LeanRounds Instead of Seed Rounds for Early Stage Startups


Seed Vs Lean Rounds

Seed Vs Lean Rounds

In an earlier post we saw how the lean startup principles can scale an idea. However we are facing resistance to the concept on account of prior commitments. My company ‘s services are commissioned to build quality products but there is a tendency to “stay in the building”. Promoters and investors decide to walk along a certain path and there is no room for course correction. In fact investors might treat any deviation from the business plan as a breach of contract. Investors are wary of entrepreneurs frittering away the invested funds on activities other than the business plan. This is contrary to the lean startup method of doing course correction based on continuous market feedback and hypothesis validation.

The traditional seed investors generally review the progress of the portfolio ventures on quarterly basis. The startup is required to stay committed to execute the business plan. In fact the term-sheets often mandate that startups use the invested funds only to execute the business plan. This arrangement is often counterproductive in business environment which is becoming increasingly volatile, uncertain, complex and ambiguous (VUCA). Frequent customer feedback needs to be taken. Startup needs to change its direction based on market feedback. With no feedback startups often miss early warnings of impending failure. Promoters love staying focused on the business plan that embodies their dreams. Often no feedback is sought and unsolicited feedback that doesn’t resonate is ignored. These circumstances result in startups deploying resources and building momentum much before they have valid reasons to do so. Startups need to be more responsive, agile and lean.

More than a decade ago our startup received seed funding from StarTech. We received the seed round with a rider that we use the invested money and our energies only to build the product as per the business plan. Halfway through the process we realized what we were attempting was too big. We would have been better off building something much smaller. However we continued executing the business plan – just hoping against hope that luck would bring some customers to pay for a product that wasn’t even 10% ready. As expected we ran out of money before we could sign up any customers. Had we done some course correction and opted to build something smaller we might have had a better chance. But we had our marching orders which didn’t allow us to think of any other approach.

Ten years later the tables have turned. As a successful entrepreneur I along with a few angel inestors have launched a fund called LeanRounds. This post explains the guiding principles of LeanRounds.

Harsh Reality of startups is that nine out of ten startups fail in the first year itself! The main reason for this failure is lack of mentorship and investments. LeanRounds plans to provide these two essential inputs to selected early stage startups. We don’t plan to invest in business plans. We would rather invest in assumptions or hypotheses that need to be validated. The central idea is to fail early and learn from the failure. We still have a lot of runway left even if nine out of ten hypotheses turn out to be invalid. These experiments carried out to validate the hypotheses would cost very less and would not run longer than a couple of weeks. Depending on whether the hypothesis is valid or not, the investor and the startup may decide to continue along the chosen path or change the direction or drop the idea.

As an investment fund; LeanRounds would divide its risk over many units in its portfolio. Each unit is not a startup with a business plan, but a falsifiable hypothesis. Instead of investing in a dozen or so startups; LeanRounds plans to invest in hundreds of hypotheses. Traditional seed stage investment decisions are based more on the credibility of promoters and their track record than the business idea itself. This is one way the investors try to reduce their risk. However they tend to ignore many promising business ideas from teams without any credible track record.

Baby steps instead of long strides

Baby Steps Vs Long Strides

Baby Steps Vs Long Strides

There was some value associated with startups staying on course and committing all their energy and time to a mutually agreed business plan. In fact as we saw earlier some term-sheets mandate that the invested funds be spent on the business plan and entrepreneurs were discouraged from using these funds for experimenting with other ideas. This way of working served its purpose in relatively stable business environments of yesteryears.

The business environment is constantly changing. The assumptions that are valid today won’t remain so for long. LeanRounds believes in frequently validating hypotheses. We advise startups to build products in agile iterations. Each iteration lasts only for a couple of weeks. Startups should seek market feedback and validate their assumptions at the end of every iteration. They should avoid long development cycles as it distances them from market feedback. Each iteration has a falsifiable hypothesis to be validated. It could be an assumption that customers will behave in a certain way. While it may turn out that the customers behave entirely differently thus falsifying the initial assumption but resulting in new insights and learning that could help to formulate the next hypothesis.

Does this mean that entrepreneurs will fritter away their time and money experimenting with various ideas? That would obviously not happen because LeanRounds invests in hypotheses that are worth testing. Each round of investment comes with some advice that the entrepreneurs need to follow. We also ensure that chosen teams have the needed experience, skills and ability to execute the business idea should the hypothesis turn out to be valid.

Lifecycle of Startups in LeanRounds Portfolio

StartupLifeCycle

Startup LifeCycle

As it might have become clear by now; startups have to continuously form and validate hypotheses. These may be short experiments lasting a couple of weeks in the initial stages of the lifecycle. However once the startup has passed through the initial filters of problem-solution validation; further hypotheses and validations might need longer running experiments. To illustrate this point we have identified seven hypotheses that typically represent seven stages in the lifecycle of a startup. Some finite number of startups will get filtered out at each stage of the lifecycle. The hypotheses grow in time and money needed to validate them as you progress through these stages.

More Details About LeanRounds Investment and Exit

Investment Ladder

Investment Ladder

LeanRounds investments start small and grow as a startup validates its basic assumptions and moves to validate bigger assumptions. Initially a startup needs to validate if the problem they are trying to solve is worth solving. This can be done by using very low cost methods like landing pages. Later we need to build a MVP or prototype and test it in the real market which needs higher investment.

Along with investment comes some advice from experienced entrepreneurs who’ve been there and done that. This advice helps the startup to accelerate its value ten-folds in very short – lean and agile sprints.

The value of startups multiplies in orders of magnitude as they move up the ladder shown in the diagram above. We believe that a credible team focused on solving a problem that is validated to be worth solving is an order of magnitude more valuable than one that does not know whether the problem that they are attempting to solve is hurting enough customers to have them pay for having it solved. In the same vein a startup that is further along by having a validated solution that’s better than the existing solutions for customers to switch is an order of magnitude more valuable.

The investments are linked to hypotheses being validated. At each stage the experiments become more demanding and cost more. A prototype might cost ten times as much as a landing page and version 1.0 of the product might be 10 times more costly as compared to the prototype.

Bigger investors take interest as the startup climbs the ladder. The mortality rate is highest in the fist two stages of the lifecycle and the investments are too small to attract any investor. These are the times when a startup can turn to LeanRounds instead of bootstrapping or going to friends and family to raise the money. LeanRounds plans to exit once the startup is at a stage in the lifecycle where bigger angel investors and private equity firms start showing interest.

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One thought on “LeanRounds Instead of Seed Rounds for Early Stage Startups

  1. Vinayak – came to your site thru Ramesh Adavi – Very happy to read this stuff – resonates a lot with my experience – had heard the term Lean Startup – but your article above puts things so succinctly – will look forward to staying in touch.

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