Assessing Early-Stage StartupsFeb 01, 2022
5 ways to determine if they actually have product-market fit
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So, you’re interviewing for a role as VP of Sales in an early stage start-up and the founder claims they have achieved product-market-fit (PMF), just got a series A and they’re looking for a VP of Sales to come in and accelerate growth.
In this newsletter, I’ll cover the differences between having PMF and not having it if you’re a sales leader, and how to uncover whether the startup really has found PMF, and isn’t just dreaming it up.
Often this is the difference between the task being put at your door being possible vs impossible.
Defining product-market fit
The definition of product-market fit varies depending on who you speak with and the type of company (VSMB vs Enterprise), and I like Rahul Vohra’s general approach where you want 40% or more of your users to be very disappointed if the product was taken away from them.
However, very few early-stage startups have either done this level of analysis or have the traction to offer any kind of statistical significance, especially in enterprise SaaS.
So I take a less scientific approach based on personal experience…
If you have PMF, the market is pulling from you more than you are pushing to it, and if you don’t have PMF you are pushing to the market more than it is pulling from you, more on that below.
In very early-stage startups getting to PMF is the holy grail. It’s the trigger for everything from raising a funding round, to hiring, to developing new products.
The challenge is, if you call it too early you create a shitshow, and many founders do just that!
For example, if you don’t have PMF it’s impossible to set quantitative goals, because you’re still discovering whether you can prove value and repeatably sell to your defined ICP. You’re in discovery mode, not growth mode.
In this scenario, you need to agree on qualitative goals with the founder for multiple months whilst you and the executive team work together to find PMF. You’re basically operating in a founder-led sales role at this point.
If you do have PMF, it’s really about creating repeatability in the sales motion and building the sales team around that motion. In this scenario, it’s easier to set realistic quantitative goals.
You can see the challenge though right?
A founder will be very disappointed if they are expecting to set you quantitative goals on day 1, and upon reflection, you push back and suggest the timing is off because now you are through the door, you don’t believe they have PMF!
So you need to determine if they have PMF before you agree to join them.
Can funding stages indicate PMF?
Funding rounds have changed so dramatically over the last few years it’s hard to benchmark much against a funding round these days. However, here’s my general thought process for early-stage SaaS startups.
Seed: If you’re going into a venture-backed startup that is pre-series A my assumption is always that they don’t have PMF.
Series A: If you’re going into a series A backed startup the founders have likely convinced investors they have PMF, but my best advice is to completely dismiss that as validation of PMF, you need to build your own point of view.
Series B: If the startup has secured series B they have traction but does that truly mean they have PMF? Maybe, and frankly, they should have PMF at this stage. However, I know of multiple companies that have secured series B, I’m totally unconvinced they have PMF!
The moral here is, funding stages don’t indicate PMF, build your own point of view.
How to build your own point of view
Here are 5 key things I look for:
1. Engagement in the product:
Nothing beats customers actually using the product on a high frequency!
Any SaaS company worth looking at will have a clear handle on their Daily/Weekly and Monthly active users.
According to David Sacks at Craft Ventures “a SaaS product with excellent engagement might have a DAU/WAU that crests at about 60% (3 workdays per week) and a DAU/MAU that crests about 40% (8 workdays per month).”
Get these numbers out in the open, and have a discussion around them.
Warning: I have seen multiple series B companies raise >$20m at valuations >$100m without product-market fit AND without solid user engagement in their product! No joke!
So I repeat, just because an investor invested, doesn’t mean you should.
2. Have multiple customers replayed the value in crystal clarity back to you?
ROI is a critical indicator of confidence by a customer, and my advice is that if the startup is serious about you, and you are serious about them, they should invite you to speak with their customers.
Yes, case studies are valuable to read, but speaking with an economic buyer at a client to get their unadulterated view on how big a problem they are solving and how they measure ROI will be very telling.
3. What does Net Revenue Retention (NRR) look like?
As a reminder Net Revenue Retention is:
(existing revenue + upsell) - (all churned revenue) = NRR
Anything beneath 100% is a red flag, anything above is good, 115%+ is excellent.
A solid founder will know this number off the top of their head and will be willing to share the data with you.
If a startup is established enough to have these numbers (if they are more than 1 year into generating revenue they should), then this is one of the strongest indicators of PMF in my opinion.
4. If they haven’t had customers complete one contract cycle, look for successful early renewals and upsells
Valuations of SaaS companies are built against the future growth of the company and most of that future growth comes from growth within existing customers. To that end, a “land-and-expand strategy” is very common in SaaS.
This sees companies sell in at a lower value than the expected lifetime value, which means for them to be successful they’ll need to see upsell.
If customers are requesting more seats/licenses/access just months into using the product for the first time this is a great sign, and it’s those customers I’d want to speak with.
5. The sales team are swamped!
Assuming they are set on your ideal customer profile (ICP), the sales team being overwhelmed is the ideal situation you are looking for. Once the market gets wind of a product that can impact the core effectiveness of their business, it does not take long for news to spread, and the sales team are the first to feel it.
If you can see that lead volume is increasing, and that the time to respond to leads is increasing, or simply that leads are not being followed up in a thorough fashion, this is typically a sign that the market is pulling from you - and you almost certainly need to hire.
These are all good problems to walk into.
To sum up
You must build your own point of view and don’t rely on others. Your opinion on whether a startup has product-market-fit is something you have to own.
If you love the startup but you don’t agree they have product-market fit, my advice is either reach that agreement with the founder and agree on expectations for the first 6 months in writing, or walk away.
Alignment with the founder is critical, and just because they’ve set the expectation with investors that they’re ready to go hire a VP of Sales and to 3x ARR does not mean it’s possible or that you should sign up to it.
Good luck out there folks! 👊🏼