Tuesday, October 8, 2024
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Should Only Startups with Products Get Funded?

The “trend” of startups without a well-defined product idea getting funding was discussed in a recent Forbes blog post. Here’s an excerpt:

Having some kind of notion what line of business your fledgling company might want to pursue used to be a prerequisite to raising capital. Now, it’s a mark of hubris. You don’t tell the market what it needs; you gently offer it a series of options, which are less viable concepts than ritual sacrifices aimed at cultivating the favor of the start-up gods. It’s called “iterating.”

The gist of the post is essentially this: if there’s no product, there’s nothing to invest in, yet people seem to be investing anyway and OMGITSABUBBLEWE’REALLGONNADIE!! (ok, I’ll admit my version has extra drama).

The post doesn’t offer up much to back up the thesis that startups with no specific product idea are getting funded left and right (positioning Instagram as a typical startup is, in my opinion, bonkers) but it raises an interesting question – is there really value in a company that doesn’t have an offering? Suppose you invested in a company with a product, that later changes the offering significantly – does that mean you screwed up?

Pivots aren’t new. Admitting we do them is.

I’ve been involved in loads of version 1 product concept/development/launch exercises I’ve yet to see one where the offering didn’t significantly change after initial customer feedback. At what point in the product life-cycle these “pivots” occur however is shifting earlier and earlier as most self-respecting entrepreneurs have read Steve Blank and are now embracing the concept of early customer feedback and “customer development”. If anything, I think we are seeing less iteration post-investment than we ever have before because many startups are getting it done earlier.

I’d make the argument that previously startups were embarrassed to talk openly about pivoting precisely because we did it after investments (and investment cases based on selling a set product in a well-defined market) were made. We often pivoted, but we were sneaky about it. A shift in target market for a later-stage startup was an “expansion to serve a new customer set” or a “refined market focus” and a major product shift was a “next-generation solution”. Unlike their later-stage peers, early stage startups can more freely come out of the pivot closet because their shifts put less money (if any) at risk and often serve to demonstrate a growing understanding of the market, making them more attractive to future investment, not less.

Just because you have a product, doesn’t mean anyone wants it.

But hey, just because folks have been investing in pre-pivot companies all along doesn’t make it smart (VC returns on average DO kinda stink). Coming back to the question – Is your startup really worth anything before you’ve settled on your exact offering?

Leaving aside the issue of the skill of the team (which is difficult to assess and there’s an argument to be made that previous success doesn’t necessarily predict future success), it still takes two to tango. There are markets/desires on one side and there are offerings on the other. The money only comes when both are viable and a match for each other.

I know there are cases of companies that have developed/launched solutions without knowing what problem they would solve or what market they would eventually serve that were later successful but I think doing it that way requires a lot more luck and effort than doing it the other way around. If you get what customers are trying to get done, why they want to do it, who they are, how they make decisions, how they want to buy and how much they are willing to pay, then you essentially have the basis for a solution because you understand the requirements and the constraints.

On the other hand, simply building and releasing an offering doesn’t prove that your company knows anything about the market or that anyone wants it. You might have that knowledge but you can certainly build stuff without it. And by “stuff” I mean crap nobody wants or will pay for.

So if both have no customers, why on earth would a company with an offering necessarily be more valuable than one without? There is absolutely no inherent value in effort put toward something nobody will buy. The value comes with market knowledge that informs the development of the offering, which in turn, increases the chances of market success.

Is a startup with deep market knowledge but without a well-defined solution yet worth investing in? I don’t think anyone can know for sure but if I were a gambler I would bet my money on the folks that were certain about demand but uncertain about the way to meet it over the folks that had a solution they weren’t sure anyone wanted.

(thanks to Mike McCarrell @mmccarrell for pointing me the Forbes post 🙂

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90 COMMENTS

  1. I have heard of incubator programs allowing entrants who have no firm idea.

    I also hear of VCs backing a startup because they believe in the team not the product.

    But if it was my money, I agree, I would only invest where customers are already buying.

    PS love the captcha

    • Hi Giles,
      The question is really for early stage companies that don’t have paying customers yet – how important is having a set product? I’m making the argument that the value at that stage is more in market knowledge than in building a product that quite likely will change substantially.
      April

  2. Hey, call me crazy, but I think gate for investment should start with a) company exists and b) has a sound business plan. The thing that marked the previous bubble was crazy investments in companies that in hindsight (and most likely in foresight by insiders) did not have a sound business. Anything else is speculation.

    • Hi,
      That’s really my point too. The value is more around what the company knows and understands about the market at the early stages. Where the Forbes article is wrong in my opinion is the assertion that having a set product is really important. In my mind it isn’t because we all know the offering is very likely to change a lot.
      It’s all speculation in the early stages because so many things can just NOT work on the execution side of things but if you can demonstrate an understanding of the customers and where they see value then you are better off than a company that has simply delivered a product but has yet to do any customer discovery.
      April

      • I think the problem is compounded by the amounts of money and the less tangible the returns. Giving 10’s of thousands to an idea is fine but as the bubble accelerates it morphs into 100K’s and more. When everything goes to hell, the VC’s back off completely. Look at VC’s in Canada (are there any?) What I hate to see is good ideas turned down because they aren’t even web-related (who actually builds something physical anymore.) I’m super excited about kickstarter, I’ve been funding video games there that I really want to see made.

        • I would include a web service in my definition of an “offering” – I don’t think it has to be a physical thing.
          My point is that having a deep understanding of a market (who the people are, what they are willing to pay for, how you would sell to them) is really, really valuable. Simply having a product (or a site, or a game) doesn’t necessarily mean you’ve done your market homework. And let’s face it – anything you have available in the early stages is going to change a lot down the road, so saying that the “value” in a startup is the offering doesn’t make a ton of sense.
          My argument is that in the early stages the value is in how much you understand the market you are trying to crack.

          With respect to VC’s in Canada – we had many, then for a while there things looked pretty bad, then suddenly there are quite a number that are not only active but pretty smart in my opinion. And there are incubators galore around here right now. Like you, I love the idea of Kickstarter – it will be interesting to watch that evolve.
          April

  3. Of course you are joking right? No one would seriously read an article in Forbes…

    Anyway, the amount of investment in a startup should be relatively small, i.e. $5,000 – $10,000 enough for the founders to take 3 months and test their hypotheses to determine if there is a market that will buy their idea. That small amount is chump change to a Forbes reader, they spend more than that during a weekend in the Hamptons. So what if they lose their investment?

    Then once the initial research has been done, and a market has been verified with written & signed letters of intent, they can go back and raise some real money to begin the build-out of their product.

    Call it the startup toe-dip.

    And stop reading Forbes. Stay cool.

  4. Hey, we’re just starting to look for investment and we’ve already pivoted several times – not in the product/service itself but in how we talk about and who we position it for. Does that make us more valuable? 🙂

    • LOL – oh sure it does!
      Actually you make me think about how horribly over/mis-used the word “pivot” is. I feel like we need a new or expanded vocabulary to talk about this stuff.
      April

  5. April said “Is your startup really worth anything before you’ve settled on your exact offering?” then commenter Steve had a name for the appetizer funding “Call it the startup toe-dip.” So if we’re talking a low, initial investment to get things rolling, I say yes. $5,000 is low (commenter Steve’s suggestion, up to $10,000) for the expenses associated with the exalted/dreaded demo day but I think it’s a good trend. It provides validation to the entrepreneur(s), gives them a way to pay for graphics if they don’t have a cousin that can do it and let’s them see if they have what it takes to get to the next level of fund raising. I also like April’s points (specifically “My argument is that in the early stages the value is in how much you understand the market you are trying to crack.”) in the body of the post and in the comments section. Pivot happens, know thy market.

    @juliefogg

  6. Hi April,

    I always love your posts and read as soon as one lands in my inbox, if possible. But this time I wasn’t quite sure of your point until your replies in the comments. Seemed like you were just asking questions?

    -Mike

    P.S. No need to apologize, the extra drama was my favorite part; it made me smile. 🙂

    • LOL – people often have that reaction to stuff I say in general so no need to apologize 🙂
      I try my hardest but like all marketing – not everything works around here 🙂
      April

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