Unit of Progress

Based on the stories published in the media, it would be easy to assume there are only two critical moments in the life of a startup:

1. When a startup attracts new investment; and
2. When a startup is sold

There is a simple explanation for this: it’s easy to write an enticing press release about both of these things.

Unfortunately it doesn’t tell the real story of startups at all.

Any success is typically the result of thousands of little good decisions rather than one silver bullet. The reality of a successful startup is much more grind than glamour.

Of course, this doesn’t make for such interesting headlines.

For example, during the early years of Xero there were two stories that dominated media reports:

• Xero reports another loss
• Xero raises massive amounts of new capital

Both of these stories were true. But, the connection between these two facts wasn’t often explored - all of that capital was funding the losses, but what were the outcomes that were being achieved in the meantime, in little steps?

A much more interesting story was hiding in plain sight: the consistent growth in customer numbers; the sales channel that was being forged - to small businesses via accountants and bookkeepers; and the remarkably low churn rates (which underpin high customer lifetime value).

It’s curious how we mostly celebrate startups when they raise investment.

It’s like we’re applauding the pilot for refuelling the plane.

When we think about flying, the type of jet fuel used, the name of the company supplying it and even the amount of fuel supplied isn’t normally the story.

Obviously it’s important that somebody is paying attention to those details and so the pilots responsible for flying the plane need to keep a constant eye on the fuel gauge. But that will only be the headline in the news if we run out.

Otherwise the thing we should talk about is where we are heading and why.

There is a lesson here for anybody who wants to raise capital to fund a startup and also for everybody who might be tempted to invest (and also for all of those who argue that we need to continue to subsidise fuel tankers):

Describe a clear and measurable unit of progress.

That is, the improvements we believe we can make in the immediate next stage of the business; the specific things that will demonstrate our momentum.¹

We’re not trying to predict or even describe our final destination. While it’s important to think several steps ahead and understand how this next step will open up opportunities beyond that, it’s best to avoid getting too distracted by the end game. Smart investors know that great companies are bought not sold, so the immediate goal is to create the sort of business and team that will eventually be attractive to potential buyers rather than focus too early on difficult-to-predict “exit” plans.

Remember: we use evidence to identify problems, but we use experiments to solve problems.

This is why startups are funded in stages (and also why planes are refuelled for one sector at a time).

Each investment into a startup is described as a round. These are given names like: Seed, Series A, Series B etc. Each round of funding will typically dilute the existing owners by up to 20-30% and provide enough capital to cover 18-24 months of expenses.

This time period is sometimes called the runway - another aeronautical metaphor! The hope is that the funding buys enough time to get airborne, before we get to the end of runway.

A well articulated unit of progress is a great way to determine exactly how much capital is required. Once we can estimate that, then the current valuation of the business is a simple function, based on how much dilution is necessary to tempt new investors.

In my experience, companies tend to spend all of the money they raise in each round, often faster than they expected, so it never really helps to raise significantly more than required to fund the next experiment - it only increases the dilution for founders and existing investors, with limited additional upside.

The unit of progress will change with each round, each one building on the one before, as the startup moves from early-stage to high-growth.

Some examples…

In a Seed round, we might want to prove that we can build a prototype product and find some initial customers to give us confidence we’re making something that people want to buy.

In a Series A round, we might need to demonstrate a repeatable sales process and a channel that allows us to acquire customers at an acceptable cost.

In a Series B round, we might want to show we can attract the people we need to grow the capacity of the team - especially in engineering and sales and perhaps expand beyond our local market into different geographies.

In later rounds we might need to hire a more experienced executive team, to move beyond the reliance on the founders and generalists who created the foundation in the early-stages, and focus on improving unit economics.

Those who are paying attention may recognise that these examples map nicely onto the four stages of growth. Every stage in this model builds on the lessons from the previous stage.

When we raise a round of funding it’s vital that we are specific about the things we hope to prove or disprove in that limited time; that we are confident that we can do it - i.e. that it’s possible to complete the experiment in that timeframe; and that, if we do, it will leave us in a sufficiently better position at the end.

Again, the real test of an investment round, once we have the benefit of hindsight, is: did the additional capital create more value than it cost?

Founders need to choose their investors carefully. My advice is to look for those who have consistently demonstrasted they create more value than they capture for themselves. Over time I believe the best opportunities will flow to those investors who consistently do that for founders.

We don’t applaud pilots for refuelling. Or for successfully taking off. Or for landing in any random place.

The reason we take flight is because we want to travel somewhere.

The thrill is the journey but mostly the destination.

So don’t be distracted by the random things that the media report on. Be more specific.

Be clear about where we are going and what it will take to get there.

By the way, if I were a business journalist reporting on startups I’d base all of my work around this concept of “unit of progress”.

Anytime a startup wanted me to write about their capital raise I’d ask them about the unit of progress for this round, and write about that. Not the amount they have to spend, but the outcomes they want to achieve with it. If they couldn’t answer or didn’t want to share that, then I’d write about that.

And then, 18-24 months later I’d write a follow-up documenting if those things were achieved or not.

Any journalist doing this would quickly uncover all of the important patterns. Which startups are consistently doing what they said they would do? And, who are the investors who repeatedly back those founders? Those are the startups and investors that are worth following closely. That would be a simple way to get beyond the current situation where those who make the most noise or have the most recognisible names get the most coverage.

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