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When a great product hits the funding crunch


Building a great product is not enough
Today I read a well-done article by The Verge on the shutdown of Everpix, a photo startup that’s gained a small but loyal following. It’s a great read, and I’d encourage you to check it out. There’s a lot of things to comment on, but the Everpix story is a common one these days- a lot of startups have built great initial products, and even shown some strong engagement, but ultimately not enough traction to gain a Series A.

The essay on Everpix drove home a lot of recent trends in startups that have gained momentum for the last year or two. Let’s examine a couple of these trends.

Funding goalposts continue to move
The first thing we’ll talk about is the company metrics. One of the best things about this article was that they did a good job of covering some of Everpix’s stats on engagement, conversion rate to premium, etc.

Everpix stats

  • 55,000 total signups and 6,800 paid users
  • Freemium biz model of $4.99/month or $49/year
  • Free-to-paid conversion rate of 13%
  • 4.5 star rating with 1,000+ reviews
  • MAU/signups of 60%
  • WAU/signups of 50%
  • Raised $1.8M and then a seed extension of $500k
  • Ex-Apple founders with 6 FTEs

You can see that other than the top-line metric of total signups, the other metrics are quite solid. If this company were started just a few years ago, I’m convinced they would have had no problem raising their Series A. These days though, it’s gotten a lot harder.

The reason for that is the “moving goalposts” on what you’re expected to do with your funding.

It’s been widely noted that investing milestones have evolved quickly over time:

  • In 1998, you’d raise $5M Series A with an idea and not much else. The capital would be spent to build the product, and hopefully you’d have some customers at the end of it, but it wasn’t required. You had to do crazy stuff like put machines into a datacenter, at this point. Then you’d raise a Series B to scale the marketing. The qualitative bar for the team, idea, and market was high.
  • In 2004, you’d raise $500k with just an idea. Then you’d build the product and spend $5M to market it. At this point, you could use a free Open Source stack which would accelerate development. You didn’t need to build a datacenter either.
  • In 2013, these days, you are expected to have a product coded up and ready before you raise your first substantial angel round. Maybe the product won’t be launched, but people will want to play with a demo at least. Then you raise $1-2M to get traction on your product. Then if you have millions of signups, then you get to raise your Series A of $5-10M.

In fact, it’s been famously written by Chris Dixon, now a partner at Andreessen Horowitz, that 10 million users is the new 1 million users. I’ve previously written that Mobile Startups are Failing Like It’s 1999, due to the long launch cycles that the Apple Store encourages. I’ve also written about mobile getting harder and not easier over time.

There’s a couple things going on: The sheer proliferation of seed-funded startups, combined with investors who want to invest post-traction, post-product/market fit. Combine this with 1999-style launches for mobile apps, and you have a big mismatch in the supply and demand for funding. Series A venture capitalists are often acting like growth investors now, where they want the entire equation de-risked before they put in much capital, and it’s reasonable to expect this given the technology stack and massive distribution channels.

My question is, in 2016, will the bar be even higher? Maybe angel investors will expect a working product, reasonable traction, and product/market fit all before they put in the first $1M? How much can market-risk be proved out before any professional money is raised?

Monetization won’t save you if it’s not combined with growth
The Everpix story also shows that having a business model isn’t enough- after all, a 12% conversion rate to premium is stellar, which you can compare to Evernote’s 6%, as they mention. The problem is, if you have monetization in place, investors also want to see a lot of growth. Or you need enough growth and scale to be profitable without outside funding.

Work backwards on the latter to see what that looks like:

  • 6 FTEs plus operations costs about $100k/month
  • At $5/month, you need 20k paid subscribers to break even
  • At a 12% free-to-paid rate, you need 160k signups

Turns out, 160k users is a lot, especially if you have a short runway. It’s well outside the boundary of a list of friends and family, or a Techcrunch article, or a big week of promotion from Apple . If you combine this with the rest of your schedule, like 6 months to raise VC, another 6-12 months to build the product, etc., then you don’t have much time to hit your traction milestones.

In contrast to the option to hit profitability, VCs don’t care that much about small scale monetization. They understand that a freemium service can get 1-5% conversion rates, and the question is if you have enough top-of-funnel signups to make the revenue numbers big. In fact, too much focus on monetization too early can lead a red flag, since it’ll mean maybe the entrepreneur is thinking small rather than focusing on winning the market.

A modern startup’s costs are all people costs
The final thing that’s worth pointing out in the article is the cost structure of the company and where the money went:

  • $565k consulting and legal fees
  • $128k office space
  • $360k operating costs
  • $1.4 total personnel costs

In other words, 80% of the costs went towards the employees and contractor/consultants/legal. It’s basically all people costs. You could argue that the office space is really just a function of the people too. Really, only ~15% of the capital went towards actually running the service.

If anything, this trend will only continue. San Francisco housing costs continue the rise, while computing infrastructure only gets cheaper and more flexible.

The nice thing about these costs, of course, is that you can always scale them down by scaling down your team. It’s complicated to do this, of course, since the value in this acquihires incent you to keep a large group of people going up until the end. But if you are convinced to work on the business for the long term, you can always scale things down to a few core folks, though it can be painful.

This is another reason why increasing your cost structure can be tricky if your product isn’t working in the market already. You end up in a case where just a year or two down the road, you have to make the tough decisions to keep going, or to shut the product down. So if you are working on something that you’re really passionate about – or as they say, amazing founder/market fit – then you may want to delay the team buildout so that you don’t end up creating that situation in the first place.

“Milestone awareness” and clear product roadmaps
Ultimately, this flavor of startup shutdown will continue to happen. Products that hit immense traction are the exception, not the norm, for a reason. Given that, what can you do? Ultimately, every founder needs a strong sense of “milestone awareness.” What I mean by that is the ability to understand what you need to accomplish before the next round of funding, and then to work backwards on that until you can put together a reasonable roadmap to get there. You might have to cut costs if the plan doesn’t seem to work. And you’ll have to revisit this plan on a regular basis to understand how it fits together.

The problem with hyper product-oriented entrepreneurs is that they often have one tool in their pocket: Making a great product. That’s both admirable, and dangerous. Once the initial product is working, the team has to quickly transition into marketing and user growth, which requires a different set of skills. It has to be more about metrics rather than product design: running experiments, optimizing signup flows, arbitraging LTVs and CACs, etc. It’s best when this is built on the firm foundation of user engagement that’s already been set up. In contrast, an entrepreneur that’s too product oriented will just continue polishing features or possibly introducing “big new ideas” that ultimately screw the product up. Or keep doing the same thing unaware of the milestone cliff in front of them. Scary.

Any startups that are at the “just add water stage” should email me and I’ll connect you with the resources and people to grow.

It’s funny that people take the lesson away from Apple that you should just focus on product. That’s only half the story, I think, because when you dig into why Apple is so secretive, it’s because the company is really focused on advertising and product launches. The secrecy that’s so deeply embedded in the organization facilitates their distribution strategy- can you imagine building your company culture around your marketing strategy? That’s what Apple’s done, though it’s not often talked about.

Good luck, guys
Finally, I want to wish the Everpix team good luck- they put together something that thousands of people enjoyed. That’s very hard, and more than most people can say. And they took away some very useful lessons that will only make them better entrepreneurs.

It’s never an easy thing to shut down something you’ve worked on for years, but I was insanely happy to see such a high-quality post mortem from The Verge. Thanks for writing this up, guys!

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