Introducing Funding Market Fit. Now a critical concept for founders and entrepreneurs...

Recently I read this tweet question from a great entrepreneur Danielle Morrill.

 After months of gyrating markets and dozens of similar questions from founders, it was the straw that broke the camel’s back for me. Danielle’s question is a great one. Yet after reading the answers to this and other similar questions around the web, it’s clear that populist answers are all over the map, often conflicting each other and mostly only reflecting a tiny piece of the much bigger picture.

For example:

Again, not picking on this answer which may be perfectly reasonable, but generalizations like xx in revenue and breakeven are tough. And what has valuation got to do with it anyway? Yes I know that’s provocative to entrepreneurs - it’s intentional :-O

Every business is different and key factors like the potential size and emergence of the market, your own readiness to address it and the like could make the tweet above absolutely right or completely wrong.

As per usual, I don't have an answer, just a point of view with a framework for you to evaluate your decision making. If all you want is the Twitter version, here it is:

 If you want more, here's the thinking behind it. It's mostly obvious common sense...

Funding Cycles vs Market Opportunity

First of all you can't control the funding climate you have to work with. So instead, focus on what you can control (click to tweet). The timing and amount of your cash raise and your spend to intercept the market you’re going after.

The key mandate as an entrepreneur is to track how the market itself is emerging and understand how your prospects and customers are responding to your offerings. Armed with that data, pace your go-to-market spend according to your customer acquisition metrics. Look at both how long and how much it takes to acquire and where possible expand customers. Don’t overspend if time and cost to acquire are not becoming more repeatable and declining. And never ignore churn. If you pace well, you'll intercept the evolving need of the market with just the right amount of investment to capture an early leadership position.

Easier said than done and of course it still requires cash.

On the subject of how to much to raise, I've written about that for the WSJ here. On the subject of timing your raise, early this year I wrote this article on why “cash has become king again”. So plan your funding to both raise in advance of when you'll actually need the cash, but also in the context of key milestones you’ll need to show to raise again successfully. For example show you’re meeting a real market need, prove repeatability with your product offering, and then think at least one round of funding ahead to what it will take to prove as many major milestones as will justify your next funding round. (At Underscore.vc we call this Vector Funding? - defining the Vector from where you are funding now to where you need to get to for the next raise.) As you think about your vector to get funded again, get more specific than populist expressions like Minimum Viable Product (MVP) and Product Market Fit. Get granular and think of things like your Minimum Viable Segment (MVS - see definition here) and show how you can show tangible progress, prove value, lead or even dominate in your tightly defined early market engagements.

Introducing Funding Market Fit

If you do this right and fund yourself at the right pace to capture your market leadership, then you have what I call Funding Market Fit.

Here's Underscore.VC’s simple framework for Funding Market Fit.

Figure 1: Intersecting the market - just right!

It's tough to find the “goldilocks” just-right formula, and some of it is personal to your profile. In this case, think about the four quadrants that may guide you as follows:

1. Learning

• Probably better not to raise too much until you both understand product market fit and your own propensity for risk

2. Diluting

•  Raising too much too early can be good if you're risk averse, but it requires real discipline not to overspend as you figure out the right way to pace your spend to the emergence of the market.

3. Muscling

• Muscling your way into a market with more cash than anyone else can work, but it's risky and expensive (click to tweet). Some VCs even try to scare competitors off by choosing to use exclamative funding to aggressively possess a space. Again it can work but don’t bluff if you’ve not got the strong overall company-market-fit hand!

4. Missing

• Too little, too late and you guessed it, you're just going to miss the market opportunity :(

Think about how you can move from bottom left in the diagram to the center, by defining tight iterations of customer and market learning. Like most things in the startup world it will be an iterative learning process that also includes and is specific to you, your team, value proposition, go to market, and you business model. Don't try to prove too much in each step. Reduce execution variables. Then recognize:

You can execute flawlessly but if the market isn't evolving, pace it, don't force it or overfund it.

Funding Market Fit will give you the ability to not only pace the capture of your market and lead it, but do so in a capital efficient manner. It’s not easy so let’s review a couple of scenarios at each extreme, so you can think about how to target your Funding Market Fit (FMF).  (Oh dear, did I just give you another TLA?! Ignore the Three Letter Acronym if you like but please don’t ignore the concept, it will be at your peril.)

If you are too early, you'll burn cash trying to turn a latent aspirational need into a blatant critical need and that's expensive. Worse still as the market pioneer with arrows in your back, you may well get run over by a better funded competitor who comes in later than you and can ride the trail you've blazed more cash efficiently, capturing the pull of the market as it comes to life.

Then of course if you're too late, well, you're too late! And of course someone else will have captured the market ahead of you and begun building the customer relationships that you'll have to win back in order to gain market share.

And even if you then “Muscle” your way into the market late, with a big fund raise, you’ll probably have to play by the early market leader’s rules, have to contend with disappointed customers on rebound sales cycles or worse still replacement sales, which are often even harder and more expensive.

Maybe you tell yourself you can co-exist or settle for a fast follower position? It could be your only choice at that point, but lest you forget it, market leaders gain a disproportionately high valuation compared to their followers. They get the higher valuation for many good reasons. Their marginal cost of customer acquisition is often lower, they have a larger installed base to offer upgrades and new products to, and are therefore more attractive for partners to work with. I could go on. But the point is all of this feeds a virtuous cycle that is self reinforcing of their market leadership and makes it much more difficult to unseat them in the market ecosystem.

Talking of valuations, I’ve not yet mentioned the other top reason why trying to time your funding to optimize valuation rather than Funding Market Fit is just plain foolhardy.  Here's why... 

Bottom line: Great entrepreneurs don't over optimize valuation. They prioritize value creation and market leadership. (click to tweet) Great investors don't optimize short term financings, they prioritize large outcomes. And finally great partnerships between entrepreneurs and investors are formed when we get in sync on what matters for the long term.

Curious to learn what the above chart is about and find out the other key reason Funding Market Fit is so important ? Read the rest of this article here.

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At Underscore VC, Michael and his team partner with daring entrepreneurs to invest in founders and build from inception to market leaders. As a former entrepreneur turned VC, Michael has backed and built teams that have created billions of dollars of value focusing on large, market-changing technologies such as Cloud Computing, IoT and Big Data as well as disruptive business models such as Open Source and SaaS. Current representative investments include Acquia, Cazena, Demandware (NYSE:DWRE), Mautic and Salsify.

Follow Michael on LinkedIn, Twitter @mjskok, his website, and in his Harvard Innovation Lab class, Startup Secrets. Follow Underscore VC on the web and Twitter @underscore.vc.