Thank you for taking the time to meet with me yesterday to discuss your progress and goals for the next two months.
During our meetings, there were a few themes that emerged. The following observations are concerning so I hope you will read these words carefully. Please understand, these issues are very normal. What you are feeling is normal. Most entrepreneurs struggle with these issues from time to time, including your Sensei. I hope my thoughts below can provide some helpful guidance.
Luke: I can’t. It’s too big.
Yoda: Size matters not. Look at me. Judge me by my size, do you? Hmm? Hmm? And well you should not. For my ally is the Force, and a powerful ally it is.
It’s important not to get distracted on your journey. Time is precious and we don’t want to waste it. I say this with empathy as someone with entrepreneur’s ADD. So, I know what I’m taking about from personal experience having lost focus many times in my journey.
At this stage in your development, there are only two things that matter 1) finding and validating product/market fit and 2) finding and validating your path to customers. Everything else is just noise. And by everything, I mean everything.
In one of our meetings, competition came up as an issue in the mind of a young Apprentice. There are a handful of competitors in the market. They are all ahead of our company in terms of paying subscribers. This has been the case for some time. This was the case before the news that recently came to light.
The news today is that one of the competitors just announced a big funding round $8.5MM. This was a Series A round and it was preceded by a $2MM seed round. Of course, the company is based in the Valley. To date, the company said they’ve shipped 50K units.
Now, we all know that no one in Chicago gets a $2MM seed round. I’m not sure it’s ever happened in the 17 years I’ve lived here. It certainly is not the norm. Without risk capital, we build startups the old fashioned way — with customers. And yes, it takes longer.
The Apprentice, who is clearly distressed by the news, is searching for answers. How can I compete with them? Will I ever catch them? What does it mean for my funding prospects and prospects of my business?
These are difficult questions. No one has a crystal ball.
But let’s think about this. Let’s assume their customer ramp has occurred over their 18 month history. Let’s also assume most of the customers came in during the last 6 months. With these assumptions, it follows that the average customer life to date is about 7 months at best, assuming no churn. At 50K units shipped, that comes to 7,143 paying customers.
Let’s also assume they’ve burned through their seed round completely at this point. Assuming 70% of capital went into customer acquisition, they spent $1.4MM to build their business and acquired 7,143 paying customers. That makes their customer acquisition cost about $196 per customer. Their product sells for $20 per month. Assuming 30% gross margin, their average payback per customer is about 33 months, assuming zero churn. If monthly churn is just 3.0%, their entire program creates zero net present value.
This is not an efficient engine of growth. They have not found a scalable, repeatable business model. This is nothing more than a well-funded startup throwing lots of money at the problem in the hope they will become profitable later.
Let’s look at our company. So far, the Apprentice has spent about $500 on marketing. She currently has 153 customers. The average customer acquisition cost is $3.27. Her average revenue per customer per month is $17. Her payback is less than one month. This is an efficient engine of growth. Imagine what she could do with $2MM!
While it’s true the Apprentice’s business has not yet scaled, there is no doubt she is more efficient in utilizing the capital she has acquired so far.
I’ll admit the competitor is learning more quickly about how to acquire customers. This is the real problem for our company.
The solution is not to be overwhelmed and intimiated by the size of the raise. Instead, the solution is to speed up learning. Run more channel tests. Run them more diligently, more consistently. Do more customer problem interviews, more solution interviews and find more insights that you can leverage into new and creative ideas for product, service and distribution channels. There are plenty of insights to be found in this market. In fact, our Apprentice has already uncovered several key insights and is working to capitalize on them to create meaningful differentiation. Keep going in this direction. Do not become distracted by noise.
Many startups fail, included those who are well funded. Your advantage is that you are small right now. You are nimble. You can change on a dime, without having to explain it to anyone. Just focus on building a better model, on a small scale at first. Then, when you do get access to more capital, you will blow past the other guys who will be out of juice by then.
After all, what’s the alternative? Give up?
I say, keep moving forward. Run your experiments. Learn. Gain insight. Put the insight back into your business model. If you do this effectively, there is no limit to how far you can go.
2. Investors Replacing Customers
"Investors aren’t going to like it if we…"
"We need to do this to attract investors…"
"But how can we attract investors if we don’t have this or that…"
I appreciate the need for investment capital. I really do. But, this thinking is misguided.
More than anything, smart investors want to invest in great businesses. The best way to show this is to demonstrate you’ve created a great business. You do this by following the principles taught in the FounderSensei class.
In general, it’s not a good idea to make decisions based on a hypothetical, mystical investor. This person does not exist.
Replacing a focus on customers with a focus on investors is a mistake. If you do this, you are doing it backwards.
Here’s how the process really works.
Problem => Solution => Path to Customers => Customers => Investors
This is the sequence to follow if you want to be successful. The process doesn’t work in reverse. Investors are not a solution to your money problems. Customers are. Investors will not help you find a business model. That’s up to you. Focus on building a great business and capital will follow.
3. Fear Of Failure
Yoda: That place… is strong with the dark side of the Force. A domain of evil it is. In you must go.
Luke: What’s in there?
Yoda: Only what you take with you.
It’s more clear to me now that we haven’t spent enough time in class talking about fear of failure. Some Newbies are letting fear of failure drive their decisions. This is a mistake.
No one wants to fail. Yet, if you are going to do a startup, failure is part of the process. And here’s the benefit — you will learn more from failure than from success. So, if the point of a startup is to maximize learning, and it is, then failure is a good thing. That’s right, failure is a good thing if you have the right mindset about it.
The worst thing you can do at this stage is to protect yourself by avoiding failure. If you do this, you are protecting yourself from learning. That’s what big, stupid companies do. That’s not what successful startups do.
It’s ok if you fail. Be bold. Test your hypotheses in the real world. Do not be afraid. The sun will still come up. You will be ok, I promise.
Come back to us and share your failures with us. No matter how gloriously you fail, I bet someone else in the group will tell you about an even bigger failure they experienced that makes your failure look small in comparison.
Valentin offered some great wisdom during our meeting when he said, “The fantasy of the business is better than the reality of not having one.” Of course, he was talking about someone else.
The problem with a fantasy, is that it’s just a fantasy.
This is the fear some of us are struggling with. What if my test doesn’t turn out the way I want it to turn out? Does that mean my business is not going to work? Will my dreams be shattered? If so, I better not risk it. That would be too painful. This is not the right mindset.
The correct mindset is this - I’m going to find out if this hypothesis is correct. The sooner I find this out, the better off I will be. If the hypothesis is untrue, then I will simply make the adjustment! It will not be the end of the world. Instead, it will open up new worlds. My business will now be stronger because it is based on true insight and not based on a pile of unproven guesses.
Failure is temporary. Whatever isn’t working, we can change it!
The entrepreneur’s journey is the search for truth. The truth about your business and yourself. That’s all it is.
Running from the truth is the most damaging thing an entrepreneur can do. The truth, as the saying goes, will set you free. Come out of the darkness. Run to the light.
Be not afraid my young Newbies and my young Apprentice. It is your fear that holds you back.