Careful What You Wish For

High-potential startups are practically defined by their ability to rapidly grow their revenue, so naturally, startup founders and CEOs feel tremendous pressure to get on the revenue train. However, be careful what you wish for!

Building a big, fast-growing, and ultimately profitable business is the very definition of high potential. Some ingredients that go into such businesses are massive markets, novel innovations, competitive advantages, and the potential for solid margins. Rapid revenue growth “proves” most of these variables and the potentially virtuous cycle among them as described below:

• Massive markets: Big markets have many customers willing to pay for the new product or service. Eager customers will open their wallets to get the new thing that addresses their unmet need, resulting in revenue that grows in triple-digit percentages.
  
  
• Engineering, scientific, or technology-based innovations: Scalability is often found in technical innovations that do not require proportional staff increases to power revenue growth (professional service firms counterexample:  law firms, consulting firms, IT services firms, and accounting firms grow revenue by adding more attorneys, consultants, developers, and accountants who can bill their hours, requiring growing staff to increase revenue). Pharmaceuticals, medical devices, software products, and electronics are all examples of innovations that can benefit from massive scale advantages as they grow, enabling attractive price points and powering revenue growth. One of the best tests of the attractiveness of an innovation is whether the startup can demonstrate product-market fit, which really means demonstrating that there are customers (a market) who want to buy the product in sufficient volume, as shown by substantial growth rates.
  
  
• Durable competitive advantages: Patents, trade secrets, scale effects, and other advantages keep competitors out of the arena, which drives customers to the unique startup that can offer its attractive innovation. This accelerates revenue growth and provides the startup with some pricing power.
  
  
• Potential for solid margins: When the fundamental cost required to deliver the product or service is a fraction of the customer-perceived value created, while avoiding competitive pressures, this situation can yield strong margins that allow for further investment in rapid growth.

Thinking about that virtuous cycle of growth ingredients reveals why investors relentlessly push startups to demonstrate rapid revenue growth, which de-risks their potential investment. They push by asking about customer traction updates in every conversation. They push by telling startups that they need to have at least $1M in revenue before they will consider investing. They push by relentlessly asking their portfolio companies to invest in a sales force before they even have begun to figure out the sales positioning. However, that very pressure also reveals the danger of jumping into the market too soon. Be careful what you wish for and when you make the leap, startup leaders!

The very fact that fast revenue growth proves these critical success factors for high-potential startups also means that launching too soon can be a recipe for disaster. If the product isn’t ready (and I don’t mean that the engineers are still fiddling on the margins, which is when you need to push through and launch) or the regulatory hurdles are not cleared, or the supporting data and testimonials from early adopters are not secured, you run the risk of creeping rather than launching into the marketplace.

Imagine a plane that just cannot generate enough speed to create the sustained lift to fly into the sky. Instead, it bumps up and down, trying to get off the ground. That happens when the product has not yet achieved the critical elements that matter to customers. It could be that an essential specification has not been met yet. It could be that the clinical trial performance has not yet exceeded the required thresholds. It could be that manufacturing or operational bugs prevent consistently achieving requisite quality levels. It could be that the strength of the testimonials from a small handful of early adopters is not yet in hand or is not strong enough to excite other prospects.

When these critical developmental milestones are achieved because the unmet need is great and the product hits the mark, early customers’ momentum, energy, and excitement will provide that necessary thrust to get the plane moving and lifting off into the air. It is a crucial management judgment call to find the right balance between “done enough” and “needs a bit more investment in development” to achieve liftoff. Such judgment requires a deep and intimate knowledge of the product, lots of feedback sessions from real prospective customers on prototypes to gauge the readiness of the product, and an acute awareness of the need for and ability to execute compelling marketing and the level of investment required since resources are almost always constrained in the early days. Regardless of the pressure from investors, management has to focus on moving forward as rapidly as prudent so that liftoff is achieved rather than a sputtering progress. Sputtering can easily undermine the confidence of investors, running the risk of both running short on cash and being unable to raise when the launch is rockier than anticipated.

Story #1: After years of product development, a beta testing surprise caused a top-tier venture investor to walk away and the lead VC to revise the signed term sheet to a 50% lower valuation. While the round was ultimately closed, the product launch was delayed by almost a year for required product refinement, followed by extensive beta testing to ensure it was time to launch. Lessons learned? Challenge your product prototypes in real-life situations with real-life customers to ensure your understanding of critical performance specs is correct – and be careful not to launch into beta testing while trying to close a venture round.

Story #2: With regulatory approval in hand for a medical device for a smaller market indication while still seeking approval for a larger market, jumping into the smaller market means declaring that the company has moved from the pre-revenue to the commercial stage. The change in stage-related metrics investors are focused on may be hard to achieve with a smaller market. Lessons learned? Consider the timing of launching and potential synergy into various markets when you have multiple launch opportunities since smaller markets may make achieving the rapid growth investors are looking for more difficult.

Story #3:  Launching with an MVP product can begin to demonstrate product-market fit. However, the limitations of an MVP can also mute customer enthusiasm, resulting in a slow roll as features are added. This can cause investors to question the market size, customers’ willingness to pay for innovation, and the growth potential. Lessons learned? Be careful what you promise, and consider whether staying pre-commercial for longer might position you better for launching energetically.

This post is filled with caution flags about launching too early and the risks of shifting investor pressures for startups. In some ways, it is a pushback against the pressure to take crazy risks in the hunt for a unicorn, which I have seen sink startups. Yet, in closing, I want to acknowledge that for some startups, bootstrapping with customer money or taking advantage of the speed startups can achieve are viable strategies that I have already written about. At the end of the day, this is a question that only the startup team can wrestle through, hopefully with eyes up and clear about which set of risks they are embracing.