What Kind of Startup Is Yours?
Not every startup fits the popular Silicon Valley “We’re going to be a billion dollar tech company” model. In fact, the vast majority don’t. But, most of the startup literature (hence published startup advice) assumes you want to hit that $B mark.
Starting a smaller business is much different than starting a billion dollar tech company. Before you start, it is reasonable for you to know what to expect, particularly in regard to funding your startup. Once you do, you can use your time more effectively.
We’ll set some baseline expectations by considering two factors: your startup’s Scale and its Stage. Start here to scope your kind of startup and learn what you should expect.
Are you planning to start a small business, defined as self employment or a relatively local (or regional) business? Or, are you planning a large venture that will scale nationally or globally?
This is an important distinction, for two reasons.
First, only large ventures can provide enough return to appeal to angel investors and venture capitalists (and even then, only a small percentage will be funded). Yes, I know you can argue that some small businesses receive something that looks like angel investment, but those investments are typically just a form of friends and family investment. True angel investors who make a seed or early stage investment expect the venture to continue on to a Series A investment (or beyond) to finance going big. Let’s put a number to this. For investment, you should be working in a market capable of generating at least hundreds of millions of dollars per year.
Second, the team you will need to put into place will be substantially different. A small local business might get by with good old Uncle Billy helping with sales, but a global venture requires an experienced, seasoned industry expert. The same holds true for other positions — marketing, finance, operations, HR, etc. Sorry Uncle Billy.
Let’s be frank about where your business “is” right now.
- Do you have a business idea, but haven’t yet established much or any traction for it?
- Have you already demonstrated significant customer traction for your idea — and are ready to kick it into higher gear?
- Have you demonstrated traction and also have a strong team in place for that jump to high gear?
Knowing the difference is important.
Without customer traction, you aren’t a candidate for either investment or bank financing. Banks simply want to be paid back — if you aren’t selling, you can’t do that. Investors want an even higher return. Often, new entrepreneurs think, “I’ll go get some investment and use that money to develop some traction. That’s why they invest, right — to get us entrepreneurs started?” Sounds great, but it is totally backwards. Investors want to see traction before they invest.
A quick aside about customer traction.
Traction can be defined as proof that customers will buy your product. The best traction is profitable sales [obviously] — the more the better. Those purchases need to be from strangers, not from your mom or your friends. You may not be in a position to obtain sales — maybe you need more funding to make products. In that case you need to work hard to establish some other proof that customers will buy your product. Think creatively about developing preorders, positive customer trials, email signups from landing pages, beta test signups, or at least some other documentable engagement to strongly signal that customers love your product. At the very least, go talk with multiple prospective customers, show them at least a brochure or web mockup of your product, and keep track of how they respond.
Here are some things that ARE NOT customer traction.
- That guy at the store saying, “Yeah, I could sell lots of those.” That may be encouraging, but he’s not a customer — he’s a seller. Ask him to introduce you to some customers.
- People who are willing to try your product for free. Customers, by definition, pay you. Ask them to buy one.
- Your professor, teacher, classmate, local business guru, advertising sales rep, buddy, neighbor, or anyone else telling you, “Wow, that’s a great product — you’ll sell a bunch,” Unless, of course, they happen to be customers and want to buy one for themselves. Ask them to introduce you to some customers.
If you are planning a large national or global venture and want to achieve investment, traction is not enough. You also need to have a top notch team in place (or at least have candidates who are committed to join once you are funded). Investors are interested in knowing that you not only have a customer-loved product in a huge market, but you also have the ability to address that huge market successfully. That’s where team (plus other factors) is key.
So, in Regard to the Age Old Question of Funding …
Truth — lots of startup entrepreneurs have been known to spend time working on the wrong things — trying to establish funding prematurely or from the wrong funders. Here are some tips for what to expect and how to effectively use your time.
- Small scale and no traction. Prepare to fund your business yourself (maybe through sales) or with the help of family and friends. Go get some traction. Yes, that means you’ll have to build a product yourself — probably with little funds — be creative.
- Small scale and traction. Ask yourself if you even need funding other than from sales (assuming your traction is in the form of sales). If you have sales traction, and need more funding, prepare to talk with a bank (prepare historical financial statements, projected financial statements and an accompanying business plan, and a personal financial statement).
- Large scale and no traction. Prepare to fund your business yourself (maybe through sales) or with the help of family and friends. Given the potential for scale (and a great enough product), you might find a team member with industry experience who is willing to be a co-founder and either provide sweat equity, funding, or both. Go get some traction — you will need plenty. Start with a small beachhead market segment — the customer group that will have the clearest and most compelling reason to want to give you money. Yes, you will need to create a product — maybe a prototype or trial version at the very least — be creative.
- Large scale and traction. Now you are ready to talk with investors. You’ll need to prepare two great pitch decks (one to send or leave behind with prospective investors, one for in person meetings). Your deck must include a compelling and simple explanation of your venture — team, market, history, projections, etc. — plus a funding ask, the milestones you will achieve with that funding, and the exit for the investor (so they see how they can get a return). Those of you who are confident should start to assemble the documents investors will want to see when they begin due diligence (i.e. be prepared to get a term sheet). And start to find warm introductions to potential investors. Meanwhile, keep on growing your venture. Investors love growth — you don’t want to be stagnant.
Sure, boiling the world of startup funding down into just those four options is simplistic. But, as a baseline view, they are valid. And now you may have a better idea of how to focus your time and effort — to get your startup going.