The Question of Scale
The team is awesome and the product is great, we are just not sure it can scale.
I often hear some version of this quote from conversations with investors. Just the other day in fact this line came up almost verbatim with a VC partner. Generally I ignore it as some trite brush off of a startup they are just not interested in. However, I have heard this line used enough times that I am seriously wondering if VC’s have completely forgotten what business they are in, namely to help startups to SCALE their businesses.
You could be forgiven for thinking VC’s have become utterly confused about what exactly their purpose is in the startup ecosystem. Partly this stems from the fallout of the first Dotcom era and partly from the new startup economics. In the day, VC’s used to issue $5 million Series A checks as seed funding for entrepreneurs to build out something based on little more than an idea. When the bust came, VC’s ran from early stage to find safe harbor in later stage startups with product, revenue, and hefty business plans with voluminous financials. There was less risk and operational execution was the focus. Thus VC’s were not in the “funding ideas business” anymore, they were in the “scaling startups business”.
This left a gaping hole in the early stage startup funding ecosystem. Over the decade, that hole has been filled by angel investors, seed stage micro funds, super angels, accelerators, crowdfunding, and the like. We now have this active and vibrant early stage startup funding ecosystem to fill in for the funding ideas business that VC’s abandoned over a decade ago. With the addition of communities like AngelList and Kickstarter, the funding marketplace has grown significantly and become much more efficient and transparent in the process.
The key reason this gap was filled is that technology became way cheaper and more accessible. We are all well versed on the benefits that cloud computing and cheap Internet has provided. However, the key implication of that shift was that what used to take $5 million to build could now be built for $500K or $50K or even less. This made taking on angel investors or joining an accelerator a no-brainer option since the checks no longer had to be millions to have enough runway to make a real go of things.
But something strange happened along the way. VC’s were feeling left out. They jumped back into the seed stage business throwing around $25K chip shots. They were slumming with early stage startups as a way to getting in on the next big thing. Problem was they were coming in with the late stage mentality. They expected things like high traffic numbers and hockey stick growth and significant traction, but that is provenance of more mature companies that have product-market fit and have a well baked customer acquisition strategy. At the seed stage, all of this is merely a hypothesis and speculation.
Now to be fair, when shopping around for Series A funding, it behooves entrepreneurs to at least show a working product and some traction (by traction, we mean showing positive progress that demonstrates the likelihood of a successful product). Things have shifted so that what used to be the Series A of old is now the seed round of today where ideas turn into something real. Some accelerators are even casting aside ideas altogether and bringing on smart teams to figure it out during the course of the program. Regardless huge questions still remain when approaching a Series A round, the most important being how this simple 1.0 product with modest traction is going to evolve into a world beater company. That requires the talent to build out the product vision and identifying low-cost/high-value customer acquisition channels, or in other words, SCALE.
Therefore I am left to believe that an early stage investor that cites scale as the issue either:
- Does not understand the startup’s business,
- Does not have a good reason and is at a loss for words,
- Does not wish to divulge real reason for passing,
- Does not understand the difference between tractions and scale, or
- Does not have a clue.
The whole reason most early stage companies are seeking a Series A round in the first place is because they need the money to scale their business. That is money that goes to experimenting with various customer acquisition strategies in order to discover the scalable model. It is the rare startup that goes from Series A to owning the market like an Instagram. Most folks have to slog through a few rounds of funding to get it right. Whether you get a next round of funding is largely based on hitting growth metrics and getting a handle on the scale question.
This does not mean that investors should not probe founders on thoughts about customer acquisition, business development, and marketing strategy. Those are certainly valid questions, but the answers are purely speculative the earlier the startup is. What can be intuited through such discussions is how the team has logically thinking about these issues and the amount of hustle in tracking down some of their hunches. There should be some reasoned opinions on what can work from a sales and marketing perspective. There should be some grounded analysis on customer acquisition costs and customer lifetime value. Again, it is not a matter of having it nailed down and getting it right, it is about have a thought process, an initial game plan, and the flexibility to switch things up.
The question of scale is certain an important one, but only at the appropriate stage. When evaluating a late stage deal, there has been plenty of cash, time, resources to legitimately explore the scale of the business, which really comes down to the fact that either the product was not too niche or the team did not execute. For early stage startups, if you believe in the team, the market, and the product, then scalability is a question that is best addressed when there is enough money to plug into the business to help accelerate grow in a sustainable manner (e.g. not through specious growth hacking techniques or spammy user acquisition methods). Looking for evidence of scalability any earlier simply does not make much sense.
11 Notes/ Hide
- sogro liked this
- ingersollnik liked this
- abijoor reblogged this from marksbirch
- abijoor liked this
- essayeditors-blog liked this
- jmanjls liked this
- mariogor liked this
- marksbirch posted this