Pitching Angels 19

When I went through YC Startup School, their advice often made me angry. Their attitude is that the only way to build a business is to go big or go home, and that infused everything they taught. If you’re building a unicorn, their advice was usually right. For everyone else, it’s wrong. Which wouldn’t bother me so much if their attitude wasn’t that unless your startup is shooting for the moon, go back to working at Starbucks. As my previous article outlined, there’s many ways to fund a great business besides venture capital. But they never talk about alternatives, nor even acknowledge they exist.

I’m singling out YC School, but they’re not alone. Every accelerator offers the same advice on how to look attractive to VCs. It makes sense–you’re at the accelerator for help snagging VC funding. If you want VC funding, you have to fit their models. Getting you into the VC funnel of potential unicorns is their job, not to help you build a solid, stable business. But if you don’t fit the unicorn model of explosive growth and quick acquisition or IPO, instead of politely guiding you to find a different funding model, they tell you the VC model is the only way to fund a startup and you’re doing it wrong. I not-so-respectfully disagree. There is more than one way to build a business and venture funding is not the right way for many startups.

Instead of figuring out how to fund your business to fit your business plan, they instruct you to tear up your business plan and write a new one to fit the venture funding model. Putting funding first instead of customers is the tail wagging the dog, and it’s doomed to failure. Which doesn’t matter to venture investors – they expect 90% of their investments to fail. Failure is celebrated – a learning experience. Easy for them to say – they’re getting paid to make investments. For you, the founder, failure is not so easily laughed off. It’s not only years of your life but your life savings.

If you come into an accelerator with a rational plan to build a niche product, they’ll tell you to revise your business plan to address a bigger market. With the Sirens of venture capital singing from the shoals while waving wads of money, you’ll be sorely tempted to make the one of the changes I’ve described below. By modifying a few numbers on your PowerPoint slides, you’ll finally have the cash you need to get your startup off the ground. My advice: don’t do it. Follow Ulysses and stuff your ears as you navigate past the rocky shoals. Because if you try to turn a solid donkey into a flighty unicorn, you’ll end up with nothing but a dead donkey with a horn strapped to its head.

“Revise” Your Projections: “You say a TAM of $250 million and SOM of $40 million is too small? Okay, I’ll just change the pitch deck to $1B and $200M. I mean, who knows what our revenues will be in 5 years? I’m lucky if I can get within 50% of next year’s numbers let alone five years from now. How big is the market? Nobody has ever built anything like this before, so who knows? The new numbers are as likely to be right as my first guess, so who cares?”

I do. And you should too if you want to succeed at building a business instead of just grabbing a round of funding. Those projections aren’t just for investors – they’re primarily for you to plan your business strategy. A business with $10M in revenue needs to be run differently than one targeting $100M. The team is different, the marketing is different, the sales process is different. Even the product may be different – the needs of a specialized audience in terms of usability, features, and support are different than one for a general audience.

You probably think that no matter what, $100M in revenue is better than $10M. However, a business built for $10M in revenue could generate $4 million in profit, while the business built to go after the theoretical $100M opportunity may be lucky to break even at $100M in revenues. If the $100M revenues turns out to be only $25M, the company will be losing $75M. If you build the $10M business and the opportunity turns out to be $25M, it’s easy to scale up later. If the opportunity turns out to be smaller than anticipated, you’re dead.

If you don’t meet your revenue targets and grow the business as fast as promised, you’ll be forced to make major course corrections. No matter that you have a great product that customers need. No matter that you’re generating tens of millions in revenue. If the rocketship they invested in isn’t heading for the moon, you’ll have to pivot. When that doesn’t work, the VCs won’t be funding the next round. Your team is too big, your burn rate too high, so you run out of cash, and the investors sell the business off for pennies on the dollar if not shut it down completely. The company is dead, years of blood, sweat, and tears, not to mention your bank account, evaporated.

Find a Bigger Market: If your target market isn’t big enough for venture funding, they’ll tell you to go after a bigger one. Sounds easy, right? But going into a market you don’t know is the most sure-fire way to fail.

You built the product to solve a specific problem. You know the industry; you know the potential customers. (In fact, you probably were one of the potential users and the lack of a solution is what drove you to build your product.) You understand the users’ needs, and what features are critical and which are noise.

Going after a different, bigger market doesn’t mean minor adjustments to what you’ve already built; it means starting over in an industry where you don’t know the customers, don’t understand the needs.

I learned this the hard way personally when I tried to expand a product developed for computer networking to the adjacent telecommunication space. The networking folks knew they needed a solution and were very receptive so it was easy to get the business bootstrapped. But the market was small. The telecoms folks had the same problem but didn’t know it, so attempts to sell the product to them were met with blank stares. Besides market education, the way the two markets learn about new products, evaluate products, and purchase products turned out to be wildly different. Even an identical product required a complete do-over of the business strategy. In the end, it turned out what the telecoms folks needed was not exactly the same as the networking guys. There was a subtle difference in how it had to work. But that minor-seeming difference required building the product with dedicated chips instead of a standard CPU. In other words, they needed a completely different product built by a team with completely different skills and a much harder path to success.

If you build a product for customers you know intimately, you have a pretty decent chance of success. To go after a market you don’t know as well, even one that looks similar on the surface, the chances of success drops precipitously.

Built a Multi-Market Strategy: If one market isn’t big enough, what about going after two? Or three? Your original business plan is now called the beachhead market. Once successful there, you’ll attack the larger opportunities to accelerate growth. 

The answer here is somewhat nuanced. Expanding your product within the same market to grab a larger piece of the pie should always be part of your growth strategy. But expanding into separate markets rarely works for a startup. Each market has its own dynamics, specialized needs, and competitors that require unflagging efforts over years to shoehorn yourself in. Succeeding in one market is difficult. Succeeding in two is nearly impossible.

Further, if there is a bigger market that needs your product and is the real target of your business plan, why are you wasting years of effort focused on the small one? If the big market is your real target, start working on it now and build the product, team, and marketing to match your long-term strategy.

Lastly, multiple markets confuse the exit strategy which is acquisition by a competitor or partner in one of the markets. If they’re not interested in the other markets, it gets in the way of an acquisition which should be your only goal in building a venture-based startup.

If two markets is better than one, how about ten? Ten times the number of opportunities, one tenth the risk, right?  “Platforms” that can be used across a wide variety of applications usually means you have an invention in search of customers rather than a product. You’re listing opportunities you could go after, but never will. Do your customer research, find the right product-market fit, and focus in like a laser on the one best opportunity.

If your product and business strategy fit naturally into the venture model, great. If you have a big idea for a huge customer base, you’ll need venture capital. Join YC or another accelerator, read my articles, refine your pitch and raise the money you’ll need. When you complete your IPO or get acquired by Google for billions, send me a postcard from your private island to say thanks.

But if you’re building a product for a smaller market, ignore the pressure to go big. Rather than trying to shoehorn your business into the VC’s requirements, find a way to build the product that needs to be built for the customers who actually need it. It may not be as simple as sending a pitch deck to a bunch of VCs or joining an accelerator but your chances of success in the long-term will be infinitely higher.

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