I know of a company that thought they would be in this category. They ended up raising a very large seed round (1MM+) from a VC and pre-negotiating a follow-on of equal size, should they need it. That way the expectation was set from the beginning that this company might take some time to build out their product and see traction.
It's smart, because the discount for the follow-on was pre-negotiated, so investors get perhaps a more favorable discount if the company is a run-away success, and the entrepreneurs were able to buy peace of mind, and could count on the money regardless of macro-economic forces.
They ended up raising a very large seed round (1MM+) from a VC and pre-negotiating a follow-on of equal size, should they need it.
So my guess is that these founders were either already successful previously, were well connected or had already bootstrapped quite a bit of the technology that would underlie the product (ie patents, team, etc...). Any or all of that the case?
It was an experienced salesperson who saw an open market, paired with a repeat startup CTO.
They did their research and validated the market by finding prospective customers before raising. Which is a good model to remove risk from any venture – especially one that would take many years to build.
I would argue that three 22 year olds on their first startup shouldn't be building a product that can't be validated by the market in one or two years.
Define validate. That is kind of the crux of my question. If it means "profitability" then that is a different threshold than "users." I am trying to figure out what PG is trying to describe.
It's pretty obvious when it happens but it's most definitely not profitability. Rapidly growing usage (ie, traction) with an envisionable business model is usually sufficient. While the revenues themselves are not strictly necessary, it does help to demonstrate the ability to collect them.
I an not too sure about this. The debatable issue is should any investor give them any money or not? Since I doubt it almost never happens we probably don't have the data to know if it would work or not.
>They ended up raising a very large seed round (1MM+) from a VC and pre-negotiating a follow-on of equal size, should they need it.
Just out of curiosity why not just raise 2MM+? What value is there in this to the investor unless they have the ability to back out of the prenogociated follow-on? It seems like an expensive way to get no peace of mind?
That would be an exceedingly weird financial term. In effect, it would commit the investors to fronting cash, but give the managers an option as to whether and when to accept the cash at the agreed price (and deliver shares) or to reject some or all of it (and return cash).
Just from practice, you'll never see this from normal (professional or practiced) startup investors. Nor will you see its identical twin, the required second tranche.
You have to find investors who share your vision, trust your team, and are smart enough to know the business is capital intensive. I've been on 5 teams that did this successfully.
Being rich/connected is great, but there's a third option: Show early traction.
Isn't that the point of those companies though, that you aren't seeing traction for a while? It could be that PG is making the distinction implicitly between revenue/profit and traction.
So for example twitter, FB etc... were not profitable or getting revenue well after they had already amassed millions of users. If that is the case, then we aren't learning anything new and it doesn't help people who are trying to make new, hard, breakthrough technologies.
If you've managed to gain traction with a service that has a clear business model (Twitter and Facebook would obviously qualify) then you are on the right track. Booking revenues is good but mostly because it demonstrates that you can book revenues, not because you actually need the cash.
I think one thing that rarely gets mentioned, is that startups get harder.
As in, the more traction you show, the harder it becomes to continue that traction, or alternatively, more traction is now expected of you. Combine this with the increasing complexity of a growing machine.
Maybe PG's analogy is that at first it starts off a pinch, but grows to be a very large guillotine until you finally can outrun it.
So if someone starts a company that is in this category, is it just dead in the water if the founders aren't already rich/connected?