September 19, 2016
PUBLISHED BY Bryan Stolle
“I know it when I see it,” said Supreme Court Justice Potter Stewart, talking about pornography. Unfortunately, many entrepreneurs get much the same answer from VCs, when asking the question, “what do I need to accomplish or prove, in order for you to fund me?” Despite many VCs’ inability to articulate what a “fundable” business looks like, there actually is some method to the madness. Our Traction Gap framework lays out a comprehensive series of milestones and deliverables that, if achieved, should allow an entrepreneur to raise money at a lower cost of capital over time.
In my last blog, I dug deeper into the attributes of first major milestone — Minimum Viable Repeatability (MVR). “MVR” follows the minimum viable product milestone (MVP), so eloquently described by Steve Blank and Eric Reis. Like the MVP milestone, MVR is usually reached on seed financing, and is when a Series A is often raised.
Minimum Viable Repeatability (MVR) is the minimal amount of progress from the seed round of funding and initial product launch, that is compelling enough for a new investor to come to the table with more capital. There is enough repeatability in core company functions, particularly around customer/user acquisition, that an investor believes the team has the basics figured out, and the future can be roughly extrapolated.
Once MVR is achieved, the next goal is to achieve Minimum Viable Traction (MVT). When MVT has been reached, the business shifts to the scale-up or expansion/growth stage, and Geoffrey Moore’s Crossing the Chasm model becomes front and center. The MVT milestones are similar to achieving MVR, but the expectations and metrics are more advanced and mature. We have identified four areas or “architectures” that matter most in traversing the Traction Gap: Systems, Team, Product and Revenue. These are the key areas investors will focus on when making an investment decision at the MVT stage include:
- Planning and execution (Systems) – As with MVR, investors are seeking additional confirmation that the entrepreneur/team can make a plan, and execute it. The difference here will be in timeframe. At MVT, investors will expect to see two or more annual planning cycles and results, as well as consistent “up and to the right” performance over 8-12 quarters or more. As a side note, there is always the tension/debate between stretch plans that are regularly missed, vs. more conservative plans that are always beat. Speaking as both an entrepreneur and an investor, the latter is better for a host of reasons. Perhaps another blog topic!
- Attract and build a team (Team) – The focus at the MVT stage will be on whether the entrepreneur/CEO has built a team ready and capable of scaling the business for at least the next two years, as demonstrated by repeatable performance across most key functional areas. The team may not be 100% filled out, but most major pieces should be in place, especially around the product, customer and user functions. Expect investors to ask for meeting with other key members of the team, to assess their skills and experience and readiness for the future.
- Deliver a stable scalable product (Product) – Nothing wastes expansion or growth capital like a bad product that burns up tons of capital on user/customer hand-holding and remediation. There will be a lot of emphasis on customer and product diligence, to make sure the product is ready for prime-time. Especially if you are a B2B company, be prepared with a sizable list of customer references (all of whom you have prepped in advance), that you can spread across multiple investors, so that you don’t overwhelm a small set of customers with too many reference calls.
- User adoption/Sales execution (Revenue) – As with the MVR milestone, investors will focus hardest on user adoption or customer acquisition. The focus will shift, however, to how well the distribution and/or acquisition efforts fared during the scale-out post MVT. What does sales force retention look like? What does new and trained/experienced rep production look like? How many reps are meeting/beating quota? How robust is the sales pipeline? How consistently does the company convert from one phase of the sales funnel to the next? What does the sales cycle look like? As before, investor enthusiasm will be most directly tied to growth rates and predictability/consistency. If it’s a B2C company, what does CAC look like? Is it going up or down? Is there virality occurring? Is adoption accelerating? What is the effectiveness and conversion metrics for various acquisition channels? Be prepared to be grilled!
- Average ACV or ARPU (Revenue) – The company must be able to eventually achieve minimum price points that allow its chosen business model to work and produce a profitable business. At the MVR stage, there will usually be early indicators or data points to illustrate what might be possible. By MVT, there should be very clear consistent achievement of average price points that prove a viable (i.e.: profitable, at least at the unit economic level) business is being build.
- Revenue expansion/Engagement extension (Revenue) – While there may have been some data points on upgrades and addition of more users, or on increasing engagement leading to MVR, as with ACV/ARPU, there will need to be clear consistent and frequent upgrades and/or increased user engagement, that is now proving to be predictable with a high degree of confidence.
- Stable churn (Revenue) – Customer or users exiting out the back door should be occurring at a highly predictable and stable rate to pass the MVT milestone, as well as some evidence that programs designed to reduce churn have had some positive impact.
- Market expansion (Revenue) – At MVR, investors wanted to see sales or acquisition performance that gave some proof to the initial or core market thesis. Now, investors want to see that the company’s market is really as big as projected, that the company is taking market share or growing it faster than the competition, and is winning marquee customers or coveted demographics. They would also really like to see some proof of success in adjacent or extended markets.
You will note that Revenue Architecture question pre-dominate. This is because revenue (a) is the best ultimate indicator that you have gotten the other areas and the business right, and b) it most greatly influences the capital you will need to build out the business.
To sum up, there are early stage venture firms that will invest at MVR, although less than in the past – many VC’s are now only comfortable at the MVT stage or later, partly due to lack of early stage expertise, and partly because they often have to put larger sums of capital to work, which is easier to justify as the risks decrease, and the valuations increase. If you nail the points above and prove you have reached MVR, you should be in a good position to raise capital.