Startup general interestVenture Capital

Applying lean startup thinking to raising money

By December 17, 2010 3 Comments

The idea for this post, and in fact the idea of applying lean startup thinking to raising money came from a conversation I had with entrepreneur turned angel investor Sean Glass a week or two back.  Sean said he wasn’t going to get round to writing a post on the topic, and so I said I would give it a go.

Those of you who are familiar with Steve Blank’s and Eric Ries’ work on the advantages of being clear about your product and market hypotheses and then minimising the time/resource to test those hypotheses will already have worked out where I am going with this – it makes sense to take the same approach to raising money.  In fact, the process of raising money has many parallels with selling a product to consumers or businesses – it is just that the product is equity in your company and your customers are angels and VCs. 

The other differences between raising money/selling equity and building a business are that you only need to make one sale – or maybe a handful of sales if you are pulling together a syndicate of investors – and that it is perfectly possible for a company to survive and thrive without ever selling equity/raising money – there are lots of other ways to finance a business

As a result only parts of Blank’s ‘customer development model’ are relevant – in fact only parts of the ‘customer discovery’ phase of the model are relevant, and usually important concepts including ‘market type’ and ‘minimum viable product’ are best left to one side.  Additionally in the equity for cash market an iterative approach isn’t always necessary as deciding not to raise money is a valid conclusion.

The aim then should be to figure out as quickly as possible whether you will be successful raising finance (i.e. whether your equity product fits with the VC/angel market), and if not to know why not, and whether it is sensible and feasible to change what you have so that you can be successful.

On a practical basis I think that means the following:

  1. Develop a hypothesis which explains why your business will be attractive to VCs – big market, great product, great team and so on (this will become the core of your business plan should you get to that stage).
  2. Get out of the building and test the hypothesis with anyone who will listen, and the closer they are to a real VC the better.  Does everyone else believe you have a great market, product, team?  This shouldn’t be a pitch and it should be done long before you want to raise money – that takes the pressure out for both sides and which makes it easier for you to get a conversation in the first place and increases the accuracy of feedback.  Being specific will help – social media analytics might be an interesting market, but a focus on Myspace will not be attractive.
  3. Look beyond the words people use to try and figure out what they really think.  Most people are kind and won’t want to crush your dream even if they think it is ridiculous.  Potential investors won’t have heard enough from a short pitch to know for sure that they wouldn’t invest and so won’t say ‘no’ even if they think and investment is unlikely.  Gauge their enthusiasm for your project by their appetite for future meetings – do they offer to meet again?, when you ask do they look away?, do they make time soon or push you out a few weeks?
  4. Talk to lots of people – you only need one to bite and so at this stage if you have half a dozen potential investors who are looking interested then you are in good shape.  This point comes with a caveat – if there is no positive feedback from early discussions there is little point in simply widening the net.
  5. Soak up all the feedback and take a fresh look at your hypotheses.  Be honest with yourself.  Evaluate whether your hypotheses still hold and accordingly either push on to raise money, decide to finance your business from revenue or some other source, or change your company and go back to (1) – i.e. pivot.

The good news is that most good investors make themselves available for this type of feedback – it is how they build their brand and improve the quality of the opportunities they see.  You can also learn a lot by going to startup competitions and other events where startups pitch and VCs and angels give feedback.

Blank’s customer development model was revolutionary in that it sought to change the way companies developed by brining customer feedback into the process much earlier.  Applying his ideas to raising angel or venture finance turns out to be much less revolutionary – good companies and entrepreneurs have always polled VCs early in their development and long before they raise money.  The only part of the thinking that is really novel here is the idea of getting through the cycle as quickly as possible.  It seems to me that the many companies who end up on a seemingly endless fundraising trail would get to a happier place more quickly if they appreciated the value of failing fast (assuming there is an alternative).