Friday, June 23, 2006

Sales & Proving the Biz Model

This morning I had one of those totally coincidental moments where my original lunch meeting called to reschedule but within 10 minutes a friend from out-of-town had called to see if I could grab lunch on short notice. It was great catching up and hearing how well his startup is doing.

My friend has managed to bootstrap a software project off of the back of a very successful consulting business he's built. Now that he has his first paying software customer, which happens to be a very big one, we discussed the possibility of raising venture capital. My friend is smart and has enough runway right now that while venture capital would allow him to expand rapidly he does not need it to keep the lights on. Thus, his goal is to land another major customer in order to increase his pre-money valuation before raising capital.

There is no question that the more milestones he can hit, the higher he will push his valuation. The first major customer is a major accomplishment because it demonstrates that the entrepreneur has solved someone's actual pain, which takes a lot of risk out of the investment decision. However, after thinking about it more this afternoon proving out his business model is really his next major milestone. I think his first major customer puts him squarely into the seed category and if he wants to raise money from angels I'm very confident that he can do this now.

Yet, in order to raise a series A round, I think that he needs to demonstrate that his business model is repeatable, which probably means focusing on getting multiple customers rather than just one more big fish. Getting one customer or even a handful of customers can be the result of dumb luck, timing or even the entrepreneur's personal network. However, venture fundable businesses require many more customers than even the most charismatic CEO can bring to the table. Thus, investors want evidence that leads can be generated and sales closed by employees who do not necessarily share the founder's passion or network of contacts.

How does the company get new customers? Inside sales, outside sales, channel sales, direct marketing, viral marketing? The more data my friend has about how many cold calls it takes to set an appointment, how many appointments it takes to close a sale, how much the average sale is worth and how long the process takes the more evidence he will have that his business model is repeatable. Of course, a repeatable business model also adds credibility to the financial projections... or rather reduces the factor by which the VC is discounting the financial projections. ;)

Management team, product development, barriers to entry and other market factors definitely influence whether or not a startup can raise capital at seed or series A valuations. However, for first time entrepreneurs with out $100K patent portfolios or out of control viral growth the bar for raising a series A round is still fairly high. Once a company has sales, the odds of raising capital increase dramatically, but I believe it is a repeatable looking business model that pushes startups from seed stage into series A.

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