October 2012


Lately, I’ve been doing meetings with young startups in recent accelerator batches and meeting them for the first time. It’s been great to hear that they’ve bought into the iterative method of customer development and most of them have found their Minimum Viable Product or MVP, or they are well on their way to finding MVP.

This is awesome but in today’s world, you can’t raise money on achieving an MVP. Investors demand more than that.

As Steve Blank likes to say:

A Startup Is a Temporary Organization Designed to Search
for A Repeatable and Scalable Business Model

The unfortunate reality is – an MVP is not the above! Yet most of the newly minted entrepreneurs I’ve met think their job is nearly done when they’ve found MVP – they think they can go build a pitch off their early MVP and raise money!

A startup does require MVP but it is much more than just MVP. The problem is that MVP means early adoption of product and its features, maybe even some who will pay. But it doesn’t tell you how many people will do it in the long term and whether this can support the company (the people and operations within) that is behind it.

So startups are much more than MVP and requires thinking beyond just the product. This is where I’d like to coin a new acronym, which is Minimum Viable Company or MVC.

What is a MVC?

First, I would say MVCs only apply to early stage startups – you can’t really talk about achieving MVC status for a company that’s been around for a longer period of time. To be minimally viable as a company, I would say:

1. It has achieved breakeven or profitability, or has a believable and achievable plan to get there.

OR

2. It has achieved enough metrics to reach its next funding event. This includes the first funding event.

Or ideally both.

The Fundable MVC

An MVC must have achieved some sort of MVP, but having MVP doesn’t mean you have achieved MVC automatically. Nor does it mean you’ve achieved the next level of MVC which is a FMVC or Fundable MVC.

Remember that many MVCs can generate cash, but how much exactly? If you reach small or medium business status, that is great; it takes no little effort to make $500K, $1M, or several tens of millions of dollars per year. It is a notable achievement to employ a building full of workers, insuring them pay and livelihood, and providing or shipping product and services to customers. This is a win by many measures.

However, many companies like these, while there is every reason in the world for them to exist, unfortunately are not attractive to investors. This is because while they are doing great work, the likelihood of investors getting their money back and then some is very low or zero. This is the difference between an MVC and a FMVC.

We have not, as an startup/investor community, figured out how to invest in those companies whose trajectory is heading towards small or medium business status. Right now, all startups are being funded as if they are going to exit like any high growth startup. Anybody on a lesser trajectory simply won’t attract the funding it needs unless more effort is done with other funding sources or structures.

Therefore, it is the FMVC that every startup needs to achieve. What are the characteristics of a FMVC? Everything that a seasoned, high growth investor looks for: big market, big vision, lots of revenue potential, world domination plan, etc. This is what will increase the likelihood of funding, not presenting your MVP at a demo day, or even a plan for a MVC, but your plan for a FMVC.

How do you turn your MVP into a FMVC?

First, you must realize that not all MVPs yield a FMVC. MVPs could yield a MVC but not FMVC. Many MVPs have potential to attract some customers, but not enough to create a company and an opportunity large and tasty enough for investors to want to put money in. This is also dependent on the market in general, meaning that 5+ years ago when there weren’t so many startups sprouting up all over the place, you could have achieved an FMVC with your project; however, in today’s crowded startup world, you cannot.

While every project is different, I point you to some suggestions on examining what you are doing now in hopes of turning it into a FMVC:

1. Iterating on MVCs is a good thing to do; keep trying out business models and plans until a FMVC shows up. It may mean giving up on your current MVP and looking for another one. Do not be afraid of going back to the drawing board if you find your MVP does not yield a satisfactory FMVC!

However, your time limit is your bank account. Never forget that. So working rapidly and lean is key.

2. Do you have a World Domination Plan? Is it believable? If you can envision a world where your MVP dominates whatever market and customers it is pursuing, is that big enough?

3. Are you too focused on the solution and not on the problem? Becoming too myopic about their product and forgetting about how this turns into a big company is something that I find happens with many entrepreneurs. They get caught up in the success of finding a MVP, but don’t realize that they not only need a MVP but need to achieve MVC and hopefully FMVC.

4. Following on 3., it would probably be a good idea to pick up some MBA skills and start running models and scenarios to see where a given MVP can become a MVC, or potentially a FMVC.

5. A good measuring stick I use with startups is to ask what the $100M/year revenue scenario looks like. Generating $100M in business per year is no small feat – you get there and you’re well on your way to becoming a big business. So can we imagine a world where your startup is making that much and believe it?

6. The weird thing about some startups is, that some break into such new territory that it is very hard to model or you can’t model anything. New industries, new markets, or products and services that customers cannot imagine having or using are like that. So the FMVC you could create is purely via pitch, arrogance, confidence, etc. – whatever it takes to woo an investor to write a big enough check on what you plan whether you have product or not. In order to accomplish this kind of FMVC, your credentials must be unique: you must be well-known to the investor, you must be trusted. Ideally, you would have had an exit or more for that investor. You must show “extreme” entrepreneurial traits: be able to employ persuasive language, compelling/grand planning, superb salesmanship skills and technical skills, among others. These are the people who can get funding on a powerpoint when others flounder even with revenue.

This can be enough to win you funding and survivability.

In short:

1. An MVP is great but not enough in today’s market to win funding.

2. An MVC generally means you have MVP, but an MVP does not guarantee MVC.

3. An MVC can yield a small to medium business, or a big world dominating one. There is nothing wrong with building any of those types of businesses and the world is big enough for all kinds.

4. However, we do not know how to properly invest in small to medium businesses. Our money may not be returnable from such businesses using the current equity structure of our investing. Thus, we want to invest in FMVCs.

5. As someone who is trying to build a real high-growth startup, therefore, MVPs or MVCs are not enough. You must search for a FMVC.

So you have just closed on your $1m seed round.  You’re excited and ready to get to work.  The first thing you do is contact TechCrunch and PandoDaily to get some PR, hire a few engineers, a marketing person and begin paying yourself.  Your burn moves from $15k per month to $75k per month overnight.  You are driving traffic to your site, building product and showing early signs of execution.  You were invited to sit on a panel; you’re mentoring some young teams; all in all, you’re feeling pretty good about yourself.

But, you can’t help beginning to think that the clock has started ticking – 12months and counting to get to that elusive Series A.

So, you begin to scour the blogs, absorb everything that other successful start-ups have done and decide that with 12 months of cash on hand, its time to double down on the business model that you got funded and crack the formula for a scalable user base and show “Fab-esque” growth.  You throw out the idea of the lean model and say “fuck it” time to take control of my own destiny!

Sound familiar?

In the age of Lean Lean Lean, it never ceases to amaze me how many companies at the seed stage fall into the trap.  They mistake maniacal focus on growth for “fire in the belly”.

And, at month 10 or 11, the entrepreneur begins to complain to his investor base that despite all of these great metrics of growth, the company is falling victim to the Series A crunch.

When, in reality, the Series A crunch was a proxy for focusing on the wrong things at the seed stage…

In our portfolio, we believe that exceptional entrepreneurs tend to have very similar characteristics regardless of their customer/market/product differences.  We believe that they have a genetic make-up different then regular entrepreneurs.  I like to call the super entrepreneur gene that distinguishes the winners from the losers, “The Random Walk Gene”.

This gene is displayed by founders who, at the seed stage, realize that they are embarking on a 10000 mile foot race.  They realize that momentum early on does not dictate success. They recognize that a random walk down a lot of different avenues will ultimately help them in the long run.  They realize that learning from mistakes at the seed stage is usually more important then continuing to pile on to the early successes that they have had (think about this for a second, imagine if you knew all of the customer acquisition strategies that don’t work and why… as a nascent business, that information is incredibly powerful – maybe more powerful then knowing one strategy that does work since you don’t have enough $$ to milk that strategy to get you to scale).

The other unique characteristic of this gene is that these entrepreneurs are always ok sacrificing short-term gains in exchange for long term goals – and they NEVER lose sight of this.  If that means that they sacrifice revenue opportunities to continue to build on a more lucrative business model, then they build for the long-term.  If it means giving up a little more equity to bring on the right partners (employees, advisors and investors) then they swallow the dilution.   These entrepreneurs don’t calculate their personal net worth based on the last round of their valuation – they calculate the value that their customers get everyday from using their products.

As a result, super-gene entrepreneurs become pillars of stability in their company and in their community’s – they stay calm, consistent and emotionally stable.

I can name these entrepreneurs and examples off how the gene has displayed itself off the top of my head.  Not because I talk with these guys everyday, or brag about their success, but because I truly admire their ability to prioritize what is important.  Amazingly, and without fail, each of these companies ALWAYS figures out a way to pull off a fundraise, or convince another recruit to come on board or get multiple acquisition offers at every stage of their development.

Building a great business takes a long time.  Slow and steady at the seed stage may mean that you sacrifice the sexiness of running a hyper-growth opportunity, but in exchange, you will have a much more stable business on your hands.  Oh yeah, and the chances that you will stumble on the sexy business model of the moment is like 1 in a 100,000…so at the least, play the game where the odds are more in your favor.

Over the past couple months the Launch Capital Research Team has been working to update our annual Megatrends predictions. Part of this process is to consider some of the more diffuse determinants of economic development: resource scarcity (both human and material), environmental conditions, geography and inevitably politics. Although the causational relationship between the economy and political policy is often debated, it should nevertheless be accounted for.

With an enormous Federal debt and a lagging economy, the 2012 election could have major market implications. Due to the cloud of uncertainty surrounding the future of the American economy, many private investors, from large institutions to individuals, anxiously wait on the sideline; with a high premium on stability and long-term holdings. Families are embracing a similarly risk averse ideology through the deleveraging of their balance sheets, exemplified by declining average household debt (with the exception of student loans).

The indecisiveness of Congress and its inability to revive the economy continues to fuel uncertainty from Wall Street to Main Street, resulting in a “wait and see” mentality in regards to investment and new hires. Understanding the economic policies of each Presidential candidate is invaluable when attempting to predict future economic attitudes.  Based on our findings below we have concluded that neither candidate offers a strategy that is likely to gain bi-partisan support or radically change the path of the nation. Without the prospect of successful or implementable policy we believe the 2012 election is unlikely to shift individual uneasiness about their economic future.

Image

Image

Image

Data and excerpts from Tax Policy Center Analysis of Romney Tax Plan:

http://taxpolicycenter.org/taxtopics/romney-plan.cfm

Romney Policy Summary:

The full implementation of Romney’s tax policy (expected to occur in 2015[1]) would decrease Federal revenue by 900 billion or roughly 24 percent of projected revenue. In relation to current policy baseline, assuming the extension of the Bush Era tax cuts, indexing of AMT, elimination of payroll tax cuts, and the extension of all existing temporary tax policy, Romney tax policy decrease Federal revenue by $480 billion in 2015.

Romney states that the lost tax revenue will be recovered through closing corporate and individual tax loopholes, and the broadening of the tax base. Specifically, Romney claims that all tax cuts will be revenue neutral, a feat that the TPC argues to be impossible without increasing the taxes of individuals making less than $200K.[2] More specifically, the TPC argues that Romney’s plan to reduce the marginal income tax rates, eliminate the estate tax, eliminate the ATM cannot be revenue neutral with increasing tax for some individuals making less than 200K.

Romney also has yet to specify what loopholes he would target and the extent to which loopholes would recover revenue. Romney recently hinted at one such reform, which would be the capping of the amount of deductions a taxpayer could claim.

Romney promises austerity, proposing capping federal spending at 20 percent of GDP, which we assume will be gradually phased in over fiscal 2013 through 2016.

Romney’s supports the “cut, cap and balance” strategy that has been a fixture of the Republican party.

Miscellaneous:

  • Romney has stated that he will cut back on many of the regulatory measures of the Dodd Frank Act, but not abandon the act entirely.

http://www.csmonitor.com/USA/DC-Decoder/2012/0828/Obama-vs.-Romney-101-3-ways-they-differ-on-regulation/Dodd-Frank-Wall-Street-Reform-and-Consumer-Protection-Act

In the most recent debate Romney suggested he would repeal and replace the Dodd Frank Act

  • Plans on declaring China a currency manipulator, and generally more aggressive in the treatment of China

Data and Excerpts from Congressional Budget Office Analysis of Obama 2013 Budget Proposal

http://www.cbo.gov/sites/default/files/cbofiles/attachments/04-20-Economic_Budget.pdf

Obama Policy Summary:

Individual Impact of Obama’s tax policy (According to TPC):

  • Relative to current law, the entire package of proposals would reduce taxes in 2013 for nearly three-quarters of all households and raise taxes for about 6 percent.
  • Individuals at either end of the economic spectrum would be less likely to see their taxes decline
    • 30 percent of both those in the bottom quintile (20 percent of tax units) and those in the top 1 percent would see their taxes go down.
    • 71 percent of those in the top 1 percent would face a tax increase, compared with just 1 percent of those in the next-to-top quintile (60th through 80th percentiles)

By CBO’s estimate, those policy changes would, on net, add about $2.9 trillion to projected deficits over the 2013–2022 period and necessitate $0.6 trillion in additional interest payments (because of increased federal borrowing). Most of the net budgetary impact would come from changes in tax policies, but changes in spending policies would also play a role.

  • In 2013, the deficit would decline to $977 billion (or 6.1 percent of GDP)
  • The deficit would decline further relative to GDP in subsequent years, reaching 2.5 percent by 2017, but then would increase again, reaching 3.0 percent of GDP in 2022.

The CBO develops a yearly budget baseline, “CBO’s baseline projections largely reflect the assumption that current tax and spending laws will remain unchanged, so as to provide a benchmark against which potential legislation can be measured”. In comparison, Obama’s plan is projected to add $82 billion more in debt over the baseline projections

 

The American Jobs Act

  • Initially proposed in September 2011 as a $447 billion package of household and business tax cuts, public investments, safety-net spending, and aid to state and local governments
  • After the release of the president’s 2013 budget, Congress enacted scaled-back versions of two major AJA proposals for the remainder of 2012: a 2 percentage-point employee-side payroll tax holiday (AJA proposed 3.1 percentage points) and a reduced extension of the emergency unemployment compensation (EUC) program.
  • The president continues to support passage of the AJA provisions that Congress has not acted

Beyond the Policies:

Due to the current polarizing nature of politics and a divided congress, the policies proposed by both candidates face a difficult future.

Despite the political gridlock, two policies are coming to a vote following the election regardless of the politics of the presidential winner.

Fiscal Cliff 

The overarching issue is the fiscal cliff, as series of spending cuts and tax increases (including the expiration Bush Tax Cuts) as outlined by the Budget Control act of 2011 if there is no consensus on reducing the deficit. Without a consensus, based on estimations J.P. Morgan economist Michael Feroli, there would be an automatic tax increase of $405 billion and automatic spending cuts totaling $98 billion.

 

Bush Era Tax Cuts

The Bush Era Tax Cuts have been extended to the end of 2012 at which point they either expire, be extended, or permanently adopted.

Tax Rate Changes if Congress doesn’t act

  • Long-term capital gains rate raises
  • Dividend tax rates rise to 15%-39.6%
  • Child tax credit falls to $500
  • Estate tax exemption falls to $1M
  • Payroll tax rises

The biggest tax cuts in the 2003 law applied to dividends and long-term capital gains. Dividends used to be taxed at the same rate as normal earned income. The 2003 law taxed dividends at a flat 15 percent across all tax brackets. As for income earned from selling investments stocks, bonds, investment real estate — the rate fell from 20 percent to 15 percent for those in higher tax brackets, and from 10 percent to 5 percent (and to zero by 2009) for those in the 15 percent tax bracket and below.

Romney supports the permanent adoption of the Bush Era Tax cuts.

Obama’s stance, based upon his 2013 budget and his opinion in 2010 when the cuts were initially going to expire, is to continue the cuts except for high income taxpayers.

Conclusion:

Based on our assessment of both candidates proposed economic policies, we believe a drastic jumpstart to the economy due to policy is unlikely. Obama is focused on more of the same policy implemented during his first term, which added over a trillion dollars to the deficit without major job or GDP growth. Romney hopes to facilitate economic recovery through supply side economics, a strategy that currently and historically has been met with significant controversy. Regardless of the impact of tax cuts, Romney’s policy is unlikely to get Congressional approval.

Neither candidate provides an effective roadmap for reducing the deficit. Obama’s current 2013 budget proposal is expected to increase the deficit. Romney’s current tax policy significantly reduces federal revenue, and without a definitive (or fully explained) means of recovering that lost revenue reducing the deficit is doubtful.

The bigger piece of the puzzle, however, is how each candidate will impact the current congressional gridlock. Obama has failed to bridge the ideological divide, and in some cases further polarized congress. Romney’s policies represent a further continuation of the conservative Republican ideology. Romney plan of cutting taxes and spending is likely to further polarize congress. In addition, Romney’s signing of the tax pledge is also a symbolic gesture of a future unwillingness to compromise.

We do believe that the business community and the stock market will respond more positively to a Romney victory. Corporate optimism is likely to follow a vocal pro-business candidate. Romney’s policies also favor the private sector, with a significant focus on incentivizing private sector growth. We are unsure, however, how long this optimism will sustain itself due to the difficulty Romney’s will face passing partisan policy though a divided congress. Obama is unlikely to elicit the same optimism if he wins a second term. In addition, the perception of Obama as anti-business has fueled Wall Street’s unease, a trend likely to continue with a second term.

The 2012 election will provide greater certainty in who will be our next President, but we do not believe the election will lead to any fundamental changes will shift the risk adverse attitude of most Americans. While the election may provide temporary certainty on the immediate future of the Bush Era tax cuts or Fiscal Cliff, we contend that uncertainty regarding the long-term future of the American economy and government will remain.

 

 


[1]  2015 is chosen to allow for the time required to turn policy into law and the point at which temporary tax policy Romney does not wish to continue will expire.