When an entrepreneur takes investor money, they are expected to deliver on the plan and milestones they “sold” to investors during the fund-raising process. These expectation dynamics are covered in an earlier blog: http://onforb.es/25DBDfR
However, you will almost certainly need more capital in the future. The next investor also has a set of things they want to see proven out with the capital you previously raised. Unfortunately, these expectations aren’t always well communicated or understood. I find “what do we need to prove to the next investors” to be a frequent question in start-up board rooms.
In our Traction Gap model, you are usually trying to demonstrate that you have reached Minimum Viable Repeatability (MVR), or Minimal Viable Traction (MVT) depending on your stage at the last round. The first stage or “MVR” is usually reached on seed financing and is when a Series A is often raised. MVR is the minimal amount of progress from the seed round of funding that is compelling enough for a new investor to come to the table with more capital. There is enough repeatability in core company functions that an investor believes the team has the basics figured out, and the future can be roughly extrapolated.
Key areas new investors will focus on include:
- Planning and execution– The entrepreneur/team can make a plan, and execute it. It may sound obvious, but it’s surprising how many would-be entrepreneurs fail at this. There is a high correlation between start-up teams that consistently meet or exceed their plans, and successful venture returns. Many things will be looked at here: the product delivery plan, the hiring plan, and the sales or user adoption plan.
- Attract and build a team– No one can do it alone. Nothing has a bigger impact on eventual success than the quality of the team. Great teams produce great results. Great entrepreneurs build great teams. At the MVR stage, it will be more about showing a team with great multi-role players that are getting it done, than about an executive team built for the future.
- Deliver a minimal viable product (MVP)– The minimum viable product (MVP) is the very least thing the company can build and deliver that meets a real market need and creates demand at a viable price point. Note, in the case of web apps, the price point might be an extrapolation of what an advertiser or marketer might pay for the audience that is being created when it reaches scale. For an enterprise/B2B product, where early product versions are often discounted for early adopters, the “viable” price point may also be extrapolated to what early majority customers may be willing to pay after the product is more mature and much of the risk of adoption removed.
- User adoption/Sales execution– Investors will focus hardest on the level of repeatability demonstrated in user adoption or customer acquisition. Is there some rhyme and reason to “how” and “why” customers are acquired? The company should now know enough about a) who the target user or customer is; b) what an effective product positioning and sales pitch look like; c) what are the primary sales objections; and d) what causes churn, user abandonment or low engagement. The company should now be timed to hire real sales people (leveraging reference customers) or invest marketing $’s in user acquisition, and expect the investment to be at least marginally effective/efficient.
For investors, the most compelling metric will be rapid period over period (week, month, quarter) growth rates, as long as the customers or users meet some of the following criteria.
- Average ACV or ARPU– The size of the average transaction, usually measured in terms of “annual contract value” or “annual revenue per user”, tells an investor a lot about the viability of the chosen business model. In a SaaS company, for example, ACV (annual contract value) usually needs to be north of $75K to produce enough margin to fund the sales team. It will typically be much lower than that in a self-serve model. ARPU is less precise since it’s so dependent on customer acquisition cost (CAC), but as a data point, FaceBook’s North American ARPU at the end of last year was over $13.00/user. Investors will want to know not just what those metrics are today, but what the trend looks like. What do the trends suggest about long-term steady-state, and achieving a profitable business model?
- Revenue expansion/Engagement extension– For B2B, will the customer be buying more (more users, more apps or modules, etc.) and how often? For B2C, is the user engaging more frequently (or at least holding steady) and is there any evidence of a viral effect?
If the company has a land and expand business model, is there consistent proof that the “expand” part is taking place? How large have the initial purchases (land) been and the next follow-on purchase (expand)? How quickly does the customer come back for more, and how often? Because the data set is still lean leading up to MVR, it’s very common for investors to call customers, and ask them specifically about their expansion plans, and not just their satisfaction with the current state of the product. They will also delve into whether expansion is contingent on new features or other changes or improvements to the product.
Note, at MVR, CAC is probably still much higher than long-term projections, so it’s not a key diligence point; other than any declining trend is encouraging to investors. For B2C companies, the scrutiny may be higher even at this early stage.
- Stable churn– In most business models, keeping current customers is just as important as adding new customers. Approaching MVR, there won’t be a lot of churn data — much of any churn is concerning, especially for B2B companies. Expect potential investors to dig into the causes behind churn, who is churning, and how much the churned-out customers were contributing to revenue.
- Market size validation– Market size determines the ultimate value of the business being creating. Investors will look for signals in the previous metrics, to help them understand how large the market can be, and/or to validate your assessment of the market size. These clues can include types and distribution of customers (industry, size, etc.), initial, current and estimated future account value (percentage of account penetration) or LTV, etc.
At MVR, you have likely only penetrated one market segment, geography or user class. At this point, it’s more about proving you can successfully acquire target customers or users. If you can do it once, it’s reasonably likely you can do it again (but certainly not guaranteed). Initial forays into a new market area aren’t the worst idea, as long as it’s not at the expense of success in your primary focus area.
To sum up; there are early stage venture firms that will invest at MVR although less than in the past. Many VC’s are now only comfortable at the MVT stage or later, partly due to lack of early stage expertise, and partly because they often have to put larger sums of capital to work, which is easier to justify as the risks decrease and the valuations increase. If you nail the points above and prove you have reached MVR, you should be in a good position to raise capital.