Not All Traction is Created Equal
By Nick Adams
If there is one phrase that VCs use when passing on an investment that frustrates founders the most it has to be, “you’re too early;” generally followed up with, “come back when you have more traction.” For what it’s worth, we try to avoid giving this reasoning without explaining why in one additional level of detail. Often times, when I don’t love the timing of the market, or the team doesn’t seem to be well-aligned with the problem that the company is solving, I usually let the founder know that I’m not going to get comfortable leading a [pre-seed/seed] round into that particular space without more proof that the customer pain point is real enough or that the company has a unique advantage against the competition. And that brings us to the dreaded topic of traction.
On more than one occasion I’ve seen founders run off and breathlessly land new users, pilots, and customers only to come back to the VC who sent them out to get traction to find out it’s not enough. Why?
Here are a few common reasons why traction isn’t always the right traction and reduces the ‘quality of revenue’ of your business:
Current revenue is project-based and there isn’t a clear path to recurring revenue
In some situations, it’s a huge asset to get customers to pay for a product that isn’t fully developed. However, structuring a contract on a one-off basis can give the impression that the use case is not repeatable to a broader set of customers.
POCs do not have clear timelines or success criteria
Companies seem to have endless appetites to test new technology without a clear path to a larger implementation. While pilots and POCs have become a painful reality of doing business, save yourself a lot of headache by qualifying the larger opportunity upfront, before committing valuable resources to a pilot that may be nothing more than a science experiment for a bored employee. Ideally, you will get paid for the pilot and negotiate the terms of a larger deal upon successful completion of the pilot. Short of that, be sure to understand the timeline for the pilot, how success will be measured, what is the budget, who is the ultimate buyer, etc.
Contracts are signed but usage of the product is underwhelming
This is an early indication of future churn. Despite going through the hard work of signing annual or multi-year contracts, if your product isn’t solving a clear problem or isn’t being used regularly, then there is probably still a lot of volatility in finding product-market fit. Each dollar of revenue that does not renew is a dollar that needs to be replaced by new sales to continue growing at a meaningful rate which can make for a frustrating sales and marketing hamster-wheel that constantly needs to generate new pipeline to backfill for lost customers and continue growing at 15%+ per month.
Deal sizes are misaligned with the complexity of the sale
If your product requires an enterprise-level sales and marketing strategy then you need to be able to command near 6-figure annual contract values [ACV] to support the cost of those resources. It’s ok to have a land-and-expand strategy where customers start with lower commitments but be prepared to demonstrate your ability to execute the ‘expand’ part of the strategy. Needing enterprise sales resources to close deals that cap out at $25k ACV does not scale. Conversely, trying to use inside sales resources or product-led-growth for a complex sale rarely works.
Existing sales do not align with the future direction of the company
We occasionally see companies that sold a meaningful amount of software [mid six figures to low-seven figures] but are no longer focusing on the legacy product. This is effectively a pivot that won’t be a reliable indicator of future success with the new strategy and will be discounted in valuation negotiations with an investor.
None of these challenges alone is necessarily a deal-breaker for any given investor but be aware of the potential concerns and discuss risk mitigation during fundraising conversations. In today’s startup environment, nearly every “seed” round really has three rounds to it before reaching a Series A. There is often a pre-seed round or angel round, a true seed round, and a late seed round. As investors, one area of risk we need to assess for any potential investment is financing and the biggest risk to the business is often the aforementioned frictions in revenue growth. Our job is to assess which seed round we are investing in and how quickly the company can get to the next phase without having to put in additional bridge round capital to hit the appropriate metrics for Series A and beyond.
Fundraising is very much a game of momentum and, if you’re growing at the right pace, with a high quality of revenue, additional capital will be readily available.
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