I know many veteran entrepreneurs would agree that “Raising venture capital is the easiest thing that a startup founder is probably ever going to do.”
Marc Andreessen said that the venture capital business is a 100% game of outliers- it’s all about extreme exceptions.”
“…think about it…there are on the order of 4-5000 ‘fundable’ companies a year, that want to raise venture capital.”
“…and about 300 of those will get funded by what’s considered a ’top tier VC’; about 25 of those will someday get to a 100M in revenue…”
“…and those 25 from that year, will generate something on the order of 97% of all the returns for the entire category of VC in that year.”
In this episode of Market Dominance Guys, Corey asked Chris to tackle the mindset around this Venture Capital seduction process and break it down with eyes fully open to its true purpose and function. Who should you have on your team to really give you the brutally honest feedback you need…before the VC enters the picture? And most importantly, how can you ensure that your VCs goals and YOUR goals are properly in alignment?
This is the Market Dominance Guys: “The Hard Truths about Taking VC Funding”
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The complete transcript of this episode is below:
Corey Frank (02:34):
I just find that [inaudible 00:02:35] entrepreneurs, especially if they go into a traditional VC, they're not getting that to be true to the process. Maybe a list of ventures with their book seems to have that template on the process. And I think a lot of VCs and financial institutions are following that model from that PE firm. But the vast majority, they're not clinging or adhering to maybe financial process controls. But nothing outside the realm of doing what you're talking about, which is validating, vetting the customer persona profile, finding the three pieces of information, trying to get it done in quick cycles, not 500 days, not 50 days, but trying to get it done in a couple of weeks, to then rinse, lather, repeat. So where is that disconnect where they're unaware that that is helpful? It seems contrarian to how a traditional VC operates giving guidance to an entrepreneur today.
Chris Beall (03:37):
It's actually competitive without a traditional VC operates, which is why you don't see VC encouraging them. Because the VC is actually interested in putting money to work, and then maybe having a win and having high salvage value on the losses. So the three things you've got to do as a VC is you've got to fund with too much money. You have to put the money to work. So that means you want to invest in companies that need more money later. You certainly don't want to invest in the ones that don't need more money, right? Because you have this other problem. If you were running a venture firm that had a very small fund or sort of an on demand fund with limiteds that were quite happy to have their money not invested, unless it's going to be a win, then you might run a process that emphasizes early on making sure that we have a product before we build the product.
Chris Beall (04:28):
I mean, a VC that focused on that would actually just have to restructure their portfolio to say, we're always going to win, but we're never going to own as much because we don't get to put as much money to work, but we'll be happy doing that. We'll end up owning 8.7% instead of 87%, but we're going to win a hundred percent of the time. And we're still going to have the same unicorn ratios, so to speak. We'll still have the same big home run ratios, but instead of salvage value, we're going to eliminate salvage entirely and always build companies that work. It's actually impossible to build a company that doesn't work. If you go through the initial process of making sure that somebody wants your product and will buy enough to cover the cost of developing the darn thing and taking it to market, that's a working company a hundred percent of the time.
Chris Beall (05:19):
It may not be huge already, but you can actually repeat the process over and over. You can say, Hey, wait. Now we're in this market with this product. Let's find out if this product described a little bit differently with this message, can go into this adjacent market. Now, instead of one big monster market, I can go take market after market, after market. That's why the series that I've been doing on LinkedIn is called Market Dominance. It's not dominance of imaginary [inaudible 00:05:46], it's dominance of actual markets reduced to lists. When you reduce the market to a list, you have a shot at understanding what it would take to solve a problem for enough folks in that list, for enough money, that it covers your cost of building the product in the market, the cost of going to market, and the cost of supporting the product.
Chris Beall (06:07):
And you can do that a hundred percent of the time because here's what's funny about this whole situation. What comes out of discovery is completely reliable. In a discovery meeting, if you run a discovery meeting with the correct fidelity, it's like a super MRI machine. It's like a CAT scan from heaven. It tells you who needs what. And if you choose to be so bold as to ask what they will pay for them. And you can even discover through implementations. Now you can't discover this and discover it. Through your first five implementations, you can even figure out what does it take to make it work in the real world. Can you do five implementations before you take them on it? Probably. After all, VCs don't fund the Build a Products anymore. They expect you to build the product in the garage because they're so easy. So now really what is the VC funding? They're funding to go to market of a product that they don't know if it has a fit in the market. And that's the VC's risk profile, which is where all the problems come from.
Chris Beall (07:10):
The root cause of all of this is building products that don't have a place, a known place in the market to solve a known problem for a known person is within a company, so it solves the further problem, who knows how to buy it. You know, it's the unknown. You started this out, you asked the great question, which is what are the unknown unknowns? [inaudible 00:07:32] unknowns are. Does anybody need what it is that we're thinking about building? What would they pay for it? What would it take to implement it in the field? What other element of the ecosystem must be brought to healed? That is, do you have service providers? Do you have integrations that have to be done? Is there training that's needed? Our product is a great example. We need to train people on how to hold great coal costs because what's the point of having 10 times as many conversations, if you suck?
Chris Beall (08:02):
So our product naturally in its natural way, if you just unleash it like a coyote into the wild, it doesn't behave like a domestic dog. It behaves like a damn coyote. You have to train the thing to sit, lie down, and roll over. Don't pee on the carpet, quit killing the cat. Would ya? Our product is very dangerous in that sense, because it's so fast. It has to be tamed. So we had to learn through the implementation process, because you can't learn this through discovery. You learn it through implementation.
Chris Beall (08:35):
What needs to be done to have the problem actually get solved without blaming the customer for their failure to do their part? That is the step after discovery and that's the hard work. And that's the one thing you might need funding for. Because implementations, unless you can figure out how to charge enough for these things, for the whole thing, you could end up underwater. Now, I believe that there are ways to avoid that if your product is tight enough and small enough, and then you can wrap it up in some services. There's a safe way to use services as an adjunct to a product without becoming a services company. And there's rules that are easy to follow, like don't charge for the services, or if you do charge for the services, make sure that there's no goal associated with the services number. So don't give somebody that number, that tail will wag the dog every time.
Corey Frank (09:30):
And that's a common pratfall as it is, because you see companies and the software, especially in our space, they have a great software and the tech or market stack. They love it. People enjoy it. It's a klugey install. And then some CFO or VP of sales has the bright idea to say, wait a minute, if it's complicated, that means we can charge for it. And if we can charge for it, I can have a whole team of professional sales, engineers, poster, pre-sales engineers, et cetera.
Corey Frank (10:03):
And I could create a high margin product line, and in essence, you keep following that process, that flywheel and it leads to more frustration from the customer, more fear from the customer side that we fall this false flag of the Accenture model where the implementation is never done. In the new world, you're saying that just the opposite should be true, because we want intuitive, simple products that fit three needs, one of them emotional, ideally, and we want them up and going. And that's how you get to market dominance, is more people using a product, not fewer people using the product. But you're charging more for it with not just the software, but the professional services element as well.
Chris Beall (10:48):
Exactly. If it turns out that something needs to happen to make the product succeed and actually solve a problem, that work needs to be done it's fine to coordinate that work. It's fine to do that work. It's even okay to charge for that work. But if you ever give somebody that number, they'll sell that work and they'll sell every other kind of work that's close to it. The problem with services is service offerings have no natural boundary. Product offerings have a natural boundary. The product only does so much. I can only use this coffee cup for so many things. I can't actually ask it to drive me to the airport. It doesn't work. I could ask a person holding this coffee cup to drive me to the airport as a service. Okay?
Chris Beall (11:34):
So say that person's original job was to fill the coffee cup and bring it to me and make sure that it had the right coffee in it, but they're charging me for bringing me the coffee. And I could say, by the way, I'd like a ride to the airport. What's that going to cost? And they're going well, I get my commission based on how much services I charge. There's a services revenue I bring in. Yeah, I'll give you a ride to the airport. And then they say, wow, that's great customer service. But where's the boundary? I went from serving coffee to driving people to the airport. And that's what happened. That is the tail that wags the dog. And the problem is those services are an essential part of filling out the rest of the product. You can't build every feature. You can't make every integration happen.
Chris Beall (12:17):
So take integration services, a very, very common problem. In the software world, my software must always work with other software. I can build out every possible integration in advance. My problem is I don't know whether my first customer is going to have exactly that version of that thing, whatever that is, their CRM or their accounting system or whatever. I don't know what that's going to be like. And even worse, I don't know how it's configured. So I may think I've done an integration with Salesforce, but have I really done an integration with Salesforce that takes into account the fact that they use contacts for leads and that they customize the contact object? So some of its lead characteristics have to do with these additional fields, some of which were interpreted three years ago, one way, and then we changed the interpretation and they mean something else now. That by the way is the standard. That is the standard for all CRM. It's the standard for all enterprise systems. They're full of these overloads of fields that have values that used to be one way, but now are another way, where you have to interpret it.
Chris Beall (13:18):
Well actually, if it starts with an A, what that means is all of this stuff is in there. You can't integrate to a piece of technology in advance, and know that the implementation of that integration out of the box is going to help solve the problem that you are trying to solve. Services will be required. The question is, do you charge for them? If you charge for integration services, which by the way, have no independent value. So one of the rules for services is if you charge for stuff that has no independent value independent of your product, you have a real, real problem. Your problem is that, that piece of the business will run away with the business. And yet it has little appeal, so you'll undercharge. And now you'll end up with negative margins on your services.
Chris Beall (14:05):
So this happens all the time, right? So you've got to be very, very careful. Services are required. Think of it as ongoing product development costs that is not capitalized, it's expensed. Keep track of it very, very carefully and make sure it's enough to make the product work, that the feedback that comes back from the services is what tells you what to build next. So the first iteration of that product is three features that are going to solve real world problems that somebody has a field for. The second set of features are the ones that come back from the gaps that show up in services. We keep doing the same thing over and over. Let's product test that. Some of them are full, some of them are platforming. They're like, we have one in our product. We call it integration architecture.
Chris Beall (14:51):
We do our integrations out of a pre-wired integration to Salesforce, to Microsoft Dynamics, to whatever. And then we just have to do non-coding work. So taking coding, where it can turn into non-coding work by building a platform with configuration switches in it, is a way to make your product more robust without solving a new problem. You're not solving a new problem, you're solving the problem of fitting into the world that your customer lives in, and doing it without ever increasing services revenue that somebody owns. And they go, Hey, I'm going to go sell more of them integrations. You also avoid the conflict because services revenue often is charged by time, by the hour. So you have an inherent problem, which is the person who owns the services revenue number wants things to take a long time, and you need short cycles to actual usage of the product and delivery of results.
Chris Beall (15:48):
So the longer the services, the longer the cycle time between the sale and actual realization of value. And that's where the fundamental risk of the businesses is that cycle time. So you increase the fundamental risk of the business in order to make some revenue that has no value for you in the long run. It's a huge mistake. I think if we were to reduce it to a recipe, the recipe is this. We need to take our [inaudible 00:16:15] close deals because you need implementations because that's the next part of the feedback.
Chris Beall (16:18):
Corey, I tell you, I believe we're onto something here. And you know what the next natural thing for someone to do is, and this'll be on the recording so it's okay. Someone who wants to run a different kind of investment operation, who simply says, look, if you have an idea, bring your idea. And instead of having the Vista style book, which is very, very late, have the early book that says, the name of the fund is it's the Hundred Percent Fund. A hundred percent of all the companies that we launch. It's not one of those incubator blah-blah-blahs. Actually, it's a process machine in which the entrepreneur and their passion is inserted. And five weeks, six weeks later, a product pops out, and that product goes and dominates its first market. Within three years, it'll be complete dominance, but its assurance of dominance happens within six to nine months. But it's a runaway math problem at that point or best solution.
Corey Frank (17:22):
That's right. I think you're onto something on that as well. It's certainly needed today, as you said, that there's ubiquity of products, but there is a scarcity of solid go to market advice. I have a plethora of MarTech, ad tech, sales tech tools in my stack that I can amplify the suck.
Chris Beall (17:45):
Corey Frank (17:45):
Right, as you say. But if I don't have the clean closed-loop strategy feedback loop to expedite my five pivots, that invariably I'm going to hit. Pay me now or pay me later. I'd rather do that, and front load those versus backload those which is going to cost me time. It's going to cost me people. It's going to cost me ownership, and it's going to cost me potential market dominance issues, et cetera.
Chris Beall (18:11):
Corey Frank (18:12):
And marriages. That's right.
Chris Beall (18:16):
[inaudible 00:18:16] friendships settled. I mean, really when you come right down to it, time doesn't kill all deals, time kills all companies. And it kills the relationships. It kills the human side. Frankly, it's just too hard to go climb these mountains if it takes too long, and people's relationships fray when they're asked to be in the lifeboat with somebody for two or three years before they figure out if there's a destination. So I think really you come right down to it, the big issue is the human cost. We're sending people to war, and we're sending them to war unarmed and unprovisioned. and the brave ones get through, and then we say, well, look at that. Well, it was one in 10. But you know the one in 10 that make it as unicorns go in and examine the human relationships, examine the history of the human relationships in those companies.
Chris Beall (19:10):
And then ask yourself a simple question. If this had happened in one fifth of the time, would these people still be friends? Would they still have intact marriages? Would their kids still know who they are. And that's really what's going on here, is the innovation economy is a beast and it chews up human beings in a way that is not good. It's not good. It's absolutely necessary. It's the current war. If we don't fight the war for innovation, we have issues, really big issues. So, somebody's got to go out there and do that, that hard work, but we don't have to do it in a way that destroys people's lives. This is my entrepreneurial passion. This is why I'm doing connect themselves. Helping investors make money, that's not that interesting to me.
Chris Beall (20:03):
I've been in the startup world since 1984. That's a long time. I've done sincere startups, one after another. They take too long. They hurt too many people. Yeah, they sound glorious and all, but if you really go in and you really dig in and say, realistically, what happens? What happens is human beings get chewed up in a machine made out of ignorance. They attempt to solve the ignorance through the application of money, and the money poisons the relationships, and it actually poisons the companies themselves. So this is a way of getting the innovation economy to work in a fundamentally different way, by dispelling the ignorance and reducing the amount of time you need to spend in the lifeboat together, and making it much more like something that we know how to do. We should know how to do innovation. And the bottleneck of innovation is go to market, not invention. This was beyond delightful and exceeded expectations. And my expectations were pretty darn high.
Corey Frank (21:04):
Oh no. It's you have so much rattling in that brain of yours. Right. If I could do a matrix and just plug it in, and fly a helicopter out of what's in your head, learn Kung Fu or whatever it is that's in Beall's brain. That's great. Forget inside John Malcovich.
Chris Beall (21:21):
I love it. I'm now fascinated by an idea that I hadn't really thought of before that you and I might be able to work on, which is you might know some people who are open-minded enough to make a new kind of investment thought.
Corey Frank (21:36):
Oh, my buddy Ori Isen. We did 41st parameter. He's on [inaudible 00:21:42] right now. So he's good buddies with Morton Meyerson who is a very keen, savvy investor with this type of humanistic approach. Absolutely. I think that's something that we should talk about it. Beyond incubator and it's beyond VC, it's something from the heart.
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