A Primer On The Interconnection Between Growth Hacking and VC Fundraising

“In dreaming about startup success, an entrepreneur must not forget that business is around numbers, so he/she has to be asking “how do we make the numbers work” and measuring success by tracking it through the right metrics…The metrics measured would accurately reflect underlying business performance and provide insights into why a company will succeed in reaching the vision. The numbers themselves will tell if the team is getting closer to, or is in the right direction to the ultimate goal.” — Jad El Jamous, “Creating The Future” Series (Part 2): A philosophy for Entrepreneurial Success, Purpose and Spirituality

However ambitious your vision is, your startup will live and die by its metrics. While this only seems relevant in post-seed stages, we are seeing the bar get raised time after time for seed investing. The most attractive thing for investors, starting from the seed stage, is not just the product or the traction, but it is actually the speed at which those assets will be driving future revenues. A metrics-driven approach is also crucial in building a mathematical model for the startup’s growth engine. Metrics such as revenue growth, CAC/LTV economics, and retention should be approximated and given attention to at the beginnings of developing strategy and evaluating the market opportunity. This is something we take to heart at ZOTA: We are adamant about helping founders establish a solid growth framework in the very early stages, and on helping validate the business model with metrics-driven experimentation. Our promise to founders: From the very start of our involvement, we’ll work on setting up the company’s dashboards and product analytics. Once set up, we’ll regularly monitor KPIs and re-adjust strategy every month accordingly.

We fully believe in adopting a process of “moving metrics” and making founders accountable for them, only because it will push them to act on improving those metrics day after day until they’re nailed. Moreover, this approach helps prioritize resources (early-on when there aren’t many to go around) based on the potential impact of activities on those metrics. Most growth hacking advice found online recommends choosing one metric, the “North Star Metric” (NSM); that is generally recommended to be Revenue growth, or user growth if no monetization strategy exists yet. Yet our growth hacking experience in multiple companies tells us that we need supporting secondary and tertiary metrics across the business model. We also prefer the advice by Andrew Chen from a16z to focus on inputs, not outputs: “Focus on the inputs because that’s what you can actually control. The outputs are just what happens when everything happens according to plan”. If your NSM is an output, you effectively have to ask yourself “how would the inputs to the model need to scale, in order to scale the output?” To mirror Andrew’s advice, a comparison between clarity metrics and vanity metrics by Looker founder Loyd Tabb in a “First Round Review” blog post explains that the former types are the “hidden gears that drive growth”. In other words, they’re both asking us to focus on the “hidden” operational metrics that drive the revenue growth or any other NSM metrics.

“As a software engineer I try to approach problems algorithmically. That is, given some kind of input, what kind of procedure can I reliably run to generate the desired output. For example, given a bunch of numbers (input), what’s the best process (algorithm) to quickly and efficiently arrange those numbers in increasing order (desired output)?” — As Leo Polovers explains in Coding VC

Most VCs want to see revenue growth of 20%+ per month as a pre-requisite for investing. However, we think that it is not helpful for the entrepreneur to focus solely on the goal of increasing revenue. The underlying revenue growth formula, and the specific inputs behind it, have more practical value in reaching growth. An echo of “vanity metrics” vs “clarity metrics” also exists in the debate on “Lagging Indicators” vs “leading indicators” where it is said that to maximize your outcome (lagging KPIs), you need to optimize your input (leading KPIs). As it happens, revenue growth comes as the result of the company focusing on the drivers of growth. The best consumer companies not only track absolute growth in revenue and users, but they also track things like user engagement along the purchase journey — often reflected by time spent using the products, bounce rates vs activation rates, funnel conversion rates, churn rates over different periods of time, referral rates and many other metrics. We would advise to focus on a few metrics that are relevant to the business model and stage at hand, and which represent delivery of real customer value. This is also where the AARRR growth framework comes into play, and I’ll get to that.

But first, think about this example: Founder says “I would like to go from selling 50 apples to 100 apples in 2 months”. This is an output, with neither a real strategy or any reliance on inputs needed to reach this goal they’re portraying. This neither tells anyone how they’re going to run the company, nor it includes a cost analysis of how to get there, nor does it tell if the unit economics will make sense in getting there. A better strategy can be conveyed, for example, by “I would like to introduce a new product feature that increases my visit-to-activation conversion rates by 70%, hence acquiring an additional 20 customers and optimizing my marketing CAC costs to $30/customer, then I would like to build a cross-selling strategy for my existing customers that will increase my order size per customer to 1.5X by spending an extra $10/customer, and finally, I also want to launch a loyalty program that keeps my churn in check by reducing it 20% compared to last month”. These are indeed all inputs that have a total of 100 apples as an output.

“Marketing needs to dramatically evolve from the days of the Mad Men to being core to an organization’s GROWTH ENGINE. It is a complex (not complicated) integration of many parts and pieces -data, insights, tech, content, creative, storytelling, channels, media, planning, analytics etc that in isolation don’t mean much. It is no longer one-dimensional or linear. It needs to be held accountable for impact and outcomes. This mindset shift is not a choice but a quintessential response to surviving in a consumer-led era.” — Mayur Gupta, Don’t Confuse Marketing’s Outcomes From Its Outputs

This brings us to growth hacking — a process of rapid experimentation across the customer journey that follows through ideation, prioritization, testing and analysis, or insight production. Compared to traditional marketing which focuses on external channels, growth hacking is about designing the whole customer journey to create virtuous loops. While marketing used to focus on nailing the brand’s message, growth hacking focused on optimizing the product experience itself, from start to finish. Once the startup has crafted a user journey, they need to get specific on how they measure how users move along the conversion funnel, and on how that leads to business growth. As prominent investor Bill Gurley advises tech startups to obsess about conversion, he notes that the reason for that is that “Tiny moves in conversion rates have huge financial consequences which almost seem magical or unfair”. Growth hacking, as a job, should define actionable metrics to measure each step of the journey, then proceed to improve all of them in a systematic way with the right product or marketing levers. With that, growth hackers are a special breed of startup people who should be solely dedicated to the act of “moving metrics” using the scientific method, and who know that their continuous efforts to move metrics will compound growth over time. Many frameworks exist out there, but a general framework these hackers work by is the AARRR Framework:

• Acquisition is about understanding how much is being spent on advertising to attract customers to the website — it measures for example how many new users are signing up and costs per lead
• Activation is about connecting the most amount of people to the core value of a product — some call this moment of realization or excitement the “Aha moment” or even the “magic moment”
• Retention is about building a product that locks in customers — for example, retention should not be a problem if you’re targeting high-recurring needs or if no one else is providing the same value.
• Revenue is about monetization, pricing, optimizing Average Order Value, cross-selling, upselling and other tactics to increase the amount of money a customer on your product.
• Referral is about how your customers will bring in other customers — it’s not just about virality and referral programs, but network effects play a huge role in technology products.

“Great growth people are not necessarily the most knowledgeable marketers — they approach marketing like scientists. They have a thesis on how their idea (e.g. new advertising channel) will lead to growth, they run the experiment, look at the data and if the experiment is successful — they make it repeatable.” — The Startup Pivot Pyramid, Selcuk Atli (2016)

We can then turn to the SaaS growth expert Pierre Lechelle to understand better why growth for him is a process, not an end goal in itself. Pierre elegantly explains that “Growth is all about testing hypotheses…testing hypothesis means running a battery of tests to see what works and what doesn’t... We test a hypothesis because we believe that no one else has the answer to our questions”. He further explains that it’s actually a mindset, likening it to the “growth mindset” in psychology, which states that some individuals are always learning, and that there are no limits to their learning. In the same manner, he notes that “growth never stops” and that there is no success without learning. By continuously trying to understand customers better, growth hackers can always find somewhere they’re dropping off in the product funnel, for reasons that can most often be addressed. I would add to that argument another reason for continuous learning and innovation, which is that most growth channels tend to regularly change the way they behave (for example SEO algorithms or Facebook ads targeting), not to mention that if you keep spending on the same channels long there might be a high likelihood of diminishing returns on investment.

“Find out all the factors that can leverage growth. Begin with the end in mind. If you can find out all the factors that can generate growth for your business, which ones would be? Then play with those in an excel sheet, so that you link them all with the end goal: revenue or profit. If you increase them with 10%, which one of them would generate the highest growth? After that, brainstorm on strategic ideas, prioritize the actions based on the potential, resources and time to impact and make it happen!” — Valentin Radu, CEO, OmniConvert

It is important to note that in the very early stages of a venture, churn rates should be the main discussion. Most investors will want to focus on retention first before scaling, so as not to have a “leaky bucket” problem — a situation where churn outpaces growth. Indeed, if your product doesn’t work for customers coming in and they leave, then there is no use of growth hacking anything. The best line of defense against churn is to focus on solving a real problem in a way that makes them want to spend money on your solution. And if your product doesn’t work, focus on creating enough value by revamping your value proposition or even changing the target market. The best way for having a fair understanding of churn early is to talk to the first few customers and ask about their success/failure rates with the product, and about why there are dropping off. Once the growth hacker has figured out how to keep customers, VCs are more likely to believe that the solution is interesting and agree to fund the startup. Once there is a sign of product-market fit, then and only then does the growth hacker’s mission is to balance the unit economics formula by product design. Growth hacking to manage churn coming from reasons such as high price, absence of incentives, lack of trialability or bad UX is easier than if churn is coming from not providing enough value. “Slice and dice your retention curve, both horizontally and vertically,” notes ex-VP of growth at HubSpot Brian Balfour.

“You can’t growth hack a crappy product. If no one group of people finds your product compelling and worth using and buying, then regardless of the marketing or growth muscle you put behind it, it won’t grow.” -Morgan Brown, Build a Growth Machine Like Andy Johns

We’ve already established that there is no fundraising without high-growth and no high-growth without fundraising. Honestly, startup founders won’t get any funding interest from VCs if their startup is not growing fast. Yet for fundraising, particularly founder focus should be put on the “velocity of cash transformation” as Fred Destin from Stride VC explains: “Any company can be thought of in terms of *flow* — a dollar of marketing or sales at the front end of acquiring an end-user gets transformed, as a service gets performed, into $$ the company can use to function and grow”. This “flow” entails a multiplier effect to revenue, meaning that for each customer the business successfully acquires leaves enough cash, after servicing them, that can be reinvested in acquiring other customers. This positive economics loop creates a “VC fundable” company in which additional investments in the business will multiply revenues by 10x and more. This is the real reason for doing growth hacking and nailing the metrics. In fact, once a startup has a handle on the unit economics and the customer acquisition processes by which it creates cash, it is possible to build a believable financial model — one that shows sustainable scalability in the growth engine, and that can predictably lead to the next (bigger) round of financing. At that point, it should also be possible to adjust and optimize growth milestones along the way, which will impact the amount of money that you need to raise for hitting higher valuation milestones. In practical terms, the startup’s operations would have to be thoroughly validated and set in motion to reach, for example, a revenue milestone of $10M after a $2–3M equity injection.

“Really sophisticated companies (generally at the growth stages) can get fancy with this and know exactly how many leads they are going to “buy” with their new funding, how many will convert to sales-qualified leads, and how many will eventually turn into paying customers” — Sunil Rajaraman, A Fundraising Template Every Entrepreneur Can Use (Techcrunch)

To tell you the truth though, there are today two types of high-growth startups: there are the ones that need to raise money and get to become first in a category with the power of capital and branding because they might have positive unit economics someday (Think neobanks, Uber…); and then there are the ones that have sustainable “flow” early on yet they raise VC money to add “fuel” to the business and grow revenues faster. The distinction in the latter is ni revenue efficiency, which is in producing a higher ratio of revenues to capital invested (PS it can also show in higher contribution margins). There is no right or wrong model; choosing between the two really depends on your market dynamics and business model, and more so on what returns your investors aim to achieve. While efficiency is sometimes disregarded by early-stage VCs, there are few of them who believe that overfunding a company may lead to premature scaling or sub-optimal spending. However, capital efficiency is actually better for the founder — it means less funding risk (ie reliance on external investment), less pressure on growth, less dilution, and more focused resource-planning. More senior investors like Warren Buffet care much about capital efficiency and are known to zero in on the Return-On-Invested-Capital (ROIC) metric to find effective management teams. This is actually why Buffet has been looking more at tech businesses lately after disregarding them his whole life. Interestingly so, this seems to be the “back to basics” strategy for VCs in uncertain environments such as the one we have post-COVID.

If you’re just starting up and would like to get help in structuring your company’s growth engine, do get in touch!

Jad