Ask the tough questions

As a pre-seed investor, my focus is on helping founders find product market fit (PMF). PMF is that state where the market needs what you are making so much that almost any mistake you make is ignored and the momentum continues. Facebook with Beacon, Netflix with Flickster, Amazon with Fire Phone, Airbnb with some horrible overseas experiences, etc. These are companies that found PMF and the market was quick to forgive them.

Here is the report card I work on with founders:

My point of view is that any company who gets an A on this in a large market is a decacorn+, which is my goal for all of my companies. B’s can easily be unicorns and C’s can still make an investor money.

The challenge comes because as a free market, investors of all levels of sophistication invest at all stages and many invest in multiple market segments at once, not just education or future of work. That means that the average founder is confronted with people reaching out to them as soon as they show good growth. They may be an ‘F’ on the mechanics of building a huge company, but who is to argue if someone offers you a $1m seed check or $5m series A check anyway?

My advice to founders is to always take the money. In fact, I often advise them to take the money from people who have absolutely no business writing those checks because they don’t understand the business at all. YC Demo days are my favorite example of this. I have a founder right now pushing to get good knowledgeable investors instead of YC angels at demo day, and my response to her is ‘look, your business mechanics are not working yet, but you have people willing to ask no questions and pay you a valuation as if they were working — take the money!’

I advise them that because money is fuel. For companies I’m working with, I’m pretty confident that if I write an idea stage check, the founder can work for three months and either get to pre-seed metrics or not. With pre-seed, six months is almost always enough to get to seed. And with seed, a year usually works great to get to Series A. So $100k at idea, $500k at pre-seed, and $1m at seed. But markets are messy, and in times like this, we overfund those companies.

None of that bothers me. I don’t even mind paying seed-stage valuations for pre-seed companies if I like the founder and need to do that. What bothers me is that founders think that investors know what they are doing. So if someone is willing to write you a seed check, that implies that your metrics are seed-stage metrics. But given the messy market, that isn’t true.

The way that messes me up is that founders are emotion machines. If you are feeling confident because the market has validated you, it’s really easy to skip the hard work above. Blowing people away with your magic, making it easy for them to experience that, making sure they get engaged right away and see even more value a month later — these all take a lot of work. But you can fake growth, especially early, by doing PR, paying for users, etc. The market rewards you for that, and it’s 10x easier than focusing on the mechanics.

My dream would be that the above report card became accepted by seed stage investors, and they all asked the companies for those metrics. I know it won’t happen universally, but as a smart reader of my blog, I hope you will consider drilling down a level on growth and asking founders about these mechanics.

Co-founder and CEO NetGravity, Rocketship Education, Zeal Learning, Dunce Capital. john@danners.org https://dunce.substack.com/

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