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I have recently met with a variety of startups that have business models that are entirely dependant on hyper user acquisition, activation, and retention. Dave Mcclure’s Pirate Math (AARRR) remains the text book to follow http://500hats.typepad.com/500blogs/2007/09/startup-metrics.html. In these discussions I was drawn into a discussion about valuation, which turned into an email I have paraphrased below for your feedback.

First a qualifier, I don’t imagine I am the best person to discuss valuation from any angle. In my role making funding decisions, I am lucky to not have to price rounds, so valuation isn’t something I have done professionally. Similar on the pricing (revenue) side (solution value) to the market, my experience is all value (ROI) or market based (competitive) pricing in enterprise B2B, so not well aligned to the B2C startups.

To give you my 2cents, my view is that all the companies I encounter that work on user dependant models are way to early to have any concern about valuation. On the pricing front, most are not even ready to start testing, as they need to build a value proposition that is coherent. Note a problem – solution statement and a value proposition are very different though related things. Those that have a value prop and a MVP should be running pricing experiments at as high a volume as possible; inability to do so illuminates other issues (CAC & Value).

My experience with companies that are pre-funding and typically pre-revenue is that there is nothing to price in order to derive a valuation. In the seed round my view is to do a convertible note. The only logical pricing mechanism at this early phase is the value of the team’s time. Two founders who could reasonably earn $100k/ year each working for the man have a company that is worth no more than $200k pre-traction (NPV). Generally speaking investors set the price, the only say the entrepreneur has is their ability to create a market for the equity and negotiate a deal. Your company, in the early stages, is only worth what someone is willing to pay.

Most teams do not have anywhere near enough evidence to establish comps for their valuation. This makes hunting for investment a very dangerous use of time. Money goes to teams with traction, spend nearly all your energy on activity that demonstrates traction (signups, downloads, revenue, etc). Investors will not make your business work, customers will.

Here is an easy example to think about B2C valuation. A Facebook user is worth $100 (roughly) and provides the peak market comparable for every other Ad driven social consumer platform in the market. Every other company with a similar business model has a user value less than $100 per account and the drop of is extremely steep. FB has dominant market position, continued up and to the right growth, proven revenue, extreme stickiness etc. Tomorrow’s hot startup only has user acquisition on its side with no sustained track record of activating, retaining and converting those users to VALUE. Pre-value users occur at a negative run-rate (basic costs of the business, dev ops, and user acquisition costs). The amount of traction to overcome the disadvantage is huge, and to my knowledge no one in Canada has pulled anything like that off (Wattpad is working on it).

This is driving 10m users as the benchmark for a startup to become a candidate for a priced round (see http://cdixon.org/2012/08/03/ten-million-is-the-new-one-million/). If you can get that many users without spending a tonne of money you likely have some foundational value to build on. Before that you are pissing in the wind trying to raise money IMHO. Metrics change based on models but the mountain is just as daunting if you are SaaS b2b etc. The reason i dislike user models so much is that I don’t believe Canada has any sherpas that have been up that mountain, we have plenty of folks who have climbed b2b peaks.

This rant has come out of on going discussions about Canada’s accelerators and their propensity towards B2C startups. Generally speaking; asking for investment is a waste of time on Demo Day. The only route to funding is through traction. I want to see these companies make asks that drive against traction milestones, ie help the startup get on a growth curve to 10 million users. Make asks against milestones ❤ months out from demo day, ones that generate momentum and move the needle on the key performance metrics of the model. “SIGN UP for the APP now! please;) but seriously the bar will not open until you have downloaded the app”. Boom 300 users at zero hard cost, not a bad 30 minutes.

Part of the challenge is the accelerators are serving a segment of entrepreneurs that are drawn to b2c, but that is another post. What I want to see is better understanding & demonstration of growth hacking and better asks from b2c founders, because cash ain’t it.

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Much time is spent bemoaning the lack of aggression from early stage capital sources. Most of this energy is misplaced in my opinion. The real chasm companies struggle to leap, is to Enterprise Scale Solutions. Solutions that solve problems the Executive Suite of Blue Chip (F2000) companies truly care about and therefore will purchase. Many of the technology products and services consumed by Enterprise clients from SME (including startups) providers are isolated in what I will call Pilots or Islands.

These pilots or islands can be relatively large and long lasting, several millions dollars, run over several years, and touch thousands of users. I term these projects or deployments as pilots/islands because they do not register as strategic to the overall organization. Few if any other systems or processes depend on them and the relative switching (including straight deletion of the process) costs are low. Your core users inside the enterprise may scream bloody murder when you are displaced or turned off, but the overall strategy from the true decision makers will move forward with change regardless in order to achieve the broader more core goals of the company. Microsoft, Oracle, SAP, etc. are entrenched and scaled because their solutions deliver core value to the overall organization, replacing their solutions will have cascading effects that override the potential benefits of switching.

Winning Pilots is often a Series A funding trigger for enterprise software ventures. When it is not, its typically as reflection of a few things: the pilot customer does not reflect the ideal target, it is not a scalable implementation of the solution, the pilot is, has, or will not generate enough evidence to represent sufficient traction, etc.. This process, in my experience, is very similar within F500 organizations as they explore new offers and markets (funding from HQ vs. VC). The next major challenge, and often the project companies get stuck in, is post a successful pilot.

Transitioning from successful pilot to a repeatable and sustainable growth process is a Chasm a large number of companies find themselves trapped in. This chasm is not just trafficked by startups, I would wager the majority of teams in this stalled growth phase are SMEs. $5 – 50m annual revenue 10 – 300 employees, 10 – 100 customers, mix of professional services and product based revenue, 5 – 35% EBITDA.   In other words, a lifestyle business. Lifestyle businesses are awesome, if that is you and your stakeholders’ desired outcome. If you took outside money that has any notion of your business being a venture company, being a lifestyle business is painful. Wanting to grow the business for the sake of growth while in this phase is also fraught with risk for the owners personally and the business.

This chasm is the ideal conditions for Founderitis to run rampant and symptoms to metastasize. Startup founders focus on the positive evidence, ‘we have customers, revenue, etc.’; SME CEOs focus on the risk, ‘we are making money, we are comfortable’. Anyone who dares label themselves an entrepreneur has a dose of Founderitis. The question is how you harness the syndrome to the best benefit of the company.  In the Successful Pilot / Isolated Solution to Scalable Growth transition Founderitis constricts the vision of the key leaders limiting their ability to absorb and act on opportunity or required change. Optionality becomes so constrained that the business loses its momentum and dynamism, stagnating into the ‘lifestyle’ chasm.

If your company is not activating new revenue in a consistent, predictable process you are in the Chasm. If you sell a solution to a decent size market that drives a top or bottom line outcome for you customers; you should be able to forecast revenue growth with decent accuracy. A software startup that has exited the Pilot Chasm and has hit the Growth Curve should be generating better than 100% CARGR. The tactical ins and outs of individual sales cycles should only impact the velocity and amplitude of the growth curve, no individual deal should be able to knock it off the up and to the right shape. SME growth companies should be able to account for churn in the sales team and maintain predictable revenue results. Sales have become an engineered process, the sequence of inputs and outputs are known.

Yikes, we are in a Chasm; what the heck do we do? Confession, our Startup is in the Pilot Chasm, right now, scarier we maybe on an Island. I don’t have enough evidence on whether or not we are on island or not yet, so I am going to focus on the ‘known’ that we are in a Pilot Chasm. Like all problems, acknowledgement is the first step, take stock of the current state. Focus on evidence, categorizing Known Facts, Known Unknowns, Solid Assumptions, Weak Assumptions that require data, and your Current Progress Against Targets. Second step, given the evidence what trajectory are we on, does that trajectory and our current velocity propel us out of the chasm?

You need to run diagnostics on the state and severity of your Founderitis, right here, right now, especially if the evidence is showing you are not going to make it over the crest. If you are not on the roadmap you set to get out of the chasm, the leadership team has hard decisions to make. Founderitis is triggered by hard decisions. 

Our Startup is on course, we have mapped out rocks and potholes between us and the crest of the chasm. We have a partner at the top that we are roped to adding traction, we have enough capital to provide fuel, we have added talent to increase force, we have stripped off some unnecessary components to reduce drag, there are enough pilots & pipeline in process to absorb some bumps, focusing on keeping the engine turning is the core focus. Execution will keep the engine running. Three months closing on current opportunities and active pilots and we are up and out of the chasm.

There are still lots of risk. We have burned lots of fuel and have stripped off a number of the safety features; if our partner cuts the rope we will overheat the engine and stall.  The roadmap we have drawn is working, we need to keep our heads up for unknown unknowns and execute on keeping the engine running.

The question I worry about is what we will look like on the plateau above us? Will we come over the top and find ourselves on an island? For us this would be total dependency on our partner for revenue. There is also a good chance we will drive right into another Pilot Chasm in order to prove our engine is a standalone solution and not just a feature or our partners’. Good news is that we have a solid assumption that we will earn another round of funding once we exit the Chasm, thus giving us the ability to prepare a boat (to get off the island) or for another uphill climb (out of the chasm).

The key outcome of the process will be that we will have proven our revenue engine works. From there we will need to engineer a repeatable revenue generation process based on the proven use case. If we cannot repeatedly generate revenue on the product, we will have to take stock and iterate the vehicle for another rough and tumble ride through the Pilot Chasm.

The key takeaways:

1. Know where you are and where you are going, they call it a roadmap for a reason

2. Pilots are experiments to determine how your revenue engine should operate; they are not your business model

3. If you are not predictably generating new revenue you are stuck, Assess, Analyze, Act

 

“Real glory is being knocked to your knees and then coming back. That’s real glory.” Vince Lombardi

First, pursue your dream, your passion, your goals no matter what. The advise given to all, which usually generates focus and conversation on the potential positive outcomes, the ‘I gonna build an amazing product, and awesome company’ moment. This post is not about that. This post is about the near soul destroying assault that being an entrepreneur is going to launch on your self-worth.

The best startup mentors, advisers, gurus, typically at least acknowledge that building a business is ‘wicked hard’; however, I think there is little attention to the sources and nature of the hard. Yes raising capital, hiring talent, building culture, selling your solution, etc are really, really hard, but there is no lack of good insight and direction on those Rational, Tacit, Process problems. I believe the real hard, the real barrier to success, the stuff that keeps entrepreneurs up at night, is the emotional challenges that happen in the dips in your startup roller-coaster ride. I don’t think we spend enough time as a community helping each other cope with the unique life event that building a company is.

Starting, building, and growing a business is an immersive experience, it becomes the core of your life. When the business is not going well, you are not going well. This affects every other aspect of your life. We (the Startup Community) readily endorse, training, coaching, mentorship, etc to assist each other with the rigors of the day to day of a startup, including taking care of your health through, diet, exercise, family time, down time, etc. I don’t think we talk enough about the emotional work that it takes to empower the success of you and your business.

Here is some stark reality for aspiring entrepreneur. Getting money, whether it be revenue, investment, grants, etc, into your startup will take twice as long as your conservative estimate. Unless you have serious credentials (you had a SR Exec job at a big time company, you did something amazing at an amazing company, you were a key player in a previous successful startup, you achieved an exit as a founder) no one other than friends, family, and fools (the FFF round) will fund your business plan. First timers and the unproven must achieve traction prior to getting investment, traction should first be interpreted as steady MoM revenue growth, second MoM user growth, third you have built an AMAZING prototype. Please do not plan on being the exception to these rules. Yes this produces a catch22, this is the dip, the chasm, the obstacle between you and success.

These periods are IMHO what it really is to be an entrepreneur, and the difference between success and failure here is intensely dependent on your emotional talents. How do you stay confident, fully engaged, calm, cool, and collected in the 1 step forward 2 steps backwards loop? You are 30 days from bankrupt, your friends & family are anxious, your life-partner is stressed, your co-founder is off the rails, your team are looking for jobs, the ship is sinking. Successful entrepreneurs find a way to survive.

Breaking through to the next phase doesn’t happen because the anchor client finally signed, your user acquisition hit a tipping point, you got featured on TechCrunch; it happened because you persevered the emotional turmoil of the period prior to those outcomes enough to do the work that allow those things to happen. Failure to execute is rarely due to a lack of know how (plenty of blogs, books, and people), or skills (possible, but where there is a will there is a way), the failure happens inside you, the Will gives out. You need to train, plan, and actively manage your emotional well being as well as be engaged helping your team do so as well; that my friends is HARD.

Watch http://thisweekin.com/thisweekin-startups/ episode #161 at the very end, after an amazing chat about the block and tackle of startup success, both Jason Calcanis and Fred Wilson finish with the statement “it really is just about perseverance isn’t it.” Two of the biggest icons in the industry truly connect on the pain of their failures and the ability to overcome them that has produced their successes. Gary V and Kevin Rose hit it even harder, its sacrifice, ‘its always hard’, and ‘working your faceoff!’ here. What Gary V hits particularly well and consistently in most of is his content, is the raw straight at you position that building a business is going to absolutely everything you have; your success will be achieved by your passion, guts, and relentless hard work. This is beautifully simple truth. I want to outline a few ways that might help you activate, build and maintain those attributes of passion, guts, and hard work, because I know I struggle nearly every day to so.

I will start with some hard, non-emotional things that will help pave the rocky road out of or away from the hard times that will come in a startup.

  1. Save One Year’s worth of living expenses (at least six months) if you can. Money pressure is visceral and very hard to ignore; its hard to focus on building your business if you are not sure how you are going to pay the bills. Remember revenue and investment capital always take longer than planned and rarely happen in a startup in a sustainable way in year 1.
  2. Align those closest to you, specifically your life partner. No matter, how strong and positive your relationship, a startup is going to put it to the test. Never take your private relationship for granted, for good or ill it is going to impact your business life. Your partner is a part of your team, communicate your needs open and honestly and reciprocate. Two front wars are really hard to win, keep your war at work.
  3. You and your co-founder(s) are married, all the same rules apply. This is an unique business relationship, normal rules do not apply. You need to support each other emotionally not just professionally. Your co-founder’s issues at home are going to affect your business, they will resent not getting sympathy / support when the server crashes at 2am, losing a deal hurts bad talk about how it feels and wait to talk about why you lost. Your startup is your baby, you better have alignment on how you are going to parent it.

In my experience and observation, the truly critical takeaway entrepreneurs have from their failures are the emotional scars. Failure tests your resolve, it trains your reaction to adversity, it exposes you character. Failure informs you mental and emotional models for the next startup. From them you learn how to position yourself, your venture, and your team for better outcomes. I have failed twice in companies that I have founded. Those lessons inform my entrepreneurship everyday, and I am much stronger, effective, and valuable for those failures.