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More in the 50 Questions Series50 Questions: How do VCs make investment decisions? | 50 questions: What are the alternatives to venture capital? | 50 questions: What’s the difference between Seed, Series A and Series B |
50 questions: What is product/market fit, and why does it matter to your startup?
Together with Nic Brisbourne of The Equity Kicker / DFJ Esprit, I am writing a series of 50 questions you should ask when raising venture capital. We expect the series to run for a year, after which we will collate the answers into a book. We view this as a collaboration, so please comment to help make this series even more useful. This is post #11 in the series.
Many entrepreneurs were initially trained in big corporates. They learned how to develop proposals to be vetted by the boss, how to avoid failure and how to execute in a market where the business model was known and proven. The most important skill was to be a little bit better than the nearest competitor firm (or internal colleague), not to innovate, disrupt or create.
Here’s the most important thing to remember:
Startups are not mini-corporations
A corporation exists to execute on a business model; a startup exists to find a business model. (See anything Steve Blank has written on this topic, particularly posts such as No Plan Survives First Contact With Customers – Business Plans versus Business Models)
Building a startup that is structured like a corporation can work – if all of your initial assumptions are right, your market is ready and you execute well. Odds on, none of these things are true. A business that is structured as a corporate will plough on and on, executing against a flawed business model, until it runs out of money.
Then it will die.
A startup, in contrast, is structured to roll with the punches. To understand this distinction. we should turn to the ideas of Marc Andreessen, founder of Netscape.
Introducing product/market fit
If a startup is in search of a business model, how does it know when it has found it? The answer, according to Andreessen, is when it gets to product/market fit. He says:
“You can always feel product/market fit when it’s happening.
The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers. Money from customers is piling up in your company checking account. You’re hiring sales and customer support staff as fast as you can. Reporters are calling because they’ve heard about your hot new thing and they want to talk to you about it. You start getting entrepreneur of the year awards from Harvard Business School. Investment bankers are staking out your house. You could eat free for a year at Buck’s.
But here are his cautionary words:
Lots of startups fail before product/market fit ever happens.
How to get to product/market fit
A startup will fail if it believes it has all the answers. If it goes to sales meetings with prospects in order to talk, not to listen. If it tries to force the market, not be moulded by it.
(Note that this does not mean that a startup can’t be innovative, disruptive or create a product that many view as just plain crazy. It just means that they have to listen, iterate, tweak and refine all the time. Even the most brilliant people are wrong a lot of the time).
There are other corollaries to the product/market fit thesis:
- Picking a great market is better than having the right team or a killer product. I’ve see time and again VCs get excited by market potential; if the team is good, they are often prepared to invest on the *hope* that they will come up with a good product.
- Startups need to pivot if their initial assumptions prove to be flawed. A startup that has made no sales in its first year is doing something wrong; it needs to consider whether it is targeting a poor market, if its product is wrong or if it is not understanding customer needs. Just carrying on without any changes is foolish.
- Before product/market fit, you should keep costs as low as possible. Once you have found your niche, spend money like crazy and scale with the best of them. While you are still searching for that sweet spot, keep your monthly costs under control, and hire people who now how to iterate, not how to stick to the playbook.
Why does product/market fit matter to a VC round?
If you are raising seed or series A capital, you are probably before product/market fit. If you are raising a later stage round, you are past it. (See 50 questions: What’s the difference between Seed, Series A and Series B for an explanation of the different stages).
That means that seed and series A investors are heavily focused on how big your market is. They will care a lot about the team. The product matters (in fact it matters a lot), but the one thing they know is that the product will need to change as you go through the process of customer discovery and validation, of finding your business model.
If you want to maximise your chances of success as a startup (and a fundraising), pick a great market, hire a great team, and then set about the task of iterating your way to a successful product.
Venture capitalists are likely to understand that you are on a journey of discovery. If you understand this too, you are much more likely to succeed.
Hungry for more? Go to the 50 questions homepage for more insights into venture capital.