“Investing in pre-seed startups is more like a lottery than a science”
Execution is key for a young startup company that wants to raise money, argues Daan Moreels. In this column, Imec’s entrepreneur in residence gives some golden tips and tricks for young entrepreneurs that want to start a business.
Article originally appeared on Startup.be:
Raising capita is a never-ending discussion topic with all the start-ups I’ve met, advised or co-founded. Yes, cash is king, more money really solves problems. At least if the foundations are there. And one of those foundations should be the hard and essential lessons learned in the market.
The start-up entrepreneur usually operates in a resource-poor environment, constantly on the lookout for people and money, while the investor seems to have too much of the latter. The result is often that start-up founders develop a sort of hunter’s mentality, where people with money become an (easy) prey.
This column is for starting entrepreneurs. You have been working on an idea or a product for months or even years and now you understand that it’s time to find a few hundreds of thousands of euros to fund your future career. But it’s also for you, the investor, on whose door the start-up founders are knocking.
Crisp and Clear
The problem is that many of the start-up entrepreneurs believe that it’s only a matter of convincing and perseverance when pitching early to investors. It's true that perseverance and convincing is important, but effectiveness is equally important here.
There are a lot of people with tons of money and they are basically a prey for start-up entrepreneurs. Investors exist in many different formats; you have professional investors such as accredited business angels and VC's, you have seasoned entrepreneurs ('smart money') and you have tons of 'Joe the plumber'-people with some extra funds on their banks.
They too are interested in investments that have a potential higher gain, but they don’t always understand the risk. But from a group’s perspective; don't underestimate these Joe's. They represent more than 250 billion Euro on Belgian bank accounts. VC funds only account for a tiny fraction, so our Joe's are the ones who'll be financing the start-up ecosystems of the future.
Why? As you probably know, professional investors don't take much risk so they are usually not interested in a bunch of guys with nothing more than an idea. So, to find initial funds, the start-up founders focus first on the well-known 3F (family, friends and fans).
"Ditch the business plans and let the world tell you which direction you should be going"
I remember this mission from a couple of years ago when we were starting out with cloudalize.com. Literally knocking on neighbor’s doors and explain why cloud computing is the future. And you learn quickly. Every time you pitch a neighbor, or the neighbor’s father, or the local butcher, you’re forced to simplify your message to the extreme, to a point your CTO becomes angry because you are making fun of his product.
But it's necessary because your family and friends have no clue what you are talking about, so you make it easy for them, hopefully to a point where they think: "if this guy is right, I’ll be missing the opportunity of my life to get rich without working for it".
And okay, some of them don't do it for financial reasons, they just want to help you out. But nobody invests his bank savings in something he doesn’t understand, so as a start-up founder, you better make sure these people understand what you are talking about.
My advice to the young start-up entrepreneur. I get that you’re going through a tech transfer, you have been working x years on the product and the product is extremely complex. Bear in mind that it will be crucial to work with key messages that are crisp and understandable for average Joe, or you won't see a dime.
Understanding the market
I invite you to look at this from the investor's perspective. A scenario that I often see: start-up entrepreneurs work weeks or months on investor decks, business plans and financial projections while they are not able to respond to simple questions such as “why do you think your future product is a must-have?” or “why do you believe that the low-hanging fruit is situated in this particular market?”
Those are simple questions that are difficult to answer. At least if the startups haven't done their homework first. That homework is called ‘execution’, and more specifically ‘the execution of market research and customer detection’. During this phase (‘customer development’ is the official name), the questions above are asked and the market answers. (I deliberately say, "the market" and not "friendly early adopters" because the market has no compassion with you and your product. In other words: if your product sucks, it should be said).
"Engaging with the market is the only way to validate your potential product"
Engaging with the market is the only way to validate your potential product. So, ditch the business plans and let the world tell you which direction you should be going. Lack of market discovery eventually leads to lack of product/market fit or nothing more than a nice-to-have product nobody is waiting for.
When I ask these questions, some start-up entrepreneurs come up with holistic stories without much structure or clarity, and even after 30 minutes of pitching, I still don't understand whose problem they are going to solve, with an immediate red flag as a consequence.
Effective start-up entrepreneurs are specific and use short sentences, full of facts showing that they know the market and the new trends affecting it, better than the ecosystem itself. Needless to say, that the potential for a successful product solving a real market pain immediately became a lot higher.
A vision that matters
When considering a very early-stage investment (pre-seed) in a tech start-up, the potential of the product is not the most important thing. At the start of the venture, the product is still under development and will change over time. As you know, start-ups operate in the Wild West of entrepreneurship, and as such don’t have a black- and white scenario.
Studies have shown that investing in pre-seed start-ups is more like a lottery, than a science. However, there is one parameter that should be checked in more detail: the capabilities of the team members and how they executed in the past.
To increase chances of survival, the founders should have specific personal characteristics. And these characteristics are endurance, vision development (the capacity to develop and drive a clear vision based on market insights) and adaptivity(the ability to adapt quickly by continuously integrating new market insights in the ‘business model under construction’). The latter is called execution and is very different from writing a 100-page business plan.
"A great vision converts people from potential investors to ambassadors"
The road to a viable product with a great product/market fit is a multi-year process. The problem however is that start-up entrepreneurs need money in the earliest stages too, they must start somewhere. That’s where the importance of having a vision comes in.
The products they are building may not be finished yet, but the vision is strong and based on expected trends (trend-stacking). Look no further than Steve Jobs and Elon Musk: a great vision converts people from potential investors to ambassadors. And indeed, later, when the company grows, other factors such as product roadmap, sales etc. will play a bigger role, but a compatible team of team members with the right characteristics and a great vision might be unbeatable after all. And guess where the vision comes from? Market discovery, yes indeed!
So, start-up entrepreneur, work on your first impression with an adequate discovery of the market and a powerful vision backed with market trends. Collect the facts and include them in your investor decks and websites.
Write about market pains (content marketing) and translate them into value propositions which everybody understands. If you are doing this job very well, your chances are now pretty high that investors come to you instead of vice versa.
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