startups

Startup Advice on Spending with Venture Capital Funding

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More isn’t always better, especially when it comes to startup funding. I’ve personally had the experience of raising $5 million for a new startup during an upmarket, and I’ve also experienced raising $750,000 for a new concept during a downmarket. In the first case, we blew through the money in 14 months, crashed and burned. In the second, we built a very successful company and never needed to raise another nickel in outside funding. 

The fact is, you make different decisions when you have a big pile of someone else’s money in your bank account. Economists call it a moral hazard. I call it bad startup strategy. 

A startup CEO needs to make good decisions about where to spend money. She can spend it on a fancy logo, an inspirational video or building a powerful software engineering team. But as Marc Andreessen wrote in his seminal 2007 post, The only thing that matters is getting to product/market fit. Until you achieve product/market fit, spending tends to be very inefficient, at best. 

You can achieve product/market fit in two ways: by adjusting your product to fit what the market wants, or by moving the market to align with your product. The former is a whole lot less expensive than the latter. 

I believe 2016 may be the best time ever to create a new startup, because the tools available to help entrepreneurs find elusive product/market fit are more powerful (and less expensive) than ever before. Before writing a single line of software code, an entrepreneur can build a prototype and get it out in front of prospective customers for input. And once the software startup actually starts writing code, modern infrastructure such as Amazon Web Services (AWS) and open source libraries enable building a minimum viable product (MVP) for a fraction of what it would have cost a few years ago. 

In the class I teach at Stanford, each quarter we choose a fictional startup idea to work on. Last quarter we chose “Uber for fresh-baked cookies.” As the students excitedly discussed the concept, they were sure that our prime target market was going to be single guys with the munchies. I asked them how we could test that before we actually built anything.   

We decided to place two ads on Facebook, one pitching our new service as delivering cookies to you, the other pitching it as sending cookies as a gift to friends and family. The two ads were displayed over 300,000 times on Facebook … and guess what? The cookies-as-gifts concept got more than twice the number of clicks. 

Furthermore, a look at the demographics of those who clicked on our ads reveals that most of them were women over 50. That’s a huge insight. And the cost of that insight? $24 in stock photographs and $168 in Facebook ads. A generation ago, that insight would have cost $100,000 spent with an expensive market research firm. 

The concept of testing your understanding of what your customers want before you start building a product has been extensively written about by most of the leading startup thinkers today. As I’ve already mentioned, Andreessen calls it “finding product/market fit.” Steve Blank calls it “customer validation.” Paul Graham of Y-Combinator puts it even more simply: Build things customers want. 

With the tools available today, I believe it’s a crime to build any product or service without thoroughly testing your assumptions. And yet it’s a mistake made over and over again by entrepreneurs — especially those with a pile of venture capital in their bank account. Passionate entrepreneurs believe they know what the world needs and they are eager to build that product, convinced that once they build it customers will come flocking. But as Blank writes, “‘Build it and they will come’ is not a strategy. It’s a prayer. 

There’s a place for prayer, but not when spending investor money. Especially today, when assumptions about what the market wants can be empirically tested before product development begins.   

Trust me. I’ve tried it both ways. 

Bret Waters is the CEO of Tivix and a regular lecturer on business strategy at Stanford University. He has spent his entire career in Silicon Valley, helping to drive digital innovation in various roles as an entrepreneur, investor, and academic. Contact him at Bret@tivix.com and follow him on Twitter and LinkedIn. 

 

 

 

 

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