I’ve spoken with 5 different early stage companies in the last week that all seemed to be making the same mistake IMHO:
- Trying to raise a serious seed or Series A round from VC’s,
- no customers / users,
- no revenue,
- and have not tried to pre-sell to target customers.
The discussion was nearly always the same:
- We have a business plan, and our revenue projections are conservative.
- We’re going to grow like crazy.
- You won’t believe what a great idea this is.
- We need to raise $200,000, $500,000, $2 million (pick a number) for ______.
Entrepreneur: Answer 5 out of 5 times: “0, 0 and $0.”
Let me give you a more specific example from this week.
Me: For what?
Entrepreneur: We basically have the product done and have bootstrapped until now. We need money for purchasing email lists, going to trade shows, travel, advertising, etc.
Me: How much are you looking to raise?
Entrepreneur: Small amount. Maybe $100,000 - $200,000.
Me: How many customers do you have today? How much revenue?
Entrepreneur: 0 and $0
Me: Wow, there must be a lot of unverified assumptions and risks in your financial model. Have you thought about some "baby steps" first to de-risk your model? If I said you have as a goal over the next 7 days to get 10 LOCAL customers in the Philly area (the company is based in Philly), do you think you could meet that goal without spending any cash on marketing?
Entrepreneur: Yes, I could do that.
Me: And would they all be paying customers? (I've learned to ask that question: people have different definitions of a "customer" which have varying levels of importance based on the revenue model.)
Entrepreneur: We could get 10 customers to sign up (sign up is free); probably 50% would start paying $1,000 each per month. (Note: Company revenue run rate = $5,000 per month. Also note, multiple assumptions being made here that could be vetted quickly, easily, and cheaply).
Me: Okay. I bet you could give those new customers a spiff of $100 if they refer someone else who signs up and starts paying. So, you’ll give them a $100 credit for your service and you would be happy to pay it as I’m guessing that your cost of customer acquisition is probably north of $300 and you would be happy to pay $100 all day long for referrals that turn into paying customers. (I wonder if the company modeled their viral coefficient?)
Entrepreneur: Absolutely we would do that! And I think we would get referrals. (Assumption, and I bet it's in their financial model).
Me: And if I asked you in 4 weeks from now do you think, just in the Philly area, you could have a total of 50 customers signed up (including a few referrals), and half of those companies would be paying customers? No email marketing. No travel. No trade shows. Just good old fashioned "drag a bag and go make some sales." (This is not the way to scale a company, but a way to de-risk, learn, and get started.)
Entrepreneur: Yes, I think that’s really doable. (Note: Company monthly revenue = 50 x 50% x $1,000 per month average purchase = $25,000 per month).
Me: I know you’ll learn a ton trying to get those customers on board. You’ll also learn a lot about the assumptions you have in your financial model. Now, if in 4 weeks, you can be at a run rate of $25,000 per month, why are you out trying to raise $100,000 - $200,000 now? How about this: Set measurable stretch goals for the next 1, 2, and 3 months. Get your revenue up to $50,000 - $100,000 per month (Note: $1.2 million annual revenue run rate), THEN go out and try to raise money. In 3 months go to investors and say, “I have a problem: I’m at an annualized run rate of $1.2 million, I just started selling 3 months ago and I have a solid gross margin of x%. My problem is that my lack of capital is limiting my ability to grab profitable market share and grow my business.”
Now when they go to meet with investors, they would end up having an entirely different conversation. It's still not a slam-dunk that they'll get outside funding, but their chances have gone up dramatically. Investors will see that they have greatly de-risked their model, have a lot less assumptions, and they’re off to the races.
We'll be spending a lot of time this summer working with the DreamIt Summer 2009 portfolio companies to roll out early versions of their products and get feedback as well as meet with customers, potential customers, and potential partners as early as possible. We'll help them make this happen in an accelerated time frame by leveraging our experience and connections.
The above may not fit your situation, but I urge you to try to think outside the box of how you can get to sales, product/service adoption, or potential customer feedback as quickly as possibly so you can learn the realities of the marketplace, and then look to raise funds. If you're a Web 2.0 company, maybe you'll do this by getting an early beta out onto the web, and attracting traffic via Google Adwords, Twitter, Facebook ads, blogging, PR, etc.
If you are building a new product or service that will be very capital intensive (e.g., a new hardware device, new type of robotics, new medical device, very large scale software application, etc.), then it will be hard to actually sell something to a customer without having cash up front to develop the product. If this is the case, meet with companies / potential partners to get their input and reactions to your ideas. Have meetings with companies that meet your target customer criteria and ask them the right questions to find out if they would buy your product, how much they would be willing to pay, the potential objections, etc. Check out my BarshBits blog post: When can I start speaking with potential customers? Take your learnings into your meetings with investors and you'll have a lot more credibility.
Now, not every company I meet with are like the ones described above. As a matter of fact, quite a few of the companies I know that tried to sell first and build revenue before raising outside cash: nearly 50% of them have gone on to raise outside money or are growing without it.
Entrepreneurs seem to think that when they have a new idea the first thing they need to do is put together a plan and go out and raise money. I’m a big believer that you should go out and try to sell, get adoption, or get marketplace feedback first, and then try to raise money.
It’s okay to “ask for the money.” Just TRY to start the “old fashioned way” by selling something to a customer or getting user adoption, rather than selling a vision and a set of assumption-riddled numbers to an investor. I think you’ll have more success with the former, and just pound your head against the wall with the latter.