There has been a lot of discussion lately about the markets for startup financing. Many of the discussions use words like “valuations” “bubble” “crunch” etc. Words like that generally mean the writer is discussing the world through the lens of finance. This is a useful lens, but I’d like to suggest there is another lens that is also useful: the product lens. First, some background.
Startups sit in the middle of two markets: one between VCs and startups, and one between startups and customers. These markets are correlated but only partially. When the financing supply is low but customer demand is high, entrepreneurs that are able to finagle funding generally do well. When financing and startup supply is high, customers do well, some startups do well, and VCs generally don’t. And so on.
When VCs get too excited, people talk about a bubble. When VCs get too fearful, people talk about a crash. Historically, downturns were great times for startups that were able to raise money because competition was low but customer demand for new technology remained fairly steady. Downturns also tended to coincide with big platform shifts, which usually meant opportunities for entrepreneurs.
These markets shift independently between different stages and sectors, although there are connections. The amount of financing available is relatively constant, because of the longevity of VC funds and the way most VCs are compensated (management fees). Less financing in one sector or stage usually leads to more financing in others.
The stages are related because the early stages depend on the later stages for exits and financings. The result is a bullwhip effect where changes in later stages (the latest stage being public markets) lead to magnified changes in early stages.
Smart VCs understand these dynamics and adjust their strategies accordingly. Smart entrepreneurs don’t need to think about these things very often. Fundraising is necessary (at least for companies that choose to go the VC route – many shouldn’t), but just one of the many things an entrepreneur needs to do. The best advice is simply to raise money when you can, and try to weather the vicissitudes of the financial markets.
The product lens
Good entrepreneurs spend most of their time focusing on the other market: the one between their company and their customers. This means looking at the world through the lens of products and not financing. This lens is particularly important when you are initially developing your idea or when you are thinking about product expansions.
The product lens suggests you should ask questions like: have the products in area X caught up to the best practices of the industry? Are they reaching their potential? Are they exciting? Are there big cultural/technological/economic changes happening that allow dramatically better products to be created? Sometimes the product lens guides you to the same conclusion as the finance lens and sometimes it doesn’t.
For example, there has been a lot of hand wringing about a financing crunch for consumer internet startups. One theme is that investors are pivoting from consumer to enterprise. The finance lens says: for the last five years or so, consumer was overfunded and enterprise was underfunded – let’s correct this. It also helps that enterprise IPOs have performed much better than consumer IPOs in the last year or so.
The product lens is tricky. My sense is that, at least for the non-mobile consumer internet, the product lens and financing lens agree. Anyone who has had the misfortune to use enterprise technology lately will tell you that the hardware and software they use at home (iPhone, Gmail, etc) is far and away more sophisticated and elegant than the software they use at work. It feels like the enterprise tech is way behind in the product upgrade cycle.
Mobile seems like a case where the lenses disagree. The finance lens says: billions of dollars have been invested in mobile apps. It has become hit driven and there have been very few “venture-scale” startups created.
The product lens says: the modern smartphone platform began about four years ago when the iOS app store launched. This is clearly a major new platform. Platforms and apps interact in a push-pull relationship that takes decades to play out. Innovative new apps, designs and technologies are created all the time. It would be surprising – and contrary to all the historical patterns – if the mobile product evolution were already played out.
That is not to dismiss the finance lens. It could be painful along the way: financing markets might dry up, and profits might accrue to the platforms over the apps. But clearly mobile is just getting started.
Some of the biggest mistakes I’ve made as an angel investor stemmed from being beholden to the finance lens. The finance lens feels more scientific and therefore appeals to analytical types. It might sound unsophisticated to say “the products for X are crappy, and I have an idea for how to make them great.” But in many cases, it’s actually that simple.