you're in double trouble.
Here's why I'm so concerned about this company's view on their future. It's one thing when a company has some great tech and a competent team but still hasn't quite found any evidence of product-market fit yet. That's fine it just means they're early in the process. If however that company takes new investment, especially a large investment like a few million dollars, they're doubly at risk. Firstly all that money is going to mean the company will make new hires, new investments in their technology, etc. and dramatically increase their burn rate. They become more desperate for cash by the day. Second is that they need to hit certain benchmarks for KPIs (in particular revenue) and high growth rates within a short time period (12-18 months usually) in order to be in a strong position to raise their next round of funding at a favorable valuation. This second item is hard enough when you already know what your product is, who you're selling it to, and how to sell it. The pressure becomes much higher when you don't have a clear idea of any of those things. It forces you to run a lot of experiments very quickly, hope you find out those answers, and then spend the remainder of the money essentially playing catch-up on sales to try and meet those benchmarks before time is out and your bank account hits zero. The founders, not having experience in this situation, are therefore dramatically underestimating how hard it is to pull that off and perhaps how much they stand to loose if they don't and need to raise a down round.
So what's the moral of the story here? It shouldn't be embarrassing to simply be early in the process. That's not a jab at your abilities as an entrepreneur. How far along your company is, is just a simple fact. Every company starts from nothing before they become something. Being able to objectively see what stage your company is at is an incredible skill for an entrepreneur to master and one I have the utmost respect for when I come across an entrepreneur that has it. It means you are always looking for the objectively reality. It also means that you are always thinking two steps ahead and won't make the kinds of mistakes that will shoot you in the foot down the road.