Systems—The company should have implemented systems of record, engagement, and intelligence for each key business function, including customer success, engineering, finance, marketing, product management, sales, service, and support.
Traction Gap Architectural Pillars
FIGURE 26
Percentage of emphasis during this stage.
The following are the key principles Wildcat Venture Partners looks for at MVR:
■ Traction Gap Principles ■
MVR
Product
Measure your product’s success and communicate those metrics with customers to influence retention.
Revenue
Leverage reference selling to fuel a repeatable sales engine.
Team
Not everyone is good at every stage of the company. Remove anyone who isn’t consistently producing.
Systems
Spend more time on finance than you think you should; make sure the math works.
Traction Gap Hacks ▶ MVR
Generating Investor Interest: Using a Smoke Test
I invest primarily in B2B startups, and one of the things I counsel them to do is to design their product for two primary cohorts. One cohort is the group of people who will use their product to perform operational tasks. The other cohort is the group of people who are the economic buyers, those executives who won’t be using the product regularly but will be required to approve the ongoing use of the application.
The feature set for the executives usually consists of a report or set of reports that showcase key business operating metrics. These reports should contain valuable, usable content, and be designed so they can be automatically distributed daily, weekly, etc. and, if they were to stop coming, would be sorely missed.
At this stage of your startup, these executive reports can serve another very useful purpose. The following is a real-world example of how they can help you generate awareness and interest from potential investors.
I was fortunate to have been the first investor in Marketo, when it was just an idea and three people: Phil Fernandez, Jon Miller, and Dave Morandi. The company at this early stage had neither code nor customers.
After we sold Siebel to Oracle, I elected to join a venture firm to learn venture investing. One of the first ideas I brought with me was to create, or find and invest in, a startup that would transform the role of B2B marketing from what I affectionately called “party planning” into a critical revenue-generating function.
At the time, marketing was viewed by almost every company as a cost center. When I ran marketing for Siebel, marketing was indeed a cost center, but we also used Wharton “quant jocks”—Wharton is well known for its quantitative analysis curriculum and its students who excel in this area—to build models to predict—and generate—future period revenue. We didn’t always like the predictions, but we became uncannily accurate at making them. I had long thought that we could convert what we did manually into an application-software offering.
In the summer of 2006, I was introduced to the founding Marketo team, with an even better vision than mine—and experience building successful marketing applications at E.piphany; that’s why I elected to invest in them. Jon Miller told me a few years later that when they met with me, they were about two weeks from disbanding after being rejected by every other venture capital firm on Sand Hill Road. [By the way, every VC firm has its secret “anti-portfolio”: all the startups they passed on that went on to become phenomenal successes. I have mine, too: Box and Veeva come to mind.]
I remember saying to Phil Fernandez, Marketo’s CEO, at the time, “If you can make the CMO (Chief Marketing Officer) role as critical as the CSO (Chief Sales Officer), you will create a $1B company.” As it turned out, Phil, Jon, Dave, and the Marketo team did a lot better than that. Marketo executed its IPO in 2013 and, in 2016, Vista Equity purchased Marketo for $1.8B. And, the company was recently acquired by Adobe for $4.75B.
But it wasn’t all roses with Marketo. Marketo had a very difficult time attracting venture investors for its Series A. At the time, B2B marketing was considered a cost center, an expense, and B2B marketers were eminently expendable. They were always one of the first groups to be downsized or eliminated during any company downturn. And marketers didn’t have the authority to purchase technology. I know it sounds crazy today, with more than 7,000 products featured on the MarTech “Lumascape” and CMOs enjoying among the largest budgets in technology. But, at the time Marketo entered the market, marketers were typically only provided a budget at the beginning of a current quarter—and expenses were usually limited to activities such as events, PR, collateral, web design, and email campaigns.
Even after Marketo began to do well, other venture firms and most industry executives were skeptical of the marketing automation market. I remember meeting with Marc Benioff at the time to see what he thought about marketing automation. I told him what Marketo was doing, and he said something like “Why would you build a marketing automation company? Those are the first people we fire, and there are only a couple of them anyway. You can’t make any money from marketing.” He didn’t say those exact words, but this is the essence of what he said.
I didn’t share with Marc that Marketo’s pricing model wasn’t based purely on seats, that they were also going to charge based on opportunities processed. Marc’s pretty smart, so I didn’t feel compelled to let him in on everything.
We were eventually able to persuade two other venture firms to invest in Marketo. I believe they invested because the partners at those firms had some operational background and could see the potential for Marketo and its offerings.
It wasn’t until three or four years later that the tables turned and the company began to be deluged with interested investors. Why?
Growth hackers employed by venture firms? No. That was a little-known concept at the time, and Marketo was a B2B startup, not B2C. So it had very little “digital exhaust” to hack.
Curious as to why Marketo had suddenly become so interesting to the venture community when it had been a virtual pariah, I did some investigating. I spoke with a few of the partners from the venture firms that had expressed interest in Marketo.
Interestingly, each said they had recently attended several of their portfolio board meetings, and at each of them they were presented with a new type of report showcasing leads, lead conversion rates, customer acquisition costs, etc. And these reports had all been produced by Marketo. When they saw the Marketo logo at the bottom of every page, they decided they needed to check out the company.
Marketo may not have intentionally engineered this outcome—but you can. If you are selling into other startups, you too can develop one or more reports featuring key business metrics that are easy for your customers—startups—to put into their board decks. By doing so, like a billboard on the freeway, you can capture the attention of venture investors “driving by.” If they see these reports and your logo often enough, they will reach out to you.
7
THE FINAL SPRINT TO MINIMUM VIABLE TRACTION
As I have shown at the end of prior chapters, different Traction Gap architectural pillars come into prominence at different stages.
For example, Product Architecture is paramount through the go-to-product phase and will determine whether you reach Minimum Viable Product.
Beginning with MVP, Revenue Architecture takes a critical and central position. Until Minimum Viable Repeatability, Systems Architecture does not play a significant role. Now, however, as you move from MVR to MVT, Systems Architecture comes to the forefront because it is time to scale the processes you’ve put in place at all levels.
Industry data suggests that once you reach MVR, you have about 12 to 18 months to reach MVT, demonstrating month over month/quarter over quarter incremental growth. Your business model—B2B, B2C, or B2B2C—will determine what that growth velocity needs to be to generate interest from the
investment community; I’ve outlined and discussed these metrics in prior chapters, although there are no absolutes.
By now, you should have released several versions of your product. You have marketed and sold your offerings multiple times to companies or consumers. You are beginning to get a sense of what it takes internally to make that happen. You have hired more people into the organization. Your value propositions are working and your business model is hardening. You have proof that you have reached market/product fit and, more importantly, as I explained previously, marketing/product fit. You are beginning to be able to reliably predict prospect conversion rates because you are building a historical track record of your startup’s pipeline and team’s performance.
You have quantitative and qualitative proof that it is time to “power up” and scale. But scaling will require more capital, people, and technology (systems).
Yes, that’s right. It’s time to raise capital. Joy. Not.
Once again, you find yourself having to “get outside the four walls,” but not for market or user feedback. Now it’s all about visiting the investor community to raise capital. And it definitely comes at an inconvenient time, because you must also manage your ever-growing business. And you can’t miss a beat: hitting monthly and quarterly growth targets is mission critical.
You can’t “stay inside” with your current investors because in most cases it is unlikely that they will lead this next investment round. They may participate in the financing, but most assuredly they expect you to reach out to the next group in the venture ecosystem: mid-stage investors. And, these mid-stage investors are a different type of “hunter”; they seek startups that show early signs of market momentum, and they use facts—performance metrics—to confirm that you are the game they seek.
■
RAISING CAPITAL
Very few startups can get from MVR to MVT without a fresh round of capital. For example, if you are a B2B SaaS company, at MVR you will be generating about $2M ARR. To reach MVT, you must get to $6M ARR ($500K MRR) within the next 12 to 18 months. That’s an incremental $4M ARR, not accounting for any churn—that is, loss of customers. I have more detail about churn later in this chapter.
Startup Life Cycle Timeline
FIGURE 27
As I outlined in Chapter 3, for every $1 of new bookings, you will need at least $1 for sales and marketing and another $1 for R&D and GA. So, to add $4M of additional ARR, you will typically need to raise and invest at least $8M of capital.
This monetary need suggests raising a new round of $10M or more just after reaching MVR, to give you the resources and time to reach MVT—and a little beyond—before you need to raise later-stage capital. Refer to the chart at the end of Chapter 2; there you can see that the median capital raise for startups at MVR is about $11M.
Unlike your last capital raise prior to MVP, which was based upon team, market opportunity, and some early customer/consumer wins and adoption, you will raise this round (or not) based on your business performance. Your valuation will be a function of your growth velocity (how fast revenues and/or usage rates are growing over what period of time), CAC, CAC ratio, gross margins, new logo attainment, churn rates, etc.
“I’ve found that success in an enterprise software company can rely so heavily on the acquisition of certain clients. For example, at Salesforce, customers become emblematic of progress and tipping points. At Krux, we were an early stage company with great ambition trying to get our legs under us through the acquisition of our first top customer. However, we had a chicken and egg problem; to acquire a paying customer we needed to already have another top customer on board. Catch 22.
To overcome this hurdle we employed a clever sales hack. Our very first customer was a friends-and-family deal with a prominent digital media company. I knew the President, called him, and I said ‘Hey this is a $0 license. It’s free, but I need you to issue a press release saying you licensed our software.’ And they did. That moment was an inflection point for us that changed the trajectory of our company. It created a patina of momentum with a hint of shock and awe. Companies in our space were whispering ‘What’s going on with Krux?’ That single tactic created a Hollywood façade of pure demand-gen. It was never a rampage, but customers started coming to us like moths to a flame after that.”
TOM CHAVEZ, CEO & Cofounder, Krux
Whereas your last investor deck led with an overview that featured the market opportunity and your product and a few customer/consumer testimonials, your new investor deck must begin with and feature the performance of the business. Mid-to-later-stage investors get excited about performance first; everything else is secondary. They want to see evidence that the proverbial dogs are eating the dog food.
I find that most entrepreneurs, even at this stage, make the mistake of featuring their product first in their investor decks. It’s understandable, because they are proud of their innovation and that is what works with prospective customers and consumers. But that isn’t necessarily what savvy early-stage investors are evaluating. If they are experienced, they look for teams who have identified a big problem or opportunity with a large and addressable market ripe for disruptive innovation. This interest is why early-stage entrepreneurs in the go-to-product phase should lead with a story about “epic change” in a large market and how they intend to disrupt it before diving into their innovation’s product features and a demo.
A mid-stage investor deck, which still requires an epic story up front, must quickly move into an overview of the startup’s performance featuring the quantitative over the qualitative. You must lead with “here is how we are doing,” not “here is how great it will be.” The product overview and demo should come after your epic story and performance discussion, not before.
I know some venture investors will disagree with me about what elements an investor deck should prioritize first, second . . . but I’m basing my comments on watching the reactions and comments from my partners and other investors over hundreds, if not thousands, of early-stage startup presentations.
The vast majority of startups that reach this point have raised venture capital previously. The process of raising capital this time is virtually the same; identify firms and GPs in those firms who have demonstrated an interest in startups at your stage and have made investments in the market(s) where you participate. This time, you will be walking in with actual performance metrics that demonstrate that you can build a product and acquire users cost-effectively. Feature your metrics. Then show them how big the market opportunity is and how you will become the category leader in it.
So, what are investors looking for to ensure you’re ready to begin the scaling process? My Wildcat partner Bryan Stolle breaks it down as follows:
Planning and Achieving the Plan—Investors want to know whether the startup can make a plan and execute it. This may sound obvious, but it’s surprising how many would-be entrepreneurs fail at this. We have found that there is a high correlation between startup teams that consistently meet or exceed their plans, and successful venture returns for investors and significant wealth-creation for the founders and employees. The key parts of the plan and performance to plan that will be most scrutinized include the product delivery plan, the hiring plan, and the sales or user adoption plan.
Attract and Build a Team—No one can go it alone. Nothing has a bigger impact on eventual success than the quality of the team. Great entrepreneurs build great teams. Great teams produce great results. During the MVR stage, investors will be more interested in a team with great multi-role players that are getting it done, than in an executive team built for the future.
User Adoption/Sales Execution—Investors will focus hardest on the level of repeatability demonstrated in user adoption or customer acquisition. Is there some rhyme and reason to “how” and “why” customers are acquired? The company should now have a decent grip on: a) who the target user or customer is; b) what an effective product positioning and sales pitch lo
oks like; c) the primary sales objections; and d) what causes churn, user abandonment, or low engagement. It should have solid use cases with demonstrable ROI, and the ever-critical success stories and reference customers. The company should be ready now to hire real salespeople, or invest marketing dollars in user acquisition, and expect the investment to be reasonably effective and efficient.
For investors, the most compelling metric will be rapid period-over-period (week, month, quarter) growth rates, but only as long as the customers or users meet some of the following criteria:
Average Annual Contract Value (ACV) or Annual Revenue Per User (ARPU)—The size of the average transaction, usually measured in terms of ACV or ARPU, tells an investor a lot about the viability of the chosen business model. In an enterprise SaaS company, for example, ACV usually needs to be north of $75K to produce enough margin to fund a direct sales team. In a self-serve model, ACV will typically be much lower. For ARPU-driven models, there isn’t a hard target number or range, because the viability of the model at any given ARPU is so dependent on customer acquisition cost (CAC), but as a data point, Facebook’s North American ARPU at the end of 2017 was over $13.00/user. Investors will want to know not just what those metrics are today, but what the trend looks like. What do the trends suggest about long-term steady state, and achieving a profitable business model?
Revenue expansion/Engagement extension–For B2B, will the customer be buying more (more users, more apps or modules, etc.), and how often? For B2C, is the user engaging more frequently (or at least holding steady), and is there any evidence of a viral effect?
Traversing the Traction Gap Page 19