Most tech startups go through three phases: 3Fs, Seed and VC/Scale. Understanding these stages, and the objectives for each, is an important factor in strategy development and decision making. Not understanding the stage you’re currently in is one of the most common reason tech startups fail to move forward, or worse, fail.
The Three Phases:
3F’s: Friends, Family and Fools. In this phase, your investors are investing because they know you, your reputation, and your abilities to execute. They are investing because of you, not your idea. They believe in your integrity and your ability to take the business to the next level. Typically, a 3Fs round is $100K plus or minus.
Seed: In this stage, your investor is Angels—semiprofessional investors who may know of you, but largely invest in a business plan backed up with your market validation. Typically, a Seed round will be $500K to $1.5M. It is not uncommon to include strategic investors (companies who will win big if your successful) in this phase as well.
VC/Scale: In this stage, your investors are VC (sometimes strategic). These are professional investors who invest in a proven scalable business. Proven business equals a team with a set of processes that produces a profit. Scalable means these processes can be replicated by mere mortal employees in a systematic way. Typically, a VC/Scale round will be $5M to $20M.
The objective of each phase is to do “just enough” to qualify for the next phase.
Pre-funding, you raise money by means of your network and your reputation within this network. Sometimes the founder may be able to fund this phase themselves; however, this strategy can backfire. Without the ability to raise money, a tech startup will fail. If you cannot raise money from your network, you will most certainly not be able to raise money in other phases: seed and VC/scale.
The ability to raise money is a talent, and if you do not have this talent, or cannot find a co-founder with this talent, do not start a tech company. If you’re not sure if you have this talent, then try to raise money from your network, even if you can fund it yourself.
In the 3F’s phase, “just enough” equals only those things necessary to validate your business model. For most tech startups this means a lot of market research, validation testing (maybe with MVPs, but not pre-production prototypes) and business modeling (understanding your cost and cash flow).
As a founder, you should be able to do most of this work yourself—don’t hire anyone. What you cannot do, can be outsourced to service companies. The founders should be spending a lot of time externally talking to people in the ecosystem—including possible investors (which are Angel investors, NOT VCs).
The end result will be a presentation, backed up with empirical data, that convinces an Angel investor to write a check. Expect to spend at least 1,000 hours of your time in this phase.
Common mistakes to avoid in the 3F’s phase include:
- Designing the perfect product
- Hiring a team
- Skipping market validation
- Not talking to customers/vendors/regulators
- Talking to the wrong investors
- Using service providers that don’t specialize in startups
- Funding the business with your life savings
- Believing you can raise money with the “idea” alone
In the seed stage, “just enough” equals only those things necessary to develop a proven scalable business. Prove you can make the product for XX dollars. Prove you can sell the product for YY dollars. Have written procedures for each function in the business, most importantly sales and operations.
In the seed stage “proof” usually means you have actually done it at least once—if not several times, and you know the true cost of that activity. For example, a customer progressing through the funnel with each steps defined and costed” compared and contrasted with “sold one to the guy I knew in my last company.”
In the seed stage “scalable” usually means you have everything you need, except the capital, to grow the business. For most tech startup this includes:
- A Management Team (at least identified, it not already on board)
- Well documented product with vendors on board to produce/operate the product
- A well-documented and proven sales and marketing system were the CAC (Customer Acquisition Cost) is not in doubt
Common mistakes to avoid in the seed phase include:
- Over hiring (outsource as much as possible)
- Ignoring sales and marketing processes
- Choosing the wrong vendors
- Poor (or no) management of the product engineering
- Poor (or no) product management
- Poor (or no) operational management
- Underestimate the time and budget
Tech Startups go through distinct phases. Rarely is there a straight line path from idea to exit. Each phase has its own objectives. These objectives are tied to the next level of funding. Understanding what phase you’re in and developing strategies for each phase is one key to success.