The Building Blocks (Pt.1)

Hello! Hide Sustle is a blog exploring the intersections of entrepreneurship, finance, and psychology. Welcome to the first edition. 

Enjoy! 

Note

The following framework is relevant to anyone who wants to build a business or a startup, but it is specifically geared toward those founders looking to build a Venture Capital-backable startup. 

What does that mean? 

What is the difference between a business and a startup?

What constitutes a VC-backable startup?

Startup vs. Regular Business 

There are some distinct differences between a startup and a regular business. The first is revenue expectations. The goal of a business is to generate revenue from day one; the startup focuses first and foremost on gaining users for its product or service. For the startup, this may result in immediate revenue-generation, but it is not expected nor necessarily the goal, especially if it gets in the way of rapid and exponential growth. 

This leads us to another significant difference: the rate of growth. A conventional business typically experiences slower but steady growth, aiming to gradually increase its margins over time. In contrast, a startup's objective is to achieve exponential growth within a short timeframe by gaining widespread adoption of its product or service.

This underscores why many startups pursue Venture Capital funding. The ambitious growth objectives of startups often necessitate external financing. This capital is crucial to sustain founders, scale their team, and meet the substantial production demands required for rapid expansion. A startup founder might prioritize market share acquisition over immediate revenue generation in pursuit of growth.

Venture Capital Psychology (a quick overview) 

When a VC looks at a potential investment opportunity, the first question they ask themselves is this: Does this startup have the potential to be a fund maker (a company that returns the entire fund)? 

In an extremely oversimplified and non-exhaustive summary of the basic fund structure of a venture capital firm: 

Within a VC firm, there are people called Limited Partners that supply the fund with capital. These LPs can be family offices, pension funds, university funds and / or angel investors (high-net or ultra high-net worth individuals). 

The General Partners are those individuals working within the fund that manage the money for the LPs. They invest on behalf of the LPs. The GPs make the investment decisions - essentially, whether or not to invest in your startup. 

Every fund generally has a time limit that usually equates to approximately ten years in which they need to return the fund - this is the time frame within which they need to invest and have provided returns for the LPs. 

A VC wants to see the following from an early-stage startup: 

• A clear and validated need. 

• In a hot and growing market hungry for a solution. Here the market potential should be in the billions of dollars. 

• A competitive founding team who are the perfect people to capitalize on the market opportunity. 

• A competitive edge - also known as the moat. This is something that you know that your competitors don’t (which gives you a competitive value proposition), or an advantage (technological or otherwise) that you have over your competitors. 

• Some semblance of a business model - an idea of how you will make money. 

• A competitive and effective go-to-market (GTM) strategy. 

• Traction - the team has been hustling and there has been clear evidence of progression. 

To be considered a VC-backable startup, you must understand what kind of investment a Venture Capitalist is looking to make - mainly, one that nets the largest ROI possible, on the order of hundreds of millions of dollars.

This is a great article by NfX which further breaks down “The Psychology That Drives Investing Decisions.”

Now, on to the main event. 

There are only a handful of things an early-stage founder should be putting the majority of their time, energy, and effort toward. I have listed them as questions for you to ask yourself.

In this piece, we will be focusing on the first question and doing a deep-dive into its underlying components and nuances. 

Have you discovered a problem worth solving?

To make sure, you have to go through the problem validation process. There will be some nuances here. One could argue that any problem is inherently worth solving if it positively impacts even one person's life, but in this framework, we are focusing specifically on problems that lead to billion-dollar ideas. We are focusing on the problems that, if solved, will provide the problem-solver hundreds of millions of dollars in Annual Returning Revenue (ARR). 

[Remember, this piece is geared toward anyone who wants to build a business or a startup, but specifically it is addressing those individuals that wish to create a venture capital-backable startup, hence the specificity toward solving big problems that net big returns if solved.]

Is the problem you are solving extremely painful to the entity experiencing it?

In relation to this criteria, there is terminology that is often used to describe the type of solution a founder is inventing. In the entrepreneurial space you may hear the question asked of you, “is this [solution / product] a vitamin or a medicine?” 

A solution or product is a vitamin if it is “nice to have.” It’s something people and organizations can live without.

Conversely, a product that is a medicine is essential - in the startup realm, it is something that saves time and money in a quantifiable and scalable way. In this instance, the decision to part with the money it costs to acquire the solution is a no-brainer.

There are interesting exceptions to this rule. For example, every social media app, such as Instagram,  Snapchat, and yes, even TikTok, is inherently a vitamin - nobody needs these platforms to survive (barring those who have created businesses reliant on them, but again, prior to the existence of these platforms, this was not the case). However, these platforms became akin to a medicine due to their addictive qualities. 

The pain in this instance is human beings' psychological tendency to avoid the fear-of-missing-out (FOMO), and our need for connectedness - we succumb to the social pressure of being on these platforms. And if you are someone who has established a revenue-generating presence on these platforms, you are all the more embedded within them.

Today, they have evolved into self-made medicine, because they remedy the very pain that they cause. 

Generally, a solution that is a vitamin is solving a problem that is not very painful, while a solution that is a medicine is solving a very painful problem. 

But how do you know if the problem someone is experiencing is very painful?

The ramifications of the answer to this question determine the future difficulty you’ll have gaining customers and market share, your level of competitiveness in the market, and your ability to hit your projected company milestones.

Unless you are building something you believe will prey on the psychology of human minds - unless you are inventing cane sugar - it is imperative that you choose a problem that is extremely painful for the entity experiencing it. 

We will go over how to understand whether someone is experiencing a painful problem in a future piece which discusses how to conduct unbiased Customer Discovery Interviews. 

Are there many of those entities that experience the very painful problem? 

The problem should be extremely painful to the entity experiencing it, and there should be a large number of that entity who experience the painful problem. 

In a Business-to-Consumer (B2C) or Direct-to-Consumer (D2C) narrative, this means many (as in millions) of people experience the painful problem. 

In a Business-to-Business (B2B) or Business-to-Government (B2G) narrative this means that a few large corporations with larger budgets experience the painful problem. 

The reason for this distinction is because, depending on the type of entity you are targeting as your customer, you are playing a simple numbers game.

If you are selling a direct-to-consumer product and aiming for $100 million in annual recurring revenue (ARR), achieving this through a $10/month subscription model would require approximately 833,333 paying customers ($8.33 million per month / $10 per customer). 

Alternatively, if you are targeting large corporations with large wallets, you need fewer customers paying you a higher monthly or yearly dollar amount to equal the same ARR. 

Why $100 million in ARR? This is an exceptionally hard milestone for startups to achieve. Today, I would argue that achieving $100M in ARR should be the metric by which a venture is considered a unicorn.

To be clear, for early-stage ventures raising pre-seed and seed money (and even for ventures considered growth-stage raising Series A and above) this is not a metric you have to achieve before you raise - quite the opposite. But this should be the venture’s potential. Remember, you are selling the dream to the VC that you have the potential to be a unicorn. This example, therefore, is representative of the scale at which an entrepreneur should be thinking. 

The question to ask: Is the market I am targeting big enough for this type of revenue generation to even be a possibility?

You might be thinking, but there are a lot of well-known direct-to-consumer companies who do not generate revenue from their consumers. You would be correct. There are many different types of business models a startup can implement, and many different “lines of credit” that can be taken advantage of. But know this: if you are not paying for the product, you are the product. To be more explicit, you are paying for the usage of the product with your data. 

I am not advocating for you as the founder to have a fully fleshed out business model - this is nearly impossible in the beginning phases of any startup company. But, if you aren’t making a product whose prime metric is usage (which in some ways enables you to put off who and how you’re going to charge, as long as you accumulate a large enough pool of users - and therefore a large enough pool of data and eyeballs to market) you should have some inkling of how you are going to make money. 

All this talk of market share and potential revenue has not even touched upon your industry landscape, competitive edge, the market share the current largest players in the space hold, etc. We will get to that in a later piece.

Of those many entities that experience the very painful problem, are they willing and able to pay for a solution to solve it? 

Your ideal customer should not only be willing to pay, but have the ability to pay. If you are promoting a luxury product to lower socioeconomic individuals, they may want your product and be willing to pay for it, but they won’t have the means to. 

Similarly, when targeting large corporations, you not only have to validate that the organization wants your product, but that they have a percentage of their budget allocated to the purchase of such a product or solution (and if not, you should make sure that the sales cycle to divert a portion of the budget to your solution is not centuries long).

Back in the day, I attempted the difficult exercise of coming up with a valuation for the pre-revenue venture that was Koala. I fleshed out both Top-Down and Bottom-Up analyses of the market potential and attempted to perform discounted cash flow analyses by building various Profit and Loss statements estimating the timing and cost of customer acquisition. 

During the process I came across a piece of writing that I believe would be sacrilege not to share with you. 

I hope you found that as enjoyable as I did. 

Fin! This marks the beginning of a series that explores the different stages of building a Venture Capital-backable startup. I hope you found this introduction informative and entertaining.

- Ariella

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