Two Questions that Separate Seed and Venture Investing

This evening, I had a conversation with a close friend building a great business. We were talking about his growth and the company’s current operations.

My friend’s business is growing efficiently but slowly. He’s keeping his burn low and avoiding unnecessary costs as he demonstrates that he can build something pretty phenomenal, using the customers he already has. Unfortunately, when he goes and speaks with venture capitalists about upcoming rounds, they’re skeptical. They’d like to see him demonstrate that he can make some maneuvers to grow even more rapidly.

It’s a more common complaint then you’d imagine. Early in your business’ lifecycle, all you care about is building something that can last. Your early investors harp on you about product-market fit and your constantly terrified of running out of cash. Then, all of a sudden, when you’ve found your product market fit, you start getting asked about growth. People start worrying that the business isn’t scaling as fast as they’d like.

As someone who has bridged seed stage and venture investing (however briefly!), this is an issue I can identify with. When I deal with seed stage businesses, I am often thinking about their viability. Is there a market for them to exist at all? When I am dealing with businesses that figured out there is a market for them to attack, I start thinking about whether they can capture it. One is a theoretical question. The other operational.

For entrepreneurs, the best way to identify with investors is by understanding how they are approaching issues. When you’re early, your investors are asking:

Can you build something people want?

Building something that people want is not a question of efficient use of capital and timing. Assuming that a problem goes unsolved, and your solution is good enough to drive adoption of a new “thing,” then building something people want is rather binary. Either you deliver something great or you don’t. Early stage investors often get involved with businesses before this is established. In order to succeed, they need their entrepreneurs to create great product.

Not running out of cash is an important thing. But running out of cash is inevitable. And growing rapidly is a luxury their entrepreneurs can only afford once they deliver product that is truly differentiated.

If a team is in the right market, with compelling technology, just executing on the building something that people are willing to buy is good enough at the earliest stage of investments.

When you’ve established that you are building a product that could see some real adoption, the biggest risk to your business comes from an inability to execute. The biggest question becomes:

Can you grow the business that provides things people want?

Growing a business is a very different challenge that building something that people want. Growing a business means competing with all the other folks who will copy you. It means spending capital effectively and judiciously, but knowing when to turn the burn up to capture growth efficiently. It means dealing with people issues, negotiating partnerships, and dealing with the mundane reality of things like accounting, legal, and financing.

Once you’ve proven that you have something people want, investors immediately identify these risks as those that pose the biggest challenge to your business. Can you actually overcome the barriers in front of you. At this point, your business is no longer binary. It’s worth something - you’ve proven that. But it’s only worth a lot if you can take it and scale. The faster you can build something big, the more it’s worth to investors. The faster you can build something big, the more likely you’ll see returns in the short run.

It’s here that a lot of early entrepreneurs fall down. After months or years of being questioned on the merits of your idea, this is the point where people start questioning you about things like scaling more rapidly. To your investors, all of a sudden, it makes a difference that you’re growing 6% a month instead of 12% a month. It seems crazy to you at first... but when you dig into the numbers you might realize that change makes the difference between building your revenues by ~4x and ~8x in 2 years. When you’re investing in a real product, those differences matter. And testing that your entrepreneurs can deliver against those slightly higher numbers is critical.

Once you’ve de-risked your business from a product market fit perspective, this becomes a big deal fast. As entrepreneurs, at this point it becomes your job to back solve into the numbers you need to deliver and figure you how you can create a plan to get there.

The challenges of operations before and after establishing product market fit are very different. But the change happens on a dime. It’s often hard to prepare for inside the company - luckily or unluckily, the investors you turn to for new rounds of financing will remind you of this fact. As an entrepreneur, it’s important not to be caught out of the blue by this. Building a great company is a marathon. As soon as you tackle one challenge, you’re off to the next. Product market fit is important. Scaling quickly and efficiently is too. Be ready to create that growth plan and execute against it. Have a hypothesis about the numbers you need to hit to be appealing in new financing rounds relative to your peers. And then make sure you create a plan to get you there.

If you don’t, you’re planning to answer one critical question, but not the other.