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“If You Are Not Drowning in Demand, You Don’t Have Product-Market Fit” (2017) (capitalandgrowth.org)
95 points by jkuria 50 days ago | hide | past | favorite | 74 comments

This is largely good advice, but… I find that in 2021 the capital environment has become so much easier compared to even 5 years ago, some of this advice feels a little out of date. Yes investors want a company that can scale 1000x, but these days I’m hearing a lot of VC interest in companies whose ceilings are probably in the $50-250M range, and who are offering pretty good terms. You don’t need a unicorn exit for that, you “only” need to make a product that works with a degree of traction, and then get acquired by a bigger player. As long as you don’t raise too much that can still make for a nice outcome for all involved.

It’s really astounding how much money is chasing so little return right now.

There's a huge unstated detail there: to access that non-unicorn capital you need to be recurring revenue SaaS. The older focus on unicorn outcomes allowed for more creative revenue models and higher risks. Companies that don't have revenue really figured out but have an ultra compelling product can get unicorn-targeted funding.

The VC interest in these smaller companies is predicated on the revenue and valuation multiple predictability that comes alongside recurring revenue SaaS. Much lower risk for an investor. The margin structure of these types of companies is a nice bonus. If you're a founder trying to get access to this reduced-target capital you need to have 10%+ monthly recurring revenue growth, gross margins above 70%, and ideally a clear acquirer.

Not affiliated with this group, but this article explains in more detail: https://leadedge.com/why-we-like-saas-businesses/

> There's a huge unstated detail there: to access that non-unicorn capital you need to be recurring revenue SaaS.

Agreed. I know almost a dozen actually cashflow-positive companies that want to take some investment in order to expand and can't get anyone to call them back.

The reason why there seems to be a "shortage of good companies" is because the VCs are all chasing the exact same very narrow niche formula.

They should contact firms like Lighter Capital who make Revenue-Based Financing loans.

One of the things that bothers me about the startup ecosystem is how much it's oriented around VC. There's nothing wrong with VC, but you also have to understand that they have a specific business model and are looking for only a specific type of startup to invest in. They want the companies that are small enough that they can buy a big chunk for relatively cheap, and ambitious enough that they might possibly have ultra 1000x unicorn growth. They know that most will fail; that's fine, they intend to make it all up on the superstar.

It's perfectly fine to start a company that's only going to grow 10x or 20x best-case. VCs won't be interested in you, but that's fine, you don't necessarily need investment.

"It's perfectly fine to start a company that's only going to grow 10x or 20x best-case. VCs won't be interested in you, but that's fine, you don't necessarily need investment."

I'm not saying this is your fault and I get where you're coming from. But saying 'only' 10x-20x growth is 'fine' as if that's something to be embarrassed about... Yeesh, talk about messed up perspective...

By my reckoning, if you're generating value, have a sustainable business and are giving people gainful employment that in and of itself should be reward enough.

Definitions help:

Start a company: You + enough business not to go under in X months = covering living expenses for one person or family = $50k / year starting negative of working up to profitable

10x = $500k / year, by the previous measure = competing with the top end of a big tech salary.

So there are people reasonably "unhappy" at 10x because of opportunity costs.


Being able to create an honest, profitable business pulling in 'only' 500k$/annum. Must suck to be that guy.

It's real easy to play the 'grass is always greener' game. Everyone has their own aims in life. Some want money, some want to live a life they're proud of and pretty much everyone is some combination of the two. But trying to frame someone establishing a business with 10x-20x growth as a failure, assuming they're able to support themselves and believe in the value of their venture, is absurd.

500k profit a year (which is still good!) often means 5 mil/yr revenue. Considering the years of work, super high stress, lack of support network common to this, and generally bootstrapping from their own funds?

That is decent, but considering all those factors, far from a huge win. If they had put similar work (with the same skill set) into a normal job, they would likely have similar returns with less risk.

Especially since there is large ongoing risk of market shifts or the like making it fail with no warning in the future, and at least working in someone else’s enterprise they wouldn’t have their capital at risk.

It's subjective of course but most would call that a very far cry from a huge loss which was the original point.

For some of us there's a lot more to life than whether or not the wealth we accumulate squares up with the amount of risk that we take on compared to others. Being able to contribute to something you believe in while being able to avoid Taleb's silent graveyard doing it is enough.

I happen to agree with you.

There are many others who make different bargains of course, and for their own legitimate reasons.

Except that you can sell the business and get a windfall.

Very true - if you can get that far.

It’s very, very high risk even getting here though, and not just money.

Police to bank robber: “why do you rob banks?”

Robber: “that’s where the money is. What, do you want me to rob libraries?”

VC have money. Spending other people’s money is a frequent pastime. If SoftBank is willing to give you $100m to expand the reach of your IRC replacement, why wouldn’t you take it? Combine this with companies that are built to be sold to one of FAANG (ones that try to solve an actual customer’s problem but mostly just enough to catch the eye of a giant and sell to them) and you have SV.

What if I don't feel like building an irc replacement? There's real problems that don't have a potential for multi billion users. For example, working on problems that working scientists face: there's a potentially huge second order impact, but a small potential user base and not necessarily a lot of cash floating around.

Let's not forget that vc money is scarce outside of the US. If this is actually better or not is difficult to tell.

> why wouldn’t you take it?

One reason is because of what you're giving up in exchange. Obviously equity, for one. Quite possibly also control, if the investors also get board seats as part of the deal. If they have a different vision for the company's future (not to mention your personal future) than you do, that could create problems.

Yes, this. I get the impression that VCs are mostly looking for either ultra-growth no matter the risks or a high-value buyout by one of the tech majors. If you want steady growth and modest profit, your interests will be misaligned and there will be trouble. I'd say, don't take investment unless you have both a plan for exactly what you want to do with the money, and a vision for the company's future that's well-aligned with your investor.

Well of course. But between working as a drone for a company and getting VC money to spend (with restriction) on how you see fit, the VC option is pretty appealing.

There is a middle ground - start something yourself, bootstrap, get profitable, spend the revenue how you see fit without restriction, and own it all. And you can still exit down the road if you so choose.

The restrictions, stress, and pressure that comes with VC feels a lot different when you see them on a term sheet you are trying to decide to sign or not after already busting your butt for a long time making something real, vs from behind that desk at a company.

It is a real, and sometimes very undesirable tradeoff. Go big or go home, vs wealthy but not obscenely so through steady effort?

The money added to the company’s coffers gets added to its valuation, so you are not trading equity really unless you are personally selling (a “secondary”). It’s just that the pie becomes larger.

Now, most VCs don’t want to be in the business of management. Each partner oversees 5-10 companies, they do not intend to be managing each. Most intervention comes when the founder is running the company into the ground. I can find many more cases of scandalous compliance by VCs than active intervention. The first thing VCs look at is the quality of its founding team, it’s not for wanting to kick them out.

> the founder is running the company into the ground.

Except that their definition of running a company into the ground is more about whether or not the company is track to be the their 1000x return or not. They push for high-risk, high-return moves, which are not the same thing as striving for a sustainable business. I've seen founders building companies that are stable and growing, and still getting booted by the VCs because they wanted to push for higher returns.

Growing for aggressive returns is the deal you sign up for getting VC money.

That said, I haven’t seen VCs pushing a founder out for this offense first hand, even in companies approaching somewhat of a zombie status. Usually VCs will just divest their attention.

I have seen companies run into the ground with the VCs pushing the throttles forward though.

Sure, but a lot of people would rather own 10% of a billion dollar company than 100% of a 10 million dollar one.

While many others would prefer the other way around.

There's no inherently better model. Someone might prefer flexibility over ambition. Others ambition over flexibility.

I think bootstrapping is overly romanticized. In many cases those entrepreneurs aren’t good at taking feedback or telling their story or have a lousy idea to begin with. Not to say that it’s not going to work or not admirable, but getting VC money is a very early kind of “product market fit” in the sense that you need to sell people your vision in return for money.

I did both bootstrap and VC paths. You can get it wrong in each, but I know that my previous insistence on not taking external money was somewhat rooted in arrogance.

I bootstrapped a SaaS business from my kitchen table...it's now worth just shy of $100M.

I thank the heavens everyday that I didn't go the VC route. I can pretty much do whatever I want without this constant growth at all costs pressure. It also gives us a massive advantage against VC backed competitors. We can make decisions that reap benefits 2-5 years out.

This has created a situation were every competitor follows the same trajectory where it eventually leads to an over-complicated, bloated product that users hate. They come to us and it's like a breath of fresh air.

But now you have to look at the expected value as well.

A 10 million dollar company, lets say at a conservative 5x earnings multiple means 2mil annual profits. At 80% margin that's 2.5mil ARR. For a B2B SaaS product you should be able to get at least $1,000 / customer annually, which means you need to find 2500 customers to own 100% of a 10 million dollar company, which in the age of email and Facebook marketing is very much within reach.

And these are conservative numbers. A strategic buyer might very well pay 10x if you're showing nice growth, margins of 90% are not unrealistic in SaaS, and you could possibly raise prices depending on the value you are providing and who you're selling to.

Now ask how many stars have to align to reach a billion dollar valuation, assuming you haven't been screwed over by your investors by the time you reach that point.

There is actually a very good reason why a VC-backed/VC-backable business shouldn't take 100M from Softbank at a 1B valuation:

Because it removes the possibility of exiting for tens or hundreds of millions--the preference stack will eat up all the equity.

Most VC backed companies that exit do so for far less than a B; if the startup has been responsible about fundraising then a 50M, 100M, etc exit can be life-changing for the founders. Raising too much makes this impossible and turns the whole venture into much more of an all-or-nothing affair.

Of course, the VCs don't care: they make money from the big winners, so they could care less about a 50M exit, but the founders should not.

Softbank et al isn't giving you anything. It's an exchange; and with that comes responsibilities, and so on.

The sibling comments go immediately to the evils or virtues of VC as though that were justification to stay small or go big, but this comment captures the vast majority of small business activity that produces thriving economies and stable lives for owners and workers alike. I have friends who opened automatic garage door repair shops. They are a two-state business and live comfortably and are engaged in the lives and wellbeing of their employees.

Disruption is glamorous but small is foundational.

I’m sorry I feel like we should clarify your numbers. VC money hopes for 10x or 20x as a goal and is quite happy to have that in their portfolio. If you are a 1x-5x company that isn’t enough return for the equity risk.

1000x is an anomaly and would make one fund round do exceptionally well compared to all others but most funds don’t ever get that kind of investment return.

One reason of many that I like Indie Hackers, it's geared towards bootstrapping without VC involvement [0].

[0] https://indiehackers.com

>It's perfectly fine to start a company that's only going to grow 10x or 20x best-case. VCs won't be interested in you, but that's fine, you don't necessarily need investment.

But is that a startup at that point or just a small business ?

Well,it's just a business if you self-referentially define startup as a business which must have the characteristics that would make VCs interested in investing in it.

(In fairness, I'd probably roll my eyes if someone called their McDonald's franchise or arts & crafts retail store a "startup" but plenty of today's big businesses got to where they are without VC funding or really looking much like what people think of as a startup today.)

We've been over this a lot before. I'm not saying pg's definition is the end-all and be-all, but for usefulness in discussion "high growth potential business" is the most reasonable definition: http://www.paulgraham.com/growth.html

I don't really disagree. Much as the "But pg says..." school of argument is like fingernails on a blackboard for me, there is clearly a qualitative difference between a business that's just intended to support one or two people and maybe some other employee--and has no larger ambitions--and one that will possibly take off or, more likely, close down within five years (or whatever).

Obviously there are still other businesses that aren't inherently self-limiting but that aren't really constructed for go big or go home either.

The problem with "startup" is that there are two separate issues mixed up in the same word. PG defined it as hypergrowth which is certainly one class of startup, but there's another one as well. The other aspect of startups is that they are newish products doing something new in new markets. As such, issues like product-market fit are key. The problem is when you start to say things like you're not a startup, you're a traditional business is that most traditional businesses don't have the product market fit issue, and thus most traditional businesses are far far less risky. For example, I don't need to convince a bank that my coffee shop will achieve product-market fit, we know people love coffee and have lots of tools for evaluation the financials of a potential coffee shop, which is why I can get a bank loan to go start up my shop.

Now there's the issue of starting a company that is trying something new and lacks product-market fit, thus is higher risk and we don't have good tools to evaluate those risks, but is also looking to grow conservatively thus isn't able to get the interest of those looking to give out high-risk funding, ie VCs.

Not that I have tried to get a loan for a coffee shop but IMO there's very much a question of fit of your particular coffeeshop concept and your particular market (and location).

The parameters are narrower than in the case of some totally novel software or hardware product but just because "people buy and drink coffee" is not remotely a guarantee that your particular coffeeshop will be sufficiently successful to stay in business.

To me (just some random person on the internet that works at startups) the defining characteristics of a startup are growth and employee equity as compensation. The second has to come from the first, since equity is worthless if there isn't some future promise of payout.

Interesting point of view on coworking spaces:

"I am especially against co-working spaces but if you must join one, first walk in and just listen. If it is quiet maybe people are actually working. But if it is loud, run for dear life!"

> More startups would succeed if they were bull-headed about keeping the customer and the problem the same but changing the solution. This is why passion matters. You are unlikely to pivot quickly through lots of different problems or customer types if you care deeply about the initial problem you set out to solve.

What would be some examples of companies that did and did not do this?

we are drowning in demand as we have manual processes. Multiple times our CEO (cofounder) has threatened to quit because the demand is too much and she has had a hard time finding people that can do the job. We had to put a minimum order size in to reduce the number of orders and we are still hitting records. We also temporarily stopped taking orders for items that require the most "order processing" time.

We are currently building the features that will automate more of the manual processing to free up time. But everyday I feel bad as I see the order count going up knowing the CEO is miserable. The CEO wants to do fundraising but is helping to process orders (the orders are complex) so doesnt have time.

Sounds like the beginning of a Theory of Constraints-style novel.

He's being a bit of a stickler here about product-market fit.

I wonder if there are any counterexamples, where we can say that there is strong product-market fit without an immediate tsunami of demand.

What about the case where purchases tend to be large but infrequent or consist of long-term contracts? In that case, wouldn't you be able to say that you've identified product-market fit at some point earlier than when the actual purchases are made?

Keep in mind Michael Seibel is a co-founder of Twitch. Twitch is on extreme end of the monetization scale where it's success depended entirely on whether they could add free users fast enough to justify sufficient investment to bridge the gap until they could monetize via ads.

The other end of the spectrum is enterprise software. In between you have self-service SaaS, premium consumer, and freemium consumer products. Each of these has very different requirements for what traction look like, all of it significantly less a pure ad-driven monetization like Twitch.

The other dimension is how big you need to be to be considered successful. VCs need massive scale, and the bigger you grow the harder it is to maintain momentum, so it's gotta look really juicy at early stage to justify the growth. YC is not a VC, but as the premier incubator that feeds into the SV VC ecosystem they definitely have that lens.

I don't remember where I read this: "Product-market fit is like porn, you know it when you see it"

The definition of product-market fit indicates that it is about strong market demand, so it would seem that the tsunami of demand is required.

That does not mean a successful business requires product-market fit. Weak market demand can still provide a great business and strong market demand is not a guarantee of business success.

One can always play the game of semantics, of course.

It sounds like semantics to me. If I start a company that makes a $100K machine that genuinely increases efficiency/saves money/etc. in some industry used to buying expensive machines, I might reasonably hope to create a successful business. I would less reasonably hope to be able to sit back and watch the tsunami of demand roll in.

And when you have products like that you don't necessarily need strong demand. A small handful of dedicated clients willing to spend incredible amounts of money due to you controlling the supply can create a very successful business. In fact, the article talks about such businesses. Looking to achieve product-market fit is particular to certain businesses (the kind Y Combinator likes to invest in) who are looking to expand to a wide audience, not necessarily something all businesses should be striving for.

What you are describing with "small handful of clients willing to spend incredible amounts of money" is very strong product market fit. The market is just small.

I am not sure I agree. Demand is weak. There are few customers and they buy rarely. It just so happens that there is also very little supply, so the price can be high and in those high prices a very successful business can be built.

On the flip side, as a farmer, I have found what is essentially perfect market fit. Nearly every person on earth wants what I produce. The problem for my business is that the supply is also huge, so I can't charge much. Often I lose money. It's a living for me, but not the greatest business or something investors are going to be throwing money at.

People buy cars rarely. Ferrari doesn't sell many cars. Ferrari has product market fit. The size of the market and the frequency of purchase are independent of product market fit.

Farmers have great product market fit. They sell a commodity and have little/no pricing power and thus earn pretty low returns on capital.

Product market fit is one thing. Market size is another. Frequency of purchase is another. Competitive advantage is another. Building a big successful business requires getting many things right, not just getting product market fit. The reason folks at YC (and others) harp on about product market fit is that they seem to see a lot of companies trying to grow before they have it - which is crazy. It doesn't mean product market fit is the only thing.

> People buy cars rarely. Ferrari doesn't sell many cars. Ferrari has product market fit.

Not by the formal definition of having strong demand. The demand for Ferraris is weak, but the equally restricted supply allows Ferrari profitability anyway.

The demand for food is exceptionally strong, but the vast supply makes profitability very difficult.

> Product market fit is one thing. Market size is another. Frequency of purchase is another. Competitive advantage is another.

They are separate things, but all come together to make up what we call demand. Product market fit hinges on demand, not those variables alone.

I'm not sure what "formal definition of demand" you referring to. In microeconomics demand is modeled as a curve and the statement "demand is weak" doesn't mean anything. Other than that, the word "demand" is used very informally.

The microeconomics definition would state that the "quantity demanded" at price X is Y. Again, "weak" doesn't mean anything in that field.

Nope, they don't all come together to make up "demand", and there is no "we" because your definition isn't what's used by the business or economics community. Those things come together to decide the size and profitability of a business. Demand is just one part. Competitive positioning is almost strictly a supply side issue. For example, there is more demand for corn than there is for coca cola, yet Coke makes a fortune and corn farmers do not. Coke has built a brand and large distribution channels - both which have large fixed cost components and hence require enormous scale. The result is a small number of soda suppliers and only 2 cola suppliers in most markets. Supply side issue.

> I'm not sure what "formal definition of demand" you referring to.

Me neither since I didn't.

> In microeconomics...

I can find no evidence that product-market fit came out of microeconomics, so I am not entirely clear on the relevance of that. Context is relevant. This seems like us having a conversation about how a pointer on a computer (you know, the arrow thing) interacts with a UI with someone chiming in to say, "In computer science a pointer stores a location in memory."

> Again, "weak" doesn't mean anything in that field.

I'm inclined to agree within the new context you have provided, but that does not mean "weak demand" is without meaning. In fact, it is a term used relatively frequently, including in respected publications.

> Me neither since I didn't

"Not by the formal definition of having strong demand" - didn't you say that? I see it there, under your name.

I did say that. The definition of product-market fit is indeed "having strong demand".

I am not sure how that relates to a formal definition of demand?

Ok, I see what you are saying now. We were just speaking past each other.

I thought you were saying there is a formal definition of strong demand. Ie, there is a formal definition of demand, and a definition of "strong" in that context and thus a formal definition of strong demand. What you were saying is the definition of product market fit is having strong demand.

It would also apply to government RFP processes.

There’s also the early days when you’re trying to light tinder with flint lock. You still need to get the fire going.

Does Uber giving out free rides qualify as "tsunami of demand" or was it artificial demand?

Well, it shows that there's a lot of demand for free rides. But that isn't actually the business that Uber thinks it's in...

Curious tangent question: what constitutes drowning in demand? I mean numbers.

The obviously it varies by sector and type of product but say for a typical SaaS.

I’ve seen a lot, just curious about what people here think.

I think you know it when you experience it, but on the engineering side it feels like an uncomfortable level of demand that you know your product can’t really handle yet. So for example, you’re turning entire categories of people away - or ignoring their bug reports / feature requests - because you literally don’t have time to write the 500 lines of code needed to support their use case yet (and you’re busy doing the same thing for another cohort with higher willingness to pay).

The “drowning” description is apt because living through that is stressful and uncomfortable, even though it can also be exciting and have fun moments. Especially great are the moments you discover a 1-hour hack that can unblock something you and your team thought was going to take 2-3 weeks to accomplish, and what a relief that is to “fast forward” in time.

Any measurable consistent demand that can be seen on a monthly basis - assuming net lifetime value >0 is really, really good.

The problem with SaaS growth is that it's a function of customer acquisition, marketing etc..

But once you account for that, if customers are sticking around (low churn) and the acquisition/revenue works out, then if you contemplate what 'compound interest' means - and the necessity of a 'large market' - then it's probably a good investment, it just depends on the terms.

I have the same question. Additionally, to me the term "drowning in demand" is relative to the current size of the business. Drowning in demand for Walmart is different from downing in demand for a convenience store.

If you have to ask, you aren't drowning in demand. Sounds trite, but it's true, you'll know it when you experience it, hard to give numbers around such an increase in demand.

Getting more demand that you can handle with your current team/systems/resources?

i would say that drowning in demand could be intended as:

signups you get per day > signups you can process per day

If you have very inefficient code that makes all your systems crawl, a much smaller amount of demand could result in “drowning.”

Is there anything wrong with just "stealing" market share from bigger companies with some unique features?

I see it all the time, these services definitely have a product market fit. It's just very small.

Q: What’s the prize in a pie-eating contest?

A: Another pie.

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