Tag Archives: Venture capital

Should a startup be Ramen Profitable?

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An interesting question was popped by Mayank in context of PG’s essay – Ramen Profitable
  • How does/should one take call between growing without being profitable or being profitable and then growing (Ramen Profitable)?

At the minimum once every 2-3 months this question pops in the head of  a startup founder. Should we invest in growth or try to become/stay profitable? If one thinks long-term: investing in growth seems to be the call.  From short-term perspective becoming profitable seems important.  What is the right answer?

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  • Every startup’s journey is made up of many “startup phases”
  • Each “startup phase” is on an average 18-24 months long
    • Phase duration could be different for different startups
    • Different phases for the same startup could be of different duration
    • Typically initial phases are of smaller durations (9-12 months) and the phase duration grows longer with each phase and finally settles at 18-24 months

All phases will typically have 3 different parts to it and i’ve detailed them below:

  • Part 1 (6-8 months)
    • You have certain amount of cash, certain goals  & growth targets that you want to achieve
    • The approach should be to invest in growth & towards achieving the planned goals
    • This is the non-profitable time that will include investing in
      • Development of the next (or first) version of the product
      • Team building
      • Building additional capacity
      • More office space (as required)
      • Customer acquisition efforts
      • New branches / New sales channels / Trying new revenue streams (not applicable for startups in the first phase )
      • And other similar activities
    • The startup will use 40-50% of the expense budget for this phase during Part 1
  • Part 2 (6-8 months)
    • Focus on reducing the gap between monthly expenses and monthly revenues and move towards cash-flow positive
    • No more major investments and laser sharp focus on increasing revenues while keeping costs the same or lower
  • Part 3 (6-8 months)
    • Somewhere in the beginning of Part 3 you should hit cash-flow positive state and become – Ramen Profitable – where your revenues are just above your expenses
    • Post that you need to continue to ensure that the gap between the two increases steadily and as a result start building some cash reserves
    • Couple of months after you hit cash-flow positive (for this phase) you can start considering fund raising options
    • To have high probability of raising funds you need both:
      • Significant growth in this phase
      • Cash-flow positive business operations
    • The above two are positives signs for the investor
      • It shows that you are capable of achieving growth as well as capable of managing your cash flow / profitability
      • Also it puts you in a position where you can continue to exist & grow organically without an dependency on any new investors
    • And every investor wants to invest in a team that can succeed without them
    • Once you raise funds or build adequate cash reserves from internal accruals you can start the next phase and repeat the same cycle

Life cycle of a “startup phase”

  • Part 1:
    • Start the phase with certain cash reserves, growth targets & goals
    • Invest in growth
  • Part 2:
    • Focus on building  revenues and reduce the burn rate
    • Start achieving the growth targets
  • Part 3:
    • Become – Ramen profitable / Cash flow positive.
    • Build cash reserves / Raise capital
    • Move to next phase & repeat the cycle

Practical advice for your VC meeting

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Important: Don’t mistake this post as set of fixed rules, these are just some possible combinations to enable you to create your own scenarios

Some top level things

  • “Before you think of raising big money, make sure your customers trust you with their money” (from Indus’s post : How much money do you need to get started?)
  • Be humble, honest, friendly and upfront
  • Speak the truth
  • Be passionate / energetic about your business
  • Listen Listen Listen
  • Share examples and stories from real experiences
  • Before the meeting – learn about the VC firm and the folks you are meeting via Google/twitter. E.g –  firm background, current portfolio, good investments, info about the guy you are going to meet
  • VC’s job is to punch holes on your business model / ask tough questions. Don’t get offended, don’t become defensive
  • Appreciate and acknowledge good suggestions / good feedback.
  • If you don’t know answer to some questions – DONT BS – Just say “I don’t know. I can get back to you on this”
  • Let it go. Never get into back & forth arguments for proving your point – even if you are right.
  • Show respect for other’s time (a surprisingly big number of founders don’t get it)
    • Note down all action items from the meeting and ensure that you get back on or before promised dates
    • Be on time for all calls & meetings. This is one of the biggest turn-offs
  • Be you. Dress like yourself (but be clean), talk like yourself. Good folks want to meet the real you, so point being someone else to impr

Have your questions

#LeaveTheVcThinking: they have done the homework , they have good knowledge of  the VC industry, i can not fool them

  • Have a set of questions that you would like to ask the VC.
  • It will be great if  you can get in your questions first and garner some useful insight. If not make sure you get some time for you questions at the end
  • Don’t be afraid to ask questions that you will offend the VC.  Good guys will appreciate it  and those who dont even have enough respect for you to answer your questions don’t deserve to fund you anyways
  • What is the background of the firm?
  • What is the background of folks who are meeting you?
  • What investments have they made so far? Any in your geography domain?
  • What is typical range in the size their investments?
  • Which sectors do they normally invest in?
  • At which stage do they normally invest in?
  • What do they look for in a team / company?
  • What value do they bring to the table?

The Team and You

#LeaveTheVcThinking: the team has a lot of passion/fire/determination, they are doing it for the right reasons, they will last & never give up, they will make it happen even without us

  • Don’t rush through your intro, good folks want to know you and your story, so that  they can see inside you and get some key insights
  • Don’t start with talking about your venture – talk about u
  • Start with where did you grow up, schooling, college, work-ex, how did to decide to do a startup, story so far, what makes you tick and all the interesting stories
  • Focus on things, items, incidents, experiences, stories that directly / indirectly relate to you as entrepreneur and your startup. Dont spend time on other things
  • Give timelines of your story. Eg: which year did you graduate in, from when to when you worked at MS
  • Every founder should personally talk about themselves

What does your startup make for customers? What problem are you solving?

#LeaveTheVcThinking: your are solving a real problem that is important enough to potential customers, this product – if done well – can get customers to spend dollars, there are no good alternatives, you really care about your customers, your approach to product development is extremely bootstrapped and iterative

  • Take them on a journey with you, make them see your passion
  • Share the story of how did you get this idea and how was it developed from an idea to a real solution.
  • What do the customers want and how are you giving that
  • Will always be compared to some companies – be prepared. How is Deskaway different than Basecamp? How can madhouse compete with Reliance? How will flipkart compete with Brick & Motar book stores?
  • Respect the competition. Don’t focus on telling why your product is better than competition or what competition is doing wrong.
  • Focus on what you are doing. Tell them how your approach to the problem is well thought off and different as compared to the solutions available in market?
    • You are creating a blue ocean, instead of getting to a red ocean
    • You are going beyond the customer expectation and delivering over and above it
  • Talk about your experience of making & selling the product
  • How are people reacting to it? How are they using it?
  • Talk about real customer stories – how your product is improving people’s lives and giving them an amazing experience

How large is the market of this service?

#LeaveTheVcThinking:  Market is very very large, customer are/ very likely to spend dollars on the kind of problem you are solving, market is no where near saturation / commoditization , if a company can take 5-10% market share the top line will be very attractive

  • Share your understanding of the market both from from top down and from bottom up
  • Top down:
    • Use some obvious data, facts, trends which are available in a public to establish the market size.
    • Share your sources of data
  • Bottom up:
    • Share your supporting hypothesis,  base it on your experience with usage of product and selling the product
    • What will it take to reach annual revenues of 10 L, 1 Cr, 10 Cr?
      • No of customers
      • ARPU (avg rev per user)
      • No of employees
      • Amount of capital
      • Time required
      • No of markets
      • Market penetration level

Product Development / Operations / Delivery: How will you continue to make and deliver quality product / experience at scale ?

#LeaveTheVcThinking: the way delivering & building can be scaled to levels of delivering service to customer when rev is 100 crore,  tech/product is playing the main anchor, it will be possible to find required human resources, business is not dependent on too many human resources

  • Talk about how are you currently building and delivering  (its ok if some of it is mannual / non-scalable today)
  • Talk about about your road map for continuing to improve technology /  operations / processes / automation  at every stage of the company
  • Talk about team which develops the product. What kind of team do you have? Are they competent enough to build the product?
  • How do you find / recruit people?
  • How do you measure / track operations / product usage?
  • How do  you plan projects and track progress?
  • What is your product development methodology? Eg: agile

What are the unit economics?

#LeaveTheVcThinking: you are the master in economics of you business, you are mad about keeping this costs low, the product can be build / sold /  delivered at reasonably good margins , the bottom line will improve rapidly with scale

  • What is the current cost of serving a customer for each type?
  • What is gross margin, expected net margin? (its ok if you are loosing money right now)
  • What are important drivers of costs / margins? How well you know them?
  • How will these costs move as you scale the business
  • What are you doing to improve the economics?

How do you acquire customers?

#LeaveTheVcThinking:  you understand the dynamics of customer acquisition, Customer acquisition can be scaled,  Customer lifetime in months * avg revenue per month > customer lifetime in months * avg cost of serving a customer + customer acquisition cost

  • What are various marketing activities you do for generating good qulity leads?
  • How do you validate leads?
  • Also talk about some of the activities that you tried but they did not work out
  • Talk about your sales process that works on converting that lead
  • Talk about factors of how a customer makes buying decision
  • What are qualities needed for someone to be a likely customer?
  • Economics of your marketing channels (cost vs sales generated)
  • Economics of your sales  channels (cost vs sales generated)
  • Economics of a sales person (cost vs sales generated)

Are you looking to raise money? How much money are you looking to raise?

#LeaveTheVcThinking : you don’t need money but whenever you are ready talk – we want to be the first guys to look at the deal , they will use money well, they can make money for us, they can give us 10x or more returns on investment

  • Show that you are are cash flow positive and are generating enough cash to support our growth (this is also a requirement for doing fund raising)
  • Your preference is continue to spend time building and growing the business, since normally fund raising is a very time consuming process
  • If this meeting is not setup specifically for fund raising – tell them your are not looking to raise money and will probably look at raising 2-3 millions in 4-6 months time frame once you have hit so and so milestones as a business (fill in your timeline and numbers)
  • If the meeting is about fund raising – talk about the amount your are looking how you can use it to really grow the product, expand sales, expand operation , build solid management team and essentially achieve the hockey stick growth
  • How much total money will you need to raise during life of the venture?

Revenues (Current & projected)

#LeaveTheVcThinking : revenues are at good level, growth in revenue is good, revenues can be scaled with funding

  • Share the revenue numbers for last 3 months, have numbers of previous months also handy
  • Monthly growth in revenues
  • Projected revenues for 3 months , 6 months , 12 months
  • Projections beyond 12 months
    • If you dont have them say we haven’t done those numbers but will be happy to get back and share them
    • If you have them handy, share them but point out that beyond 12 months its really difficult to make accurate predictions since things change quite rapidly for a startup

Competition

#LeaveTheVcThinking :  market is large and can support multiple companies, if you continue to deliver high quality service and manage your costs well you will do well, you are well aware of our competition and respect  them

  • Be honest about competition. Never try to show that you don’t have competition – that’s one of the worst things to say, competition validates what you are doing.
  • How are people solving the same problem without our product?
  • Who are our direct competitors? How well do we understand them?
  • Who are our indirect competitors? How well do we understand them?
  • Who are the potential competitors?

VC’s and startups: Looking for the right mating call

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Think of VCs  and startups like animals in a jungle who are looking for the right partner to mate. Just because two lions of opposite sex are roaming in the same area and come across each other, it does not lead to mating. The process of attraction only starts if they give each other the right mating signals.

Similarly investors respond to certain signals and for the process of attraction to start startups need to give those signals out.

Important signals:

  • Team: experience , domain expertise , passion, staying power, etc.
  • Market: potential size should be very large , your products/service /  business model should clearly indicate what problem you are solving and why will you get a significant share of the market.
  • Return on investment (only thing that matters in the end to an investor):  An investor needs to see strong possibility of a 10x plus exit. Which is a function of:

    • A large market
    • Capability of the team with its products / services to take the business to a scale , within 5-7 years. So that the investor can sell his shares @ 10 times the investment price
Apart from the signals investors are looking for, everything else is pretty much NOISE at this stage and should be minimized.

Once the investor sees the right signals, the process of attraction starts. He will come closer to you and your business. That’s when he will look for further details about products , domain, detailed financials etc. He will also spend efforts to learn more about the domain and may involve some domain experts.

He further validates the same thing:

  • Whats are the odds of getting 10-20 X Return on Investment in 5-7 years
  • Whats are the odds of getting 5-10 X Return on Investment in 5-7 years

Once he is reasonably convinced about the RoI.  Next stage for him is to look for all reasons to say NO.  He looks for things about the team / market / product / competition / legal issues – which may put the odds of RoI at a big risk.

  • And if he finds anything which can seriously risk the RoI – he will back out
  • If not, things move forward
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Y Combinator Gets The Sequoia Capital Seal Of Approval

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Techcrunch reports the news about 2 million investment in YC from Sequoia and prominent angel investors (Ron Conway, Paul Buchheit and Aydin Senku) . They also report that YC will now be doing 60 companies / year, up from 40 / year.

This is another big validation for the business accelerator model pioneered by YC and adopted by folks like techstars, seedforum and MVP. The premise of model is that the cost of doing business has gone down significantly. With the right support, guidance and capital of around 15-20K USD it is very much possible for team of Young, Talented , Focused and Passionate entrepreneurs to build a business with significant value. Which means businesses with good user traction, evolved products and business processes, revenues, break-even and more.

These initiatives are obviously good for the VC industry, and its good to see it officially recognized. The specialized and organized support for the super early startups is resulting in stronger startups, which means returns on the investments of the VC firms will be higher and more number of VC investments will lead to creation of successful companies.

Another important aspect of this model is the special focus and availability of active support from founders of companies working alongside in the same batch as well the alumni founders. All of these folks have experienced creating real companies and have unique capabilities, contacts and experience which proves useful for other folks part of the program at YC  / Techstars / Seedforun / MVP.

Read my previous about “First time entrepreneurs (FTEs) – Building businesses in India“.

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