Selling Equity vs Product: “It’s a Dessert Topping and a Floor Wax!”
VC Pattern Recognition – Startup Blog Series
When a NewCo is founded (let’s assume this is an enterprise SAAS company), the CEO often assumes multiple departmental lead roles: VP of Sales, VP of Product Management, CFO, web site designer, barista, etc. In meetings, depending on who attends, the CEO must shift responsibilities, change interpersonal styles and recast their message for each audience. When a CEO turns their attention from selling equity to venture capitalists (i.e. Raising a round) towards selling early product to customers, a deceptively profound context switch occurs. While these constituents seem related, they come from separate tribes. It turns out, creating a customer is orthogonal to creating an investor.
Startup CEOs with fundraising scar tissue know that raising a round entails dozens of repetitive meetings with venture firms. Like Bill Murray in “Groundhog Day”, the CEO lives in an infinite loop, performing the investor presentation over and over. All that iterative delivery and audience feedback creates a silver lining though. NewCo’s story may crystallize into a shiny, coveted object.
As a venture capitalist who attends more pitches than I care to admit, when an entrepreneur delivers a command performance, the encounter can seduce me like a beguiling spell. I hear soft echoes of the VC incantation: “give me $1 and we will give you back $50 when we exit.” I scan the five-year P&L showing revenue growth and find a SpaceX rocket launch trajectory. I notice goosebumps prickling my arms. I consciously manage my breathing. I internally voice my mantra, “there exists a narrow gap between vision and delusion.” But my resistance is futile.
Now Series A is raised. Cash is wired. We investors, like pigs as sizzling bacon, commit to be your equity breakfast. We too switch relationship roles - from prospective investor to board member. Our oversight perch moves to the upper bleachers. Our sight lines shift towards governance. What becomes obvious, we don’t carry much depth of customer understanding. In my experience, VCs rarely attend a sales call to hear the product pitch and watch a prospect’s non-verbal reaction. We vaguely understand a value gap may exist between product and market. But we carry an optimist’s banner. NewCo’s results will exceed the “exact estimation” plan we invested in.
An unusual byproduct arises from these countless fund-raising meetings. The CEO is so unconsciously immersed in depicting a momentous future – game changing v7.0 features, 1000s of customers, accelerating network effects – that NewCo’s success starts to feel like manifest destiny. Vast risk assumptions fade away. The Kool-Aid tastes not only sweet but refreshing. Future is mistaken for present, by both CEO and investor.
The CEO must now dispense with any fundraising preoccupation. It’s time to land customers. Regardless of how often investors invoke the royal “we,” results rest on management. Releasing v1.0 beta, NewCo’s shiny future slams headfirst into a cold, foggy reality. Offering, what in retrospect looks like a comically deficient product, the assignment is to find users willing to buy a sub-optimal solution.
One mistake I’ve seen CEOs commit is they appropriate their fund-raising deck as basis for their product pitch. It reminds me of the old Saturday Night Live ad, “New Shimmer’s a dessert topping and a floor wax!” In reality, these narratives don’t blend well together. For VCs rarely use the product and customers don’t own NewCo’s stock. The pitch that seduced investors now seems divorced from customer acquisition reality.
Finding early traction is one of the most vexing challenges in a startup’s climb towards relevance. For customer needs remain veiled. Governed by organizational circumstance and regulated by the world’s most powerful force: inertia. Often, prospects don’t know what they want from a product until it’s placed in front of them. With little market buzz, the channel doesn’t care about reselling NewCo. Potential technology partners don’t care. Obstacles surface everywhere.
Moreover, borrowing from the investor deck, NewCo’s sales pitch, whether by reps or the CEO, evangelize a half-baked game-changing “platform” that over-reaches on claims, induces a long sales cycle and raises customer fear of job obsolescence masquerading as digital transformation. The sales conversion funnel morphs into a mushroom shape, wide at top and narrow-stemmed.
One underlying metric that can re-shape a compelling value proposition and overcome prospect inertia is time to value. What Intuit founder Scott Cook called, “moments to joy.” Or, for a trial user, how many mouse clicks does one need to feel that dopamine rush?
To shrink moments to joy, there’s a product definition paradox that teaches us less is more. It seems counter intuitive. But to be more compelling, the product must do less. The idea is to target a narrow user profile with highly relevant yet accessible sales pitch. The aim is to deliver a quick and dirty “Aha! User” experience, conveniently automating a core but annoying job task. Once a user starts to care about the product, like a burgeoning romance, mutual trust develops. Users begin to reveal coveted insights into where the longer-range business value exists.
NewCo’s product roadmap may no longer resemble the one illustrated in the investor pitch. Big product ideas get temporarily shelved. Consistent with reducing customer adoption risk, preliminary pricing may be free or a one-time transaction fee. Whereas a subscription model provides investor endorphins, to a new customer, it can signify lengthy obligation. First PO’s may bear little resemblance to modeled unit economics. In short, version one of NewCo may look nothing like version three.
The journey of Splunk provides a useful illustration. Early on, most investors and competitors dismissed its v1 offering as a simple troubleshooting tool. Or as Paul Graham of Y Combinator would say, “A toy.” Splunk’s early use case narrowly defined a handful of tedious IT administration chores to automate. Once installed, the customer Aha! Happened within minutes, surfacing unexpected IT events, tapping users’ curiosity gene. With hundreds of subsequent users engaged, Splunk received a well-spring of product roadmap insight. What started out as a toy, scaled into a $30B data analytic platform over the ensuing 15 years.
Of course, a strategy shift going “vertical” to get “horizontal” can appear as though NewCo is underselling what the product can ultimately offer. It’s scary to relinquish product optionality (a dessert topping and a floor wax!) And corresponding addressable market (families and house cleaners). The CEO may justifiably fear this appears a drastic change in strategy, an all too cynical bait and switch from what investors funded.
Investors know that customer traction never takes it cues from an Excel spread-sheet plan. When early results lag the fundraising plan, NewCo’s CEO should suppress the impulse to perfume quarterly results and upgrade long-term guidance, which compounds the problem. It’s better to diagram how the customer relationship journey is not static and will morph over time. By explicitly distinguishing the operational difference between raising money and creating a customer, the board will see the correlation between short-term customer lands and long-term shareholder value creation.
Nick Sturiale, Managing Partner, Ignition Partners – 7/16/20