One of the more popular questions I get is, “What do you look for in a startup?” Startupland is part art and part science, so I’m always looking for frameworks and ideas to increase the chance of success. One of my favorite frameworks for what to look for in a startup is the Triple T: Team, TAM, and Timing.
Everything starts with the entrepreneurs. Where did the idea come from? Why work on it? What’s worked well so far? What hasn’t worked well? What’s next? There’s a story or arc to the entrepreneurial journey. Part of it is listening for examples of uncommon grit and perseverance that will prove beneficial as challenge and obstacles continually present themselves. Part of it is feeling the emotion in the pitch and assessing how that will translate to recruiting team members, finding investors, and signing up customers.
After team, the next area to assess is the Total Addressable Market (TAM). TAM is a way of asking the question: if all goes well, how big can this startup get? The best startup ideas are ones where the TAM is small today, but fast growing, such that in 7-10 years it’ll be a huge market. Of course, predicting the future is terribly difficult. On average, entrepreneurs I talk with don’t spend enough time thinking through TAM and pursue ideas that appear too small in the long run. TAM should be small today and massive tomorrow.
We’ve all heard someone say, “I had that idea years ago.” Being too early is no different than being too late. Much like Goldilocks choosing the bed that was just right, timing needs to be just right. Ideal timing is starting a few years ahead of peak market adoption such that there’s a strong foundation, great team, quality customers, and an excellent story. Then, when the market really takes off, all the pieces are already in place. For timing, be a little early, but not too early.
The next time you’re thinking through a startup idea, or talking to an entrepreneur, use the Triple T framework and assess the team, TAM, and timing.
In Christopher Nolan‘s thriller Inception there’s a important line repeated throughout the movie, and every entrepreneur should know it:
An idea is like a virus. Resilient. Highly contagious. And even the smallest seed of an idea can grow.
Cobb (Leonardo DiCaprio) in the movie Inception
Of course, an idea is the starting point for every startup. Only, a well constructed idea must be like a product. It needs to be nurtured, refined, and marketed. Value comes from impact and distribution. Too often, entrepreneurs get caught up in the general progress of the business and let the core idea languish.
Opportunities to improve the idea abound. Every new piece of customer feedback is an idea opportunity. Every new iteration of the product is an idea opportunity. Every insight from the team is an idea opportunity. Continuous improvement and nurturing of the idea helps it grow.
Ideas are massaged into a variety of formats. In startupland, the common formats are vision, purpose, elevator pitch, one-liner, and origin story. Each style is complementary to the next and valuable independently. A specific style isn’t what matters. What matters is that the idea is nurtured to evolve and grow with time.
Never underestimate the power of ideas and continuously nurture them.
As startup aficionados, we like to think of our understanding of the search for product/market fit and stages of the startup lifecycle as more evolved and sophisticated when compared to our predecessors. Only, entrepreneurs are an intuitive bunch that have been scraping and clawing their way to success since the dawn of time. I’m reminded of this when reading the book Secret Formula: The Inside Story of How Coca-Cola Became the Best-Known Brand in the World recently and learning the story of John Stith Pemberton, the inventor of Coca-Cola, as he searched for product/market fit in 1886:
As Pemberton made his adjustments in the formula for the new syrup, “it was taken to Mr. Venable’s soda fountain for the purpose of trying it and ascertaining whether it was something the people would like or not.”
Here, the pharmacist believed he was onto to something. People wanted a sugary drink that was refreshing and had a bit of cocaine for medicinal purposes (later replaced with caffeine). Then, through an iterative loop of tweaking and testing, came up with the secret formula that has since sold trillions of cases of product over the last 130+ years.
“Ascertaining whether it was something the people would like or not” sums up the most important next step of the post-idea entrepreneur journey.
When searching for product/market, remember that every entrepreneur goes through the same experience, including the inventor of Coke in the 1880s.
Last week I was talking to an entrepreneur and he said something that’s stuck in my mind ever since: feedback is a gift. As entrepreneurs, we have happy ears where we’re continually seeking validation and clues as to the best direction to head. Almost always, the best ideas come straight from customers in the form of feedback. Only, it’s up to the entrepreneur to define the culture and ensure that feedback is sought out and treated as a gift.
Cultures that treat feedback as a gift are self-reinforcing in that they regularly ask customers for input and adapt the business based on that feedback. The more feedback, the more tweaks and optimizations to the company. Sometimes the feedback might get overwhelming, but it’s always better to have too much rather than not enough.
Cultures that don’t treat feedback as a gift are often a monopoly or on the decline. Customers that don’t feel their feedback is heard and appreciated will seek out new providers and vendors. Startups that don’t embrace and encourage feedback aren’t able to adapt and innovate as fast as ones that do.
The next time you’re on the receiving side of feedback, ask the question: does this feel like it’s a gift? Do I want this? What happens to this? Feedback is incredibly powerful and should be encouraged.
Every entrepreneur should work to make feedback a gift in their startup.
Over the last couple years a business concept has dramatically increased in popularity: the North Star Metric. As expected, the North Star Metric represents the most important indicator of the health of the business. Put another way, if you were to only track one single metric for the entire company, this would be it. And in the spirit of the Simple Strategic Plan, the North Star Metric brings clarity to an area that’s often over complicated: measuring what matters.
At a board meeting last week we were talking about startup products that were working well in different portfolio companies and I was reminded of our early fundraising efforts at Pardot. Three years into Pardot we decided to raise money in an effort to accelerate growth. Personally, I started asking people in my network for intros to VCs and we were connected to one in Boston. I jumped on a call with this particular VC and he said something that has always stuck with me, “I just saw Pardot metrics in one of our most recent board decks. When I saw the intro request, I immediately accepted.” Hmm, I thought, instantly knowing what Pardot customer was also a portfolio company of this particular investor.
As expected, there’s tremendous value in having a customer that’s a portfolio company of a potential investor. Potential investors want to talk to unbiased customers. Potential investors want to understand the good and bad about a startup. What better source than an existing portfolio company where there’s a strong relationship and economic interest?
In this example, Pardot was even more compelling to the VC because it was the source of truth for marketing. By incorporating Pardot’s metrics in the board deck, it was telling this potential investor that it was a mission critical product with strategic value to the business.
Ultimately, after meeting 29 VCs, we decided not to raise money due to soft valuations (this was during the Great Recession) and our continued growth without capital. Today, the calculation is completely different. Capital and valuations are much more entrepreneur friendly.
When raising money, entrepreneurs would do well to find potential investors that already work with one or more of their customers. With this comes instant credibility and interest that’s invaluable when trying to find the right financial partner.
Learning where great startup ideas come from is a passion area of mine. Naturally, ideation and “light bulb” moments aren’t actually glamorous, but the ability to profoundly change the lives of so many people creates a sense of awe.
Last week I was reminded of this when hearing an entrepreneur pitch her business over Zoom. Her idea instantly met a number of key characteristics:
Obvious idea that needs to exist in the world
Clear offline analogy that hadn’t been brought online yet
Limited competition currently (some competition is ideal)
Small, high growth market with potential to be massive
Genuine authentic demand whereby people clamor for a solution
Key innovation available due to an advancement in technology
Most ideas don’t emerge fully formed. In fact, the best ideas often come from first exploring a related idea and stumbling upon a better idea. Putting together a simple list of characteristics provides a heuristic to evaluate against. Entrepreneurs would do well to put more time upfront in the selection of their idea, knowing it takes 10+ years to build a meaningful business.
When evaluating business ideas, start with these characteristics and adapt them to your own preferences.
Last week I talked to two different SaaS entrepreneurs that were considering acquisition offers from private equity firms to buy their startups. Historically, it was more desirable to be acquired by a “strategic” (a company that would pay a big premium because the startup fit in so well with their current business) and less so to be acquired by a private equity firm because they were often a “financial” buyer that didn’t pay a premium. Now, there’s often no difference as private equity firms are paying “strategic” valuations for SaaS companies.
Almost a year ago, I highlighted that 2021 will be a banner year for private equity SaaS acquisitions and the prediction proved correct. While I was right, my assessment wasn’t nearly the whole picture. In 2020, many SaaS companies cut staff and burn in response to the pandemic lockdown thereby making them more desirable to private equity firms (cutting costs made many of these SaaS startups profitable, a common requirement). What I didn’t expect was the pandemic to accelerate digital transformation and growth for many SaaS startups, making them more valuable (growth is one of the biggest drivers of valuation multiples). In addition, interest rates dropped dramatically making the value of a future dollar of cashflow more valuable. Finally, for these reasons and others, publicly traded SaaS company valuations skyrocketed (see the BVP Cloud Index).
Before, these SaaS exits to private equity firms were often small to medium-sized (tens of millions to hundreds of millions of enterprise value), but now with the private equity firms getting larger, they are regularly buying unicorns as well (see Pipedrive and Gainsight Exiting to Private Equity). Now, look for private equity firms to do more large and mega deals, along with the typical deals because there’s so much money on the sidelines that has to be put to work.
Finally, this all plays well into the startup community as it solves a long-standing issue of liquidity for entrepreneurs and investors. No longer is the there the concern that it’ll take 10+ years to make money off a quality seed investment. Previously, the it took both building a successful business and finding a great exit via going public, strategic acquisition, or dividends — a tall order. Now, it’s still incredibly hard to build a successful business, but the options for liquidity have grown dramatically, and private equity plus later stage investors are the main reason.
Private equity’s importance is growing dramatically in the startup community, and it bodes well for increased investment in innovation.
Last week I was talking to an entrepreneur that had just received his first real offer to sell the business to a potential acquirer. As an entrepreneur, it’s easy to think selling a startup to a strategic is a fairly routine and common part of the venture world. Only, after being in the game for 20+ years now, I know just how rare it is. In fact, for a “hot” startup in the growth stage ($5M+ run rate) and beyond, a real acquisition opportunity comes around every 3-4 years. And, that’s only after getting to scale with everything else in the business doing well (renewal rates, growth rates, size of addressable market, etc.).
When the first real offer from a potential acquirer comes in, it’s often an emotional experience. Here are a few thoughts:
Don’t Start Spending the Money It’s easy to get dollar signs on the brain and think of all the ways the money can be spent. Stop right there. Fight the urge to think about how the money will change your life as most acquisition offers don’t turn into exits.
Stay the Course Getting a quality acquisition offer is incredibly distracting. Should we sell? Should we say no? How will my life change? What will our employees think? Is it really going to happen? The questions and thoughts are endless. The best thing to do is stay the course and actively isolate the noise.
Find Alternative Options With so much money out there chasing startups, work to create an auction process with multiple parties. Reach out to the private equity firms that have been courting you and see what they’re offering. Secondary stock sales are common now, so there might be an opportunity to sell a smaller piece for financial security and not have a full exit.
Ask For Help Seek out advice and counsel. Find a mentor or advisor that’s been through this experience and lean on them to talk through the barrage of questions. Selling your startup is much more difficult emotionally than it seems.
Receiving a real acquisition offer is a major milestone for many entrepreneurs. But, at the same time, it’s also incredibly distracting. Get help, don’t start mentally spending the money, stay focused on the business, and find alternative options.