At the onset of 2012, many start-up executives are sticking their copy of Lean Start-Up on the shelf, leaning back and bemoaning the fact that they have a new set of challenges ahead of them. Although there is a plethora of advice now being given about how to find product-market fit for your fledging start-up, there’s a dirty little secret out there: Once you’ve achieved product-market fit, the hard work really begins. Scaling is hard.
After three or four years of jamming on your start-up, you’ve finally crossed a few million in revenue, gotten north of 10-20 employees, and it’s all starting to click. Now the pressure really begins. Your employees start doing what I call “phantom equity math” (if this company were worth a billion dollars, I’d become a multimillionare!), your VCs shift you in their mental models from “too early to tell” to “high return potential” and your spouse starts asking about when all that hard work is going to really pay off.
Yet, the hard scaling challenges and decisions that will enable true value creation, not just interim progress, are all ahead of you. Here are a few of the top ones that I see start-ups wrestle with once they start seeing their initial revenue projections finally come to fruition:
1. Product Strategy: Stay Focused vs. Broaden the Footprint. The initial product is working well and now the question is how broad a product strategy should you pursue? If you think the total available market (TAM) for the existing product is large enough to satisfy yours and your investor’s ambitions, stay focused. But, typically, the allure of pursuing the bigger win draws founders into ambitious efforts to broaden their product footprint through organic development efforts or even M&A. My partner Chip Hazard likes to refer to the broadening efforts as the “lilly pad strategy”: Focus on jumping on to a lillypad next to you rather than across the entire pond. By pursuing natural adjacencies, a company can increase its TAM – ideally by leveraging existing customers (meet their needs more broadly), channels (given them more things to sell) or products (extend the current prodcut footprint with natural adjacent add-ons). I’m often surprised that companies don’t think through the basics of competitive strategy when evaluating these adjacent opportunities.
At the risk of getting some eye rolls for evoking Michael Porter, I encourage start-up CEOs to think carefully about the new lilly pad’s competitive intensity, entrance threats, threats of substitute products as well as the power of suppliers and customers when evaluating the adjacent opportunities.
2. Financial Strategy: Exit vs. Raise Additional Capital. Once things are working well, there is a magnetic power that demands pouring more fuel onto the fire. If the customer acquisition costs (CAC) are proving out to be $1 and the customer’s lifetime value (LTV) are $2, why not raise millions of dollars to acquire more customers? Obviously, it’s not that easy a decision. Raising capital can be a hugely distracting, draining process — and the dilution implications, as well as the choice of investors, have deep repercussions on your future options. On the other hand, pursuing an early exit can be appealing, particularly if the entrepreneur has never had a win before, but there are many difficult considerations here as well, which I touch on in a blog post (Walking Away From Liquidity) as does Roger Ehrenberg (To Sell or Not To Sell).
3. Human Capital Strategy: Hire Grownups vs. Stay Young. There is a certain charm and many benefits to the founding team sticking together and scaling with the start-up. The culture remains true to the founding core, the young talented employees get growth opportunities, and there’s an appeal to minimizing the disruption that outsiders bring. Yet, frequently, the talented founding team that gets you to the point of scaling is not the right team to lead the scaling process. I refer to the three stages of a start-up’s life as “the jungle,” “the dirt road” and “the highway.” The team that is skilled at hacking its way through the jungle is often not as well-suited to accelerate rapidly once a dirt road has been discovered. Yet when more senior, experienced executives arrive, preserving the founding culture and maintaining alignment is critical. The best companies build teams for scale early on (e.g., hiring great VPs who can be both effective players and coaches as their department grows) and work hard to select for cultural fit (Google’s top recruiter, Mike Junge, had a great interview on hiring best practices in peHUB, “Why It Pays To Be Nice“).
4. Founder’s Dilemma: Bring in a Professional CEO? One of the biggest decisions a scaling young company makes is – who should be the CEO? The founder may be one of the uniquely talented individuals who can scale from the jungle all the way through the highway but, more often than not a senior, professional CEO is hired to help take the company to the next level. This decision is truly make or break. It rests on the founder’s desires as well as the board’s confidence in their ability to transition from a product-centric, pre product-market fit world to a sales and marketing execution-centric, post product-market-fit world. Investors would always prefer to see the founder make that transition, but if the skillset isn’t there, having an orderly transition with open communication is key. HBS Professor Noam Wasserman has written a series of cases on this topic that show some of the do’s and don’ts of navigating this transition. It’s never an easy one to embark on.
Each of these decisions can be gut-wrenching, bet the company moves. There’s a nasty image I hear used in the board room about snatching defeat from the jaws of victory. If things are going well, you want to let them evolve naturally and achieve some measure of victory, albeit a small one. This may mean sticking with a founding leadership team, a niche product strategy and selling early.
Why should each of these decisions sound limiting? Because great entrepreneurs are competitive, ambitious types who attract ambitious management teams, advisors and investors. There’s a natural allure to moving aggressively to scale once the initial product-market fit assumptions become validated. Just scale wisely. Going from $1 million to 10 million in revenue is no easier than achieving that initial $1 million. And getting to $100 million and beyond, well now you’re really in the rarified air that gets the people around you excited – and sets expectations soaring higher.
Jeff Bussgang is general partner at venture capital firm Flybridge Capital Partners. You can follow him on Twitter @bussgang