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The secret of success for startups: invest before taking the product to the market, double the rate AFTER

Original article on BusinessInsider.com
Dave mcclure

The secret of success for startups: invest before taking the product to the market, double the rate AFTER

I apologize ... the article turned out to be long (~ 2500 words). Not for the faint of heart. If you want an abbreviated version, read the following summary and 3 basic statements, then go straight to the conclusions at the end.
Summary: Venture funds are becoming smaller (this is good), the positions of angelic investors are strengthening (also good), but both need to become smarter and more innovative. The cost of startup startups has dropped significantly over the past 5-10 years, and online distribution channels through Search, Social Networks, Mobile Platforms (ie Google, Facebook, Apple) have become dominant. At the same time, the number of transactions for the purchase of companies has increased, but their size has decreased, as established companies now buy startups at earlier stages of their life cycle.

What does all of this mean? What prospects and pitfalls does this promise investors?

Let's start with the 2 initial observations of the current market for investors and for startups.

Statement # 1: Most Internet investors (angels, seed farms, big venture capitalists) have no idea what they are doing. With the exception of a few well-known companies, most large $ 150-250M funds will go bankrupt within the next 3-5 years ... and that’s good. However, small investors will have to adjust and somehow stand out against the background of others in order to make quality deals and survive.

Recently, some very smart guys talked about the relative [advantages / disadvantages] of [large / small] technology investors, especially about the changes and difficulties that venture capitalists have faced in the last 10 years. Due to the reduction in the required investment and the average amount of sales, it is now difficult to be a large investment fund (say, more than $ 250M) investing in consumer Internet. And, although I agree with the fact that the situation in the venture business is as described in the book about a way out of the crisis of one baseball team, such a conclusion would be too superficial ... and it misses more important things: the tendency for investors to specialize (or lack thereof) phased investment depending on the maturity of the product / market (I will tell you more about this later).

In my opinion, when investing in Internet start-ups, the size of the fund is not of paramount importance. I am deeply convinced that the $ 10M-100M seed funds are more manageable and better aligned with the interests of entrepreneurs than the “traditional” $ 250-500M + funds, but in the end, there will be only a few winners and a lot of losers at both ends of the spectrum. Most likely, there will be more losers among large funds than among small ones, but there are still a lot of factors that can affect success or failure.

No, the main problem is that investors have become incredibly lazy and complacent over the past two decades, if you look at their activity and IRR. Recently, the consumer Internet has brought with it a flurry of technological and behavioral changes that have led to a stunning reduction in the time and money requirements for distributing goods and services among 2-3 billion web users.

Let's look at all this in more detail:

The Internet has changed the lives of billions of people on the planet very significantly - at the same time, most investors and lawyers enter into transactions by fax and via regular mail.

To hell. This. Noise.

Most investors working with consumer Internet do not even know what they are doing. They are unsuccessfully chasing the indicator IRR, but most of them would be worth to stop and not to shame ... RIGHT NOW. Their principles of investing are dubious, knowledge of the subject area is limited or completely absent, and their desire and ability to create innovations is minimal. They just mow coupons.

Well, ATTENTION, OLD FASHION TRADERS - you, Lord Venture Capitalists 1.0, are on the verge of DESTROYING ... and you are waiting for Schumpeterian share that you have long deserved.

So it is: the majority of investors are Dinosaurs, and the World Wide Web is the Asteroid that fell on the planet, which caused a huge explosion 15 years ago. It will take another 5 years for ash clouds, the nuclear winter of browsers, search engines, social networks and mobile devices to finish off tyrannosaurs, but this is already inevitable. Summits begin to dominate and by 2015 there will be much more investors, such as Jeff Claviere, First Round Capital, Y-Combinator, TechStars, Betaworks, Founder Collective than Sand Hill VC (there’s funny, it turns out that all innovators are outside the Valley, is not it?).

And now let's consider the changes that have occurred and how you can adapt to them and become a Modest Investor 2.0:

Claim # 2: There is a great opportunity to create $ 1-5M profit-oriented Internet startups that would a) become commercially viable, b) predictably attract customers through online channels (search, social networks, mobile platforms), and c) would be sold for $ 25- $ 250M.

Historically, Venture Capital is associated with large, risky, capital-intensive investments in order to achieve two main, often expensive, goals:
Create Product.
Attract Customers.
Now, in the past, the PRODUCT means the creation of many expensive things (a lot of hardware, disks, workstations, boxed software, chips, network equipment, browsers, search engines, social networks, etc.) with the involvement of a large number of people for many years. I mean 50-100 + people creating nonsense, which does not bring profit for a long time. There will be a lot of trouble and expenses before you get the first client.

And in order to further aggravate, many start-ups that have received venture capital investments target CUSTOMERS among large technology corporations or government institutions with long-term sales cycles that require expensive, direct, dedicated sales managers ... which also requires a lot of time and money. Our massive sales and marketing campaigns are conducted using expensive print, radio and TV media. The sales cycle is annual, requiring constant action to achieve quarterly or annual goals by obtaining revenue from licensing, support, upgrades.

Finally, many of these companies were created to enter the stock exchange after many years of work and several rounds of investment, after which the entrepreneur’s share in the business remained negligible (often a few percent), and the expected amounts of sales were huge, hundreds of millions, if not billions. dollars.

Going back in 2010, let's take a look at these basics through the prism of Internet startups:
PRODUCT now basically means a website or service that runs on cheap / free open source software, hosted in the cloud or on cheap servers, developed in a few months (or on OUTLETS!) By a small group of 1-5 developers who are constantly testing and improving it in real time with working users
Market / Marketing now often means using a variety of online distribution channels through paid / regular search (SEM / SEO) on Google, viral / social advertising in new media and social networks like Facebook, Twitter and YouTube, as well as the fast-growing market for Apple mobile platforms. iPhone and Google Android. With the exception of search, most of these channels did not exist 5 years ago, while at the same time their audience now reaches 100M-500M + users with inexpensive and measurable marketing campaigns that allow even a small team to reach billions of people.
INCOME can now be easily obtained through a variety of online payment systems, transaction systems, virtual goods, subscriptions, contact generation, CPM / CPC / CPA advertising. Many people now buy goods online, and many companies are bought only for the user base, regardless of profitability. In other words, Guys are starting to get paid! Cash! It's good!
To summarize: the product development cycle has become shorter, the necessary materials and resources are cheap or free, the development teams are smaller, and new services and their combinations are created on top of existing ones that are already incredibly useful in the cloud thanks to their functions, data, network effects, and program interfaces. MARKETING costs are now lower thanks to a variety of widely available, cheap online distribution channels that can be used more transparently and predictably than ever. High-speed channels at home allow video and other rich content to be used by anyone with cable or satellite TV in their homes. INCOME can be obtained simply and reliably through direct business models and online payment systems that are becoming mainstream around the world ... such as mobile payments, even in the most remote countries with a low level of economic development.

Finally, when more and more technology and Internet companies become profitable, they, in turn, turn into potential buyers for startups with innovative technologies, necessary products and services. Using their larger customer base to increase sales, they can buy smaller companies that are looking for a cheaper way to new customers. However, as an increasing number of such companies grow and compete for the right to be bought, more and more startups are bought earlier and for less money than if they had grown to the size needed for an IPO. Since not even technology companies seek to buy innovation and experience in online services, there is a growing trend towards a large number of smaller and smaller business sales.

Okay, this is all a fortune telling about the future in the coffee grounds, but let's look at the basics and best approaches to investing in consumer Internet startups.

Claim # 3: The process of investing in startups can be divided into 3 specific phases with clear objectives and results:
PRODUCT = finding the client's problem and its solution (minimally viable), usability / usability
MARKET = assessment of market size, campaign testing, customer acquisition costs and conversion
INCOME = increase in revenue and / or market share, optimization for profit.
In many respects this concerns the use of Customer Development (Steve Blank) and The Lean Startup (Eric Ries) techniques for investing, in particular, how to research, improve and determine market acceptance of the product (Sean Ellis, Marc Andreesen), in other words “CLUTCH”, to and after investing.

This is, in fact, the basis of my investment principles: Invest before the product is accepted by the market, measure / test, does the team manage to achieve it, and if so, use their opportunity to proportionally invest in the project at the next stage AFTER successful market launch. This is similar to the game of blackjack: you make low bets at the beginning of the game, and by the middle of the deck, when you see that you have good cards in your hands, you start to increase bets.

Let's face it - most venture capitalists are sheep. They like to play unfair. We want to be sure that there are already customers, incomes, and also an exclusive thing, called CLUTCH. Unfortunately, it is obvious that if you already have clients, income and CLUTCH, then there will be a lot of investors in the trough, the struggle for the right to invest will be tough, and the price will be high.

So how do you invest small amounts, and then know when to continue and invest more?

It's not that hard, I'm serious.

INVEST EARLY and SMALL SUM in people you think are smart, who have created promising products. Find out if they know how to improve, get feedback to improve the product or promote it. Learn how to measure conversion for their business and the value of a single customer. Then, IF you see that metrics are improving, and the value of the customer base / business is growing ... then INCREASE THE BETTING.

Be that as it may, this happens in 3 specific steps:
PRODUCT: Find a [large enough] consumer segment with a significant problem / urgent need for something and develop a functional solution for them (Minimally Viable Product - MVP). I call this stage ACTIVATION. You should also make sure that using your product is exciting enough to do it again (HOLD).
MARKET: Try scalable distribution channels that will allow you to attract a large number of customers for money less than what you earn (ideally, <20-50% of annual income, so that some reserve remains). You can also go back to point 1 to review something, or check out completely different marketing campaigns and scaling concepts. If you are lucky, you may find a way to get users to talk about you, spreading information more and more.
INCOME: let's hope your MVP is already significant enough that people will be ready to pay for it more than nothing. Regardless, the goal is to test and optimize product / marketing combinations for generating a positive cash flow when scaling over short periods of time (or long if you have a source of funding). I prefer simple business models, for example, transactional models and e-commerce, subscription, partner models.
Ideally, if you have the opportunity to invest in a finished product AFTER the entrepreneur forced him to work, but sometimes they have not had time to do it, and often they still have to turn around to find an interesting segment that allows them to scale and make a profit. Anyway, I believe that entrepreneurs who understand their customers are able to create a minimally viable product in 3-6 months and <$ 100K. Sometimes it takes more time and money, but basically the way it is. If it seems to you that entrepreneurs are coping, increase the rates.

Next, you need to be able to improve the convenience for users and their retention, to make them love your product even more. If you can do it well, your customers will replace your marketing department with a low price. Even if you fail to achieve wide publicity, you still reduce the cost of attracting customers at the expense of the social multiplier. Regardless of this, you need to find a certain scalable distribution channel, which subsequently could have brought a positive cash flow. Let's hope that it will cost no more than $ 1-2M and will require less than 6-12 months. But all these costs should be directed to MARKETING channels and hypothesis testing, and not to improve the product ... you can adjust to finding new uses, but NOT adding new features. In fact, you should want to remove them (read, KILL FUNCTION). If you have scalable distribution, even without self-sufficiency, increase the rates.

Finally, if you already have a finished product (I hope, A PERFECT product with good activation / retention / recommendation rates) and you have ideas about scalable distribution channels that will lead to non-zero-income events (or intermediate events, for example, long-term use, effective partnering behavior, promotional CPM / CPC / CPA), then you need to tune in to make a profit in the foreseeable period of time that you can finance. This period can be very costly for many businesses, but I prefer to think that $ 1-5M and 1-2 years will be enough for my startups. Again, if everything goes to what you can do, raise the stakes.

To summarize, you need to think about the following steps to reduce risk and create company value:
Product: $ 0-100K, 3-6 months to develop a minimally viable product, at least for a few customers. Achieve a small market match.
Market: $ 100K- $ 2M, 6-12 months for checking marketing and distribution channels, understanding the scalability and cost of attracting customers, conversion to some events with non-zero income. Achieve significant market match.
Income: $ 1-5M, 6-24 months to optimize product compliance with market needs to achieve a positive cash flow.
I will have to edit this text a little bit, since I wrote it in a hurry to return to other projects as soon as possible, but I think I expressed here most of what I wanted to say at this point.

I would be grateful for the feedback and comments on everything that seems nonsense, can be corrected or simplified.

Translated for blog dennydov.blogspot.com
Konstantin Medvedenko

Permission is granted to copy this material with an indication of the hyperlink to the source: http://dennydov.blogspot.com/

Source: https://habr.com/ru/post/101226/

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