Finding Genius

by Kunal Mehta

  Hartman went on to expand on how Betaworks evaluates consumer engagement and explained it in terms of Facebook. While Facebook has dominated consumer attention, their business, or other social media businesses, are not built on charging the customer. Instead, the business model is to sell the users’ attention and engagement to advertisers. Advertisers are not buying space from a social network based on a cost-per-click or cost-per-mile basis, but instead on how long the average customer spends on the platform, making their views and engagement more valuable. Social media companies are monetizing as media companies and the successful ones run by focused founders have been clear about what they need to measure and why. Mobile game companies is another category of businesses that have had to be strategic with what metrics they measure in order to ensure longer term success. Mobile game companies are often targeting their users to buy in-application power-ups or in-app purchases. Still, some game company founders report on how much time people are playing their games; according to Hartman, this should not be the metric that these founders work toward. Hartman believes that genius founders know what metrics to optimize for when building a company and are able to identify unique ways to improve their operations with those metrics in mind.

  Hartman is one of many investors focused on measuring and evaluating the appropriate indicators of success for a startup. For a founder, being diligent about these metrics and ensuring that every part of the business is moving the needle forward on the priority KPIs helps focus a company’s vision and execution. VCs will ask their portfolio companies for quarterly financial reporting (as one would expect), but are equally interested in the KPIs that drive a business forward. In fact, early on in a startup’s journey, these metrics are all an investor has to determine the value of a company, and the positive correlation of these metrics often leads to investment, or lack thereof. Rick Heitzmann of FirstMark Capital shares his experience with founders who are not disciplined enough to justify getting to a Series A or a Series B financing round:

  “Tracking milestones for your business is important, not only for your investors and your board members but also for yourself as the CEO. This is even more important when you are trying to raise capital. As a venture investor, it’s frustrating when we see founders who could care less about the benchmarks about their businesses and still expect us to invest in them. I often meet founders I like that are still early in the process, but I tell them what milestones to hit over the next six to nine months that would make the business compelling to an investor. Six months later, they reach back out and tell me they’re ready to raise, but they’ve forgotten the metrics we spoke about and haven’t even moved the needle at all in any direction. I appreciate when a founder turns to me and says, ‘I know we have a meeting set up but I haven’t done the things we discussed yet, let’s postpone.’ I know thousands of entrepreneurs on the other side of this equation who are showing they’ve got grit and are working to the next milestone. If you’re an entrepreneur looking for money you should look at the VC’s criteria and ask yourself if you as a founder are meeting those criteria.”

  While investors can be opaque about many of the elements around a successful fundraise process, the venture capital industry has done a good job of documenting the common metrics that are important to meet in a certain industry before speaking with investors. Entrepreneurs should do the work to look at these milestones on what a company must hit to raise a Series A or a Series B round of financing. Beth Ferreira uses these metrics and milestones as a way to get to know founders better over time. She says:

  “If I pass on a business that is early in development, I will be transparent with founders and tell them to come back to me when they have a certain volume of sales or a specific number of paying customers and if they do, I’ll seriously consider investing. I’ll share my concerns and ask them to report back on how they have worked against those concerns. In that process they get to know me as well and that’s how we build a relationship…”

  Taylor Greene of Collaborative Fund shares anecdotes of founders who have leaned into measuring what matters with consumer businesses. To Greene, it is that focus that separates companies in the minds of customers, investors, and board members. These founders have executed on a vision and helped transform their businesses into multi-million or multi-billion enterprises. Greene uses Philip Krim, the founder of Casper — the popular sleep-product company that got its start by selling pillows and mattresses directly to consumers — to illustrate this perspective:

  “The entrepreneurs that are patient and take calculated risks are the ones that stick around the longest. It’s not a perfect calculation but they have just enough imperfect information and metrics to make a decision to move forward. They know where to invest more in their businesses and where to pull back. They know when to move forward and move it in a different direction. It’s a series of decision points and you’re looking for the people with that mentality. For example, Philip Krim of Casper has known the mattress business his entire life. When he was 18 years old, Krim created an online mattress business out of his dorm room that was earning significant revenue. He developed an incredible amount of domain expertise, which he then carried over to Casper. He knew the industry in-and-out but he also knew where the larger incumbents were not investing their time and energy. Philip understood paid search before other people in the mattress industry. He was buying ads against branded terms and doing it better than Tempurpedic. With consumer businesses there will always be paid marketing, so one point of differentiation will be about arbitrage. You need a good product to afford the acquisition costs to allow you to scale and you need to obsessively track these metrics of your business over time to understand what the levers are that you can pull. The channels of Facebook, Instagram, Snapchat exist today, and the new ones of tomorrow will be about where are people going next to hear about your product; but if you don’t have a scalable, organic, repeatable customer acquisition channel that people are talking about, you’re not going to make it. The best businesses have that, and they layer in the marketing to accelerate the growth. Retail e-commerce companies have been successful because they started six years ago when no one knew how to do Facebook acquisition. Now, you have a level playing field and investors used to look for a successful Kickstarter or some signal of some organic benefit.”

  Rebecca Kaden of Union Square Ventures builds on Greene’s point and shares how consumer companies that have raised venture capital should think of customer acquisition in light of raising venture capital dollars. Venture capital often makes founders feel like they will always be able to ‘buy’ customers by spending on expensive marketing campaigns or running promotions. This irresponsible spending is not sustainable. Kaden urges founders to work towards building businesses with strong unit economics even while competing against huge incumbents with larger budgets:

  “We don’t believe that businesses that pay to acquire customer after customer are good venture businesses. They cost too much capital and you don’t get enough leverage for those dollars. You don’t hit the inflection points if you have to pay customer after customer. I think paid acquisition can be a weapon, it can be fuel for the beginning of a funnel, it can speed up funnels later on, it can create arbitrage opportunities. I’m a believer that you need to find consumer businesses that have passionate communities, that are acquiring through word-of-mouth. If you don’t have strong, non-digital paid channels, it’ll be a long, hard slog. The founder’s strategy and ability to scale a core advantage is a key success metric with the consumer companies we’ve invested in. Allbirds demonstrated strong referral and retention metrics. Investors are attracted to a rabid fan base that forms a community with a high level of emotional engagement with the brand.”

  Kaden also referenced Stash (the popular financial mobile app targeting millennials), Glossier, Dia & Co., and Everlane for their ability to build a brand beyond the product by creating and leveraging a strong sense of community. Before investing in a consumer co
mpany, Kaden looks for this cult-like following where consumers wear and evangelize the brand proudly. In these cases, Kaden recognizes that a larger competitor with a more robust acquisition channel or capital flow will have a hard time replicating that organic enthusiasm and tribal fandom.

  Metrics that drive a business forward can be humbling to early staff members and dictate whether a pivot is necessary. Respecting what the metrics indicate about the progress of a business keep a founder honest on whether or not they should continue to pursue an endeavor that is not meaningfully moving the needle towards their vision of the future. Beth Ferreira, previously with companies including Fab and Etsy and now an investor with FirstMark Capital, details her perspective on this:

  “I can’t emphasize it enough, but you need to be very real about metrics and the metrics that are important in your vertical. Every founder thinks they’re the exception. If you only have 10,000 users at the end of year one, you might be screwed. Unless you are having a real conversation about changing the business or you’ve stumbled on some key learning or insight and are now taking a different path, it may make sense to not continue on. In the market, you hear a lot about pivots that were successful with companies like Slack and Flickr, but it’s really hard to execute on those pivots and continue to convince people to back you — especially when you’ve pitched your investors / employees / partners on one set of metrics and goals and now you’re changing your tune completely.”

  While much of this book has focused largely on lessons learned from investors backing consumer-focused companies such as Uber, Snapchat, or Airbnb, there are lessons to be learned from the anecdotes of software companies that sell into large enterprises. Software-as-a-service (SaaS) companies, given the size, structure, and approval process of the clients that they generally sell into, measure their progress through different metrics than consumer companies. SaaS companies track metrics such as total contract value per customer or the number of new customers in a period of time. Investors will often ask the founders of these companies to share details about the company’s ability to expand their product offering across all lines of business or total revenue once they have already won a customer. Given that these contracts typically span several years, annual recurring revenue (ARR) is a common metric that investors track to assess growth. Ajay Agarwal, an investor with Bain Capital Ventures, shares insight on these types of companies:

  “The simple metric I look at when evaluating a SaaS company is ‘burn rate’, which is how much money is a company spending during a certain period of time. I look at burn rate against where the company wants to be in terms of ARR within a certain period of time. How much are they spending in 18-months to hit an ARR target and is that scalable? I look at burn rate as a metric even when evaluating product milestones or key hires. I believe that this metric is one mechanism to drive alignment and focus. It’s a metric the founders can understand because it translates directly to their solution and their survival. If you run out of money, you don’t have a company. So what rate of cash burn can we maintain in order to hit a few key objectives or business goals? That’s the important metric-based question a SaaS founder needs to ask themselves. The brilliance of entrepreneurship is achieving great things in a resource constrained way.”

  The concept of resource constraints shared by Agarwal was one I found particularly interesting and a concept that other investors indirectly addressed. The constraint of not having resources is one that often unleashes innovation because it creates drives focus. It is what forces a founder to identify the white space where the bigger competitors are not actively using their own abundant resources — money, time, employees, or experience — to compete. Being resource constrained forces founders to think of novel ways to go to market or attract talent. Agarwal believes that being resource constrained, measured through burn rate, helps founders remain innovative as they look at how they’re spending a sparse resource like cash while hoping to achieve massive outcomes.

  As a company scales, these metrics continue to become core to a startup’s story. Early on, it is possible for a founder to pitch a grandiose vision of the future to attract supporters, but several years in, the metrics of the company begin to become the only relevant story.

  Building Competitive Defensibility & Reacting to Regulation

  Companies such as Facebook, Amazon, and Apple have entirely diversified their core offering. Facebook is no longer just a social network for Ivy League college students but is now using its trove of user data to enter into workplace tools, healthcare, augmented and virtual reality, mobile messaging, and gaming. Amazon is not just an online book retailer, but instead offers cloud services to all up-and-coming entrepreneurs, is experimenting with robotics and drones, and continues to launch new and innovative businesses targeted at consumers around video and audio. Apple is not just a personal computer or music player. As of 2019, Apple had acquired creator tools and AI companies, entered into music and video streaming services, and (according to rumors) will be entering into the automobile market. Companies like these possess an abundance of cash with which they can enter new industries through acquisitions seemingly overnight. By leveraging technology, they continue to quickly expand far beyond their original mandate of business and enter into new categories or industries. This is a constant threat for wide-eyed entrepreneurs on a shoestring budget.

  Entrepreneurs are often faced with the critical dilemma around competition: What will happen if a large player like a Facebook, Amazon or Google decides to offer a similar product or value proposition? By asking questions around competition, investors hope to gauge an entrepreneur’s understanding of the market landscape and where the competitive threats exist.

  Venture capitalists invest in businesses with defensibility against these threats. To build a sustainable and profitable business, the most successful entrepreneurs build deeply entrenched defensive moats around their company. Warren Buffet is quoted for having said ‘in business, I look for economic castles protected by unbreachable moats.’ These competitive moats protect startups from other industry players looking to steal market share. These moats include network effects, strong brand loyalty, an impenetrable data set, intellectual property, or a high cost to switch off your service or product. These moats may also exist due to a unique advantage created by a changing regulatory landscape. Heitzmann discusses FirstMark Capital’s perspective on moats, explaining how founders can establish superiority through their operations or market segments while larger, slow-moving players are stalled by being less willing to take risks that can disrupt their core revenue streams:

  “In the 1990s the question was: what happens if Microsoft comes into your category and takes over? In the 2000s the competitive threat was if Google entered your market. 2000s to 2020s will be Facebook, Google, Amazon. Most of the big companies can do whatever they want and can get involved and take over your market. As a founder, you need to figure out why they won’t and communicate that. While they are slow to move in your direction, you should begin obsessing over those competitive moats and how you can build them around your business to protect it from bigger players, but also from smaller upstarts as you continue to grow bigger. As investors, we tend to suspend belief around the large incumbents entering your space unless it’s something abundantly clear. We invested in a company called HopSkipDrive when most people passed because they said Uber or Lyft will eventually offer the same service. For Stubhub, investors that passed said eBay will go into the secondary market for ticketing. The founders of Stubhub convinced us that eBay was focused on other key categories. Stubhub developed a moat by guaranteeing tickets and building a supply chain around their offering. In many cases, you’ll see the incumbent of a large industry so wrapped up in their own business model that they are unable to change their whole system of operation. Delivery, pricing, accessibility make these models possible when the larger competitors can’t do it. A founder should show us what their real, tangible competitive advantage is and the innova
tion around why the larger plays can’t or won’t be a problem.”

  As of writing this book, HopSkipDrive is a successful venture-backed startup focused on the ride-sharing economy. With HopSkipDrive, parents can hire trusted drivers to drop off and pick up their children from school. Uber and Lyft, to Heitzmann’s point, could have been seen as insurmountable threats, but HopSkipDrive has carved out a niche for itself. During the pitch, the founders of HopSkipDrive demonstrated that larger competitors often have different strategic interests and are not willing to spend capital or resources on a new strategy, despite it being a large opportunity. The founders of HopSkipDrive claimed that Uber and Lyft were not focused on building a sticky emotional customer experience and were instead preoccupied with acquiring new markets. Embedded in Heitzmann’s perspective is advice on pitching a startup: it’s imperative to have knowledge about where competitors are focusing their resources, and how your startup is differentiated from that. Investors want to know that the founders have a good understanding of the landscape and what forces may impede their vision or execution over the next 18-24 months, or even on a longer-term horizon.

  During our conversations, Josh Nussbaum of Compound discussed the importance of understanding a competitive moat and not mistaking the wrong things as being defensive enough:

  “I see two common mistakes founders make. The first is to overstate their defensibility when it is not really defensible. This often happens with consumer companies who claim they have a direct communication line to their customers. It’s a different world today. It’s tricky to fall into a trap of looking at a past company and saying we’ll run the playbook the same way, when the company was established 30-40 years ago, in a different time, with a different consumer behavior on how they bought or engaged with products. Now everyone is a media company through Twitter or Facebook. No one controls the messaging, so search engine optimization (SEO) or customer acquisition through social media is not a competitive moat. The second mistake is investing and spending money to do things to build this defensibility when there is no sign or signal that there is anything there to invest in yet.”