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Summary:

The two most common mistakes startups make are spending too much money and not spending enough. VC David Skok, of Matrix Partners, explains how hard CEOs should press on the startup accelerator pedal when the company is trying to fit its product to the right market.

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As a VC and five-time entrepreneur, I frequently see two common mistakes being made by startups:

  1. Companies spend too much attempting to grow the business when it’s not ready for such growth; or
  2. Companies don’t spend enough money when the business is ready to scale.

It’s a CEO’s responsibility to decide when to hit the startup accelerator pedal. There are times when it makes sense to step on the gas and invest aggressively, but there also times when it’s smart to keep your company’s burn rate as low as possible.

Frequently, a startup CEO is new to the job and doesn’t have enough experience to understand what level of investment is appropriate at what time. Founder optimism makes them want to spend to grow the business as quickly as possible. The VCs on the board, whose role should be to help guide the fiscal decisions, often contribute to the problem, making the mistake of trying to spend their way out of problems like poor product/market fit or bad market timing.

To get the spending right, a CEO needs to understand the three different startup phases:

  1. Finding product/market fit
  2. Finding a scalable and repeatable sales model
  3. Scaling the business

A company’s behavior needs to be dramatically different in each phase. I’ll explain how and why in this three-part series.

The three critical phases of a startup.

What is product/market fit?

In the beginning, the entrepreneurs should be obsessively focused on finding a product/market fit, and conserving cash to allow them as much roadway as possible. Mark Andreessen describes product/market fit as “the only thing that matters,” but what is it?

Basically, a startup has product/market fit when it has:

  • A set of customers excited enough about your product to pay for it. Usually, that payment is cash, but sometimes it’s time. As Facebook, Twitter and Google have proven, if you can get enough customers spending time with your product, there’s usually a way to monetize it.
  • A customer base large enough to create a viable business.

Andreessen says:

[Y]ou can always feel product/market fit when it’s happening. The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers ….

You can always feel when product/market fit isn’t happening. The customers aren’t quite getting value out of the product, word of mouth isn’t spreading, usage isn’t growing that fast, press reviews are kind of ‘blah,’ the sales cycle takes too long, and lots of deals never close.

Lower your burn rate during the search for product/market fit

If your startup hasn’t reached product/market fit, you should obsessively focus on finding it and adjust your burn rate downwards to give yourself as much time as you need to get there.

The best way to find product/market fit is to get in front of customers and validate your assertions. Start early, and validate before you build anything. Use wireframes of the product to walk customers through your vision, then keep validating throughout product development.

Develop objective listening skills, and don’t get caught up in selling too hard. Often entrepreneurs only hear what they want to hear, a trait sometimes referred to as “happy ears.” When a customer disagrees, you’ll often hear these entrepreneurs say: “They just don’t get it.” This is a good indication the entrepreneur isn’t listening.

Also, ask yourself two questions about each of your assertions:

1. Is the problem you’re tackling important to the customer? Too often, companies chase problems that just aren’t important enough to spend money or time to solve. If the problem isn’t important enough, be prepared to drop the idea you’re currently working on and pivot to something different.

2. Do your solutions really solve the problem? Present the solution to the client, and ask them tougher questions such as:

  • “Is this a must-have, or a nice-to-have?”
  • “Would you commit to purchasing at this price if we build it?”
  • “Where does this fall on your list of priorities on which you’d spend money?”

At my fourth startup, Watermark Software, we got a great response when we showed our software to potential customers; our launch went well; and even the New York Times was excited enough to dedicate a half page to covering us. But while it was cool, it wasn’t a must-have, and we struggled to sell it. After two more years of hard work, we found the vertical applications that were a better fit for our product and pivoted the product into a full solution for those verticals. The business took off.

We wasted a ton of money in those two years. Had we done a better job of customer validation up front, we could have avoided that waste. I made the mistake of listening with “happy ears” instead of being objective.

Reduce your burn rate; increase your time

No one can predict how long it will take to find product/market fit. To give yourself the greatest chance of success, you need your funds to last as long as possible. In other words, you need to set your burn rate as low as possible.

The ideal startup team should be the founders, the product development team, and one or two sales people to get the founders in front of customers. That’s it. The founders are the people best suited to interacting with customers to figure out if the experiments are working and to learn from the failures. This work is the key job of the entrepreneur, and cannot easily be delegated to others.

It may also be tempting to hire a large R&D team to get to market quickly.Recognize that few products are immediately ready for broad adoption, and you’ll likely need to go through a few revisions to get to product/market fit. Set your burn rate for a marathon, not a sprint.

There can be exceptions to this spending rule when you can find things that will clearly shorten your time to product/market fit: for example, a new hire that brings in a missing but much-needed skill.

Once you have evidence of product/market fit, you can then find a repeatable and scalable sales model, which I’ll address in my next post.

David Skok has been a General Partner at Matrix Partners since 2001. He founded his first company when he was 22, and since then, founded three companies, including SilverStream Software, and done one turnaround. Skok specializes in SaaS, enterprise software and cloud computing, and blogs at forEntrepreneurs.com.

Image courtesy of Flickr user tonylanciabeta.

  1. I am very interested in how to scale. Can you also address scaling without VC money? I know it might sound crazy, but if you scale a business without VC for a while the valuations get much better. Every $1 million in sales creates anywhere between 2x and 20x in value.

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    1. Excellent point. There are two problems. One is not having the resources to put enough money or time into a project to get it to the point it is worthwhile enough to use. The other problem is not getting the type of team together that is required for success. We had the second issue at Bluestone in 1995, when Mel rejected VC offers, while our competitor NetDynamics took money and built a knowledgeable team. They leaped ahead of us in market perception even though our product was at least equal to theirs. We ended up taking money in 1996 at terms less favorable than the offers in 1995. Things then got righted, we brought in a good management team and were able to re-accelerate in that boom market.

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    2. Dan,

      Certain types of businesses can be scaled without needing VC money. There are two important attributes of this kind of business:

      1. They can develop the product for a very small amount of money. Given free Open Source software, and cloud computing that is becoming more and more common.

      2. They can acquire their customers without having to spend a lot of money. And what money they do have to spend is immediately recovered from the sale to the customer.

      Usually those are consumer internet web sites, and B2C businesses that have figured out how to sell their products or services without using a sales force.

      The problem that most companies run into is that as soon as they want to scale, they find that they need to invest money into marketing/sales which is not immediately recovered from sales to customers. That requires additional funding.

      If you are lucky enough to have a business that can be scaled in such a way that the money you make from customers pays for the scaling, then you will not need VC funding., or at least be in a position to delay it to get a better valuation.

      I do have more on this topic in a blog post on my web site called Startup Killer. I also am in the middle of writing a post that provides a spreadsheet for SaaS businesses allowing the founder to model exactly the scenarios raised by this question. Look for that to be published shortly.

      Best, David

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  2. Amazing and superb,well i am a common blogger and don’t know much about marketing and all but i must say that the product must be well market fit,at different situations the burn rate must be made sufficient that’s a big deal and that was the first point u mentioned which i noted.

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  3. Great text Skok. In that way, we don’t waste our time doing experimental sales that can lead to startup fails.

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  4. kudos …. best and most practical article ive read in a while here

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  5. Stage 1 Proof of Concept $0-$1million revenue
    Stage 2 Commercialization $1-3 million revenue
    Stage 3 Scaling $3-10 million
    Generalization but helpful

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  6. Big fan of your writings David, especially your post on Building a Sales and Marketing Machine.

    However, with this post, I feel the main points are similar to Steve Blanks 4 steps which he ought to be credited for.

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    1. Nai,

      See below for my full reply. A big part of the problem here is that I had originally written this as a single article, with the title :”How to set the Startup Accelerator Pedal”.

      I can easily see that a reader of just the first part, seeing the title it has, might not recognize the true intent of the entire article, which was to add to the writings of people like Steve Blank with another parallel topic.

      Best, David

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  7. This article is certainly right on. There was a point that my company was looking for the right market fit and we had to iterate consistently in order to find a scalable model. Now that we have found our stride, I’ll eagerly be looking for your next post to make sure we’re stepping on the gas.

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  8. It seems to me that you have been following Steve Blank and his entourage of Customer Development people. Actually, it more looks like you have experience doing Customer Development and you are just providing real world examples/applications, which is great. As a young aspiring entrepreneur myself, reading about other people using Customer Development is great. You have answered many questions I didn’t know I had. Someone asked about scaling without VC money, that’s something I’d like to know about more as well…

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  9. Great advice that can be applied to so many situations where you are trying to engage a customer. It gives me some things to consider myself. I look forward to your next post.
    Catherine

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  10. [...] require different approaches to spending. In my previous post, I talked about the first phase: finding  product/market fit. I described how entrepreneurs should have a laser-like focus on finding it, and why they should [...]

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