Can Your SaaS Startup Cross the Penny Gap?
Between the time a seed-stage SaaS startup ships its MVP and closes its first few paying customers is the Wilderness Period. This is when you find out that your MVP isn’t really MVP.
You try to sell your minimum viable product, encounter objections you hadn’t anticipated, race to code the new requirements (the new MVP), and repeat. The Wilderness Period can take two months, two years, or forever.
That unknown makes this one of the most unsettling periods in a startup’s life, as the pure potential and excitement of building the MVP confronts the reality of not being able to find paying customers. Or as Mike Tyson said, “Everyone has a plan until they get punched in the face.”
The Wilderness Period ends when the startup finally makes its first few bonafide sales. I call this crossing the Penny Gap. But selling to friends and classmates doesn’t count; only unaffiliated revenue qualifies. And the milestone isn’t satisfied just by closing the customer, you also have to implement them successfully and turn them into happy references. In other words, these deals only count if they are potentially repeatable.
The Wilderness Period ends when the startup finally makes its first few bonafide sales. I call this crossing the Penny Gap.
That first penny of happy unaffiliated repeatable revenue is the first critical milestone for a SaaS startup, as it proves that (1) the team won’t be stuck in the Wilderness forever; (2) the founding idea is not just a good story, there appears to be a market; and (3) the team has the ability to convert promise into traction.
Reverse-Engineering the Buyer
The Wilderness Period begins with the shipping of an MVP and the search for buyers. In the business-school textbook version, founders would start with a very specific customer in mind and build a product to their requirements. But in reality, most SaaS founders these days are product-first. They have a strong idea of the product they want to build and the value it will create but still need to figure out their go-to-market strategy. So they launch an MVP, see the reaction, have some initial sales conversations, improve their understanding of the potential buyer, and iterate on the product to make the offering more compelling to the next set of prospects. Effectively they reverse-engineer the buyer. The process is recursive and requires founders to answer the following questions:
- What immediate pain do you solve?
In order to find buyers, products must solve immediate pain. The sale fails when the pain point is too attenuated or abstract. Ideally someone is desperate for your product. To hit this bar, you can either make the product more comprehensive by adding features or you can find a killer feature or use case — a product wedge — that drives the sale. Conglomerating a bunch of weak use cases is not as good as one strong one. Similarly, solving minor pain for a lot of users is not as good as solving major pain for a smaller number of users.
- Who exactly is the buyer?
Once you understand what the immediate pain is and who suffers from it, you can develop a clearer picture of your ideal customer profile. Is the target defined in terms of company size, line of business, industry, or use case? Which team or role inside the company is the end-user? Now here’s the tricky part: Is this user actually a buyer? Sometimes the end-user does not control technology or budget decisions. In that case, you need a strategy to turn them into champions for the sale, or you need to better align your product’s features and pricing with the real decision-maker’s criteria and budget.
- What is the sales motion?
Once you understand who your buyer is, you need a way to get to them. Where do leads come from? Do you find them or can they find you? What is the entry point into the company? Have you identified all the stakeholders and the source of budget? Is there an event that drives the need for purchase? Do you have a winning pitch and product demo? Is the sale greenfield or rip-and-replace? Whenever possible, go after greenfield opportunities because it’s 10x harder to make a sale when you have to convince the prospect to rip out an existing technology.
- How does the team and its belief system need to evolve?
In the process of iterating, founders must constantly evaluate whether the team has all the skills it needs. While it’s best practice for founders to do the initial sales themselves (so they can hear the objections and maintain a tight feedback loop between sales and product), adding sales DNA to the founding team can speed things up a lot. Founders should hire to augment their weaknesses.
Perhaps most importantly, founders must find the balance between their vision and the adjustments needed to close the early sales. Sometimes founders are too stuck in their founding religion to see the changes they must make. The same founder belief that is so vital in getting a new company off the ground can kill a startup when it blinds founders to disconfirming evidence. When stuck founders are able to relax their religion a little bit, it’s amazing what new possibilities get unlocked.
How Long is Too Long in the Wilderness?
If a startup is in the Wilderness too long, investors begin to worry about the team’s ability to execute or their market thesis. How long is too long? It depends on the space and the length of the sales cycle. A SaaS tool that’s targeted at startups (which typically have a 1–2 month sales cycle) should be able to cross the Penny Gap in 6 months. That’s time for a few iterative loops between sales and product.
A startup that’s building to meet complicated enterprise requirements may need longer — perhaps a year — as the enterprise sales cycle typically takes 6 months. This is why I prefer a go-to-market strategy where the initial customers are startups or SMBs. You can iterate several times faster when you can test a new product-market hypothesis every 1–2 months instead of twice a year.
If you do target enterprises, it’s crucial to sell into a specific team or line of business because enterprise-wide sales are almost impossible for a startup. The key is to find an entry point, then land and expand. Bottom-up freemium adoption also helps a lot.
Since a longer sales cycle means fewer bites at the apple, enterprise startups are more likely to die in the Wilderness. For these startups, it can be very helpful to have founders with deep experience in the space, a greater capacity to fundraise, and an initial pilot customer.
Lost in the Wilderness?
The biggest mistake founders make during the Wilderness Period is letting it go on too long before making fundamental changes. If after a sustained period of iteration founders are unable to cross the Penny Gap, they may need to confront the reality that their market premise is wrong. In this case, they should pivot as soon as possible. Do not wait until the writing is on the wall.
The biggest mistake founders make during the Wilderness Period is letting it go on too long before making fundamental changes.
I’ve been through this myself. In 2007, I launched Geni.com, a family social network. We got off to a hot start, with millions of users signing up. But around the same time, Facebook opened up beyond college students and was growing exponentially. I began to worry that Facebook would eat family social networking. So I started thinking about a pivot into enterprise social networking. That idea became Yammer, which had a unicorn exit in 2012.
That outcome would never have happened if we had waited until there was absolute proof that the original idea wouldn’t succeed. Instead I listened to that gut-wrenching feeling in the pit of my stomach and acted ahead of the data. Founders who are lost in the Wilderness should heed that feeling and get ahead of the problem, while there’s still time to execute a pivot.
Great founding teams find a way to adapt and give themselves multiple at-bats.
Crossing the Penny Gap
Once you’ve crossed the Penny Gap, you’re out of the Wilderness and in an exciting new phase of learning from actual customers. This is a huge milestone and confidence-booster for the team.
Now the question is, can you keep it going? Were the initial sales a fluke or are they repeatable? Your next critical milestone is month-over-month growth. 20% monthly growth below $1 million of ARR and 10% above $1 million is the benchmark for SaaS startups. (H/t Jason M. Lemkin.) If you can hit these growth rates, you are well on your way to a great Series A.
At Craft, we are active investors in new SaaS categories (see my post on category definition here). If you are creating a new SaaS category and have recently crossed the Penny Gap, we would like to talk with you.
Acknowledgement: Josh Kopelman at First Round first coined the term Penny Gap in 2007 to describe the difficulty in getting consumers to pay anything for the premium version of a free product. Here I’ve repurposed the term to refer to a hurdle faced by SaaS companies. In both cases, the binary proof signified by the milestone is more significant than the amount of revenue, which is why a “penny” suffices.