February was the month that venture capitalists and those who track investments started talking about what I have heard referred to as a “voluntary correction” in the startup investment market.
- First came Resetting of the Startup Industry by Mark Suster.
- Then some gentle nudging from Brad Feld.
- And then Danielle Morrill of Mattermark just came out with it in Surviving Whatever Comes Next.
There is plenty of financial and market complexity that these smarter folks are talking about, but here are two (+ 1) simple concepts at the heart of it.
- Valuations have gotten out of control, creating a short term founders market on funding.
- IPOs have loss their glossy appeal over the last year and many companies are electing to stay private as long as possible (only 24 tech IPOs in 2015 down from 55 in 2014).
Equity is only worth what someone else is willing to pay you for it.
As a private company, equity is worth whatever valuation the last person invested at and if they want their value to go up, someone else will have to pay more. But stock truly only has value if you can get rid of it, typically via a purchase of the company or a public offering. In the absence of one of these two events, the pile of money is what the founder(s) have and a pile of paper is what the investors have.
This dynamic illuminates a third factor — companies with positive net income at IPO are at a low that hasn’t been seen since 2000 (incidentally, the last time investors gave piles of cash to twenty-somethings with no business model).
Percentage of tech IPOs with profits at time of offering. Spot anything familiar? pic.twitter.com/XUp7YDyvN6— DHH (@dhh) February 27, 2016
Giant valuations for companies with lots of users but no proven ability to turn that into revenue helps to create second factor of delaying IPOs. Wouldn’t you rather hang on to the cash and valuation instead of going into a public market where you are liable to get slammed by the real world for not having any revenue?
So the VC community is seemingly pulling back — revaluing, talking about “down rounds” where companies are raising money for less than their previous valuation and orchestrating “private IPOs” to continue to grow valuations without having to worry about what the public thinks.
All of this is a warning to founders disguised as friendly advice from an older sibling, but it could be read as, “You want to hold all that cash? You better hope you don’t burn through it all.”
Danielle didn’t mince words in her post to founders — “live to see another day” — fill the coffers (if you can), slim down and focus everything on figuring out how to build a business.
He who raises the most money doesn’t win, the winner is the one who provides the most value to their customers, gets them to pay an equitable price and generates enough money to evolve and grow in order to continue to increase value to those customers.
Customers > Investors
Somewhere along the way we began to value users as much or more as we value customers. Customers pay you, users are exactly what they sound like, people who are taking without giving in return.
In the history of business, there has never been an unsubsidized, profitable business model where people don’t pay for the value you are providing (though recently someone tried to convince me that it could be the business model of the future). Whether someone is selling goats or software, if they are giving them away, eventually the cost to create and maintain will drive them out of business.
At some point, to survive, you will need customers and you will need them more than investors.
This should be your mantra no matter what stage you are—forget the big teams, growth hackers, beer lunches and big offices. Customers are the most awesome perk of any business.
I met recently with a company that had a meeting with an angel group that despite being impressed by their app (which is currently free) told them to come back when they had 10,000 users (overlooking that over half of their users use the app daily and 75% continue to use it daily after a month).
I had advised the founders to start charging for the app after a free trial, but the conversation with the angels they have met with left them conflicted — if they start charging, the user base will likely shrink, making it harder to get to the volume of users that the investors were looking for.
On the one hand this is correct, however, a free app with 10,000 users only increases a company’s capital needs. Even if investment comes through at that point, the business would be burning through it while it tried to figure out how to build a business. On the other hand, with customers paying you monthly for your service you have some fertile seeds to create an actual business.
I would much rather have a relative few paying customers than a lot of freeloaders and some investors.
Sales > Investment
I know it is fashionable to go after free users, run experiments and collect data, which you use to run more experiments, but the reality is any data set (no matter how large) is still anecdotal until you start to charge for your product or service. Sure, you can get a feel for whether people think your product is useful and usable, but the relationship and response change instantly when someone has their dollars on the line and no amount of simulation can account for that. Additionally, your own attitude will change when you let people pay you, your sense of responsibility to them recalibrates and suddenly things like bugs, customer service and communication take on a whole new meaning.
As a bonus, every paying customer, whether it is $5 or $5000 will make you feel like you hit the jackpot.
Collectively, we’ve been using the word growth in place of sales, but just as users are not necessarily customers, growth is a metric that can be tied to all kinds of data points, while sales correlates directly with a transaction. If you are primarily occupied with users than you are talking growth. If you want customers, you talk sales.
There is a subconscious fallacy in the entrepreneurial mind that getting investment is somehow easier than generating sales. Early stage entrepreneurs always want to talk about slide decks and setting up meetings with angels and VCs but rarely want to talk about sales sheets and sales calls. The truth is sales is a quantifiable game based on percentages. If you make 100 sales calls, some percentage of those will listen and lead to a purchase. If you get 10 people out of 100 and you want 100 new customers this week, you know you need to make 10000 calls. This applies to eyeballs and clicks as well — if you know 3 out of every 100 visitors to the site convert and you want 1000 customers, you have to drive 34,000 people to your door.
If the conversion rate of calls or clicks seem low (or lower than you want), you either need a better script (or ad copy) or a more qualified group of customers to reach, both of which are easy to iterate on until you find something that works.
Get out there and hustle
The entrepreneurial disease is “it isn’t done yet”, endlessly delaying the time when they are willing to “launch” and allow people to pay them. The truth is you can start selling from day zero. You can’t sit down and generate investment, but you can sit down and find one (or more) customers, every day.
If you have a service you plan to offer find at least one person willing to pay you to do it and then figure out how to offer it to them as you go — spreadsheets, emails, PDFs, surveys and a thousand other tools (most of them free) can help you do anything might offer. If you do it well, it won’t matter that you aren’t providing a logged-in experience with dashboards and algorithms. This applies to software development as well, hack APIs, build the minimal interface and do as much as you can on the backside where no one can see it.
If you are manufacturing a product the barriers to entry these days are ridiculously low. Put together a compelling crowdfunding campaign and presell your way to production or pull together off-the-shelf components and combine them into prototypes to sell. You can manufacture nearly anything into a prototype for an investment of a few thousand dollars (cheaper than a WordPress consultant), which you can take around to potential customers selling them on the vision, while promising a near-future delivery date.
A guy I helped create an eco-friendly materials company (which we took public) had previously taken a cobbled together prototype red-dot laser, along with a AA battery and a ziplock bag, meeting with all of the major gun manufacturers, demoing what we now know as a laser pointer. He went home with hundreds of thousands of dollars in purchase orders which he leveraged to create a factory where he would manufacture and sell millions of laser pointers. Within a year, he took that company public and sold it off a couple of years later.
If you have something of value to sell and want to build a real business, get the idea of the perfect product out of your mind, get creative and go out to sell what you have today.
The irony is investment becomes increasingly easier to come by the more success you have, and at that point you are positioned to leverage investment dollars for what they are truly good for, exponential growth and market acquisition. Or, you might find that you have the profit to achieve your dreams and the freedom to pursue them.