The Discovery Phase Of Starting Up

Venture capital is a straightforward industry. At the end of the day, a VC’s job is to make money on behalf of their limited partners. When a VC is successful in that pursuit, they reap the rewards in the form of new funds and carried interest checks. And the most straightforward indicators of an oncoming financial windfall tends to be hidden in the exponential growth metrics of underlying portfolio companies.

Since many VCs are coin operated — and the financial metrics are the easiest indicator of future coins — VCs regularly write about the growth metrics that startups should seek instead of the more product focused issues.

Anyone who’s operated inside an early-stage company knows that starting a business is a much more complicated pursuit than the construction of an Excel model. You can’t just start with an ARR target and work backwards towards an operating plan. You have to first identify a problem and discover a way of solving it that is both profitable and scaleable. Neither of which is an easy task.

Over the past year, a few of my colleagues and I have noticed the cacophony of voices emerge on issues related to growth. As investors focused on the expansion stage, these voices addressed issues we understood well. What growth rates, margin profiles, payback periods and more metrics should look like.

But looking back, there is almost no discussion of that more amorphous discovery period of a startup’s life. So we thought we’d contribute to the conversation by highlighting how substantial, and how long, this period tends to be for entrepreneurs.

Exiting the discovery period takes a meaningful amount of time (~3.5 Year Median / ~4 Year Mean)

We turned to Sapphire Ventures’ “Benchmark Database.” With historic information on more than 50 expansion-stage SaaS businesses, the database holds a lot of insight into how companies go from an idea to an IPO’able entity. Unsurprisingly, one of the observations is that it takes time.

We characterized the period of discovery as that period before a company hits $2M in annualized recurring revenue (ARR). Before $2M in ARR, we assumed that a business was still determining how to best adapt its product and business model for its market. After $2M in ARR, that business was focused on scaling something that seemingly worked.

The difference in these two periods was striking. The median company in the database took an average of almost four years to pass $2M in ARR. Four years to figure it out. The average company that passed $24M in ARR took less than~eight years. Four years to grow the business by more than 12x.

While the data varied from company to company, the story was roughly the same. Expansion-stage companies that had found their product market fit looked very similar. They either performed or plateaued in some much narrower bands. But prior to taking off like a rocket ship, every company had a substantive gestation period. This period where the founding teams and early employees were simply figuring the business out varied from 18 months to more than 10 years.

Gestation Varies Dramatically

As VCs, I’d say we have a predisposition to judge businesses that are “long in the tooth.” We look at founding dates and speculate as to why companies aren’t already taking off like rocket ships. The reality is that the reasons for slower growth can vary dramatically:

  • Some companies need to wait on their markets to mature…
  • Some struggle to build technical solutions to highly complex problems…
  • Some use freemium or subsidized products early to build the type of information assets they need to compete over the long term…
  • Etc…

As an industry, we don’t spend nearly enough time talking about what teams can do during this discovery phase to discover that market fit faster. We tend to focus on the things that are easier to quantify and categorize. My hope is that being conscious and explicit about how substantial this period of a startup’s life is helps to change the conversation ever so slightly. Because without startups trudging effectively through the discovery phase of their life cycle, there is nothing to expand upon.