Unit of Progress

Descending Everest

Perhaps the most recognised New Zealander ever is Sir Edmund Hillary. In 1953, at the age of 35, he climbed his Everest, which just happened to be the actual Everest. After that he got on with quite a few other things. He lived a life full of adventure and also did a lot to help people less fortunate than himself. These days he lives on the $5 note.

I remember this quote from Peter Hillary’s eulogy to his dad (please excuse me if I don’t have the wording exactly right):

Don’t wait for great things to happen to you, or else you might be waiting a very long time.

I’m interested in the language we use to describe Sir Ed’s original achievement. For example, an article on the official Ministry for Culture and Heritage website starts: ¹

A beekeeper from New Zealand, Edmund Hillary, and the Nepalese Sherpa Tenzing Norgay became the first people to stand on the summit of the world’s highest peak.

Sir Ed himself had a great line about this. He was asked about the possibility that a previous expedition had reached the top before them. He immediately replied (and again I’m paraphrasing):

I always considered it a return trip.

He’s quite right. The reason we remember him is because they were the first to reach the summit who also made it down to tell their story.

A unit of progress

Our landing is what determines if we were flying or falling.²

During the early years of Xero there were two stories that dominated media reports:

1. Xero reports another loss
2. Xero raises massive amounts of new capital

Both of these stories were true. But the connection between these two facts wasn’t often explored. That capital was funding the losses, but what were the outcomes that were being achieved in the meantime, in little steps?

A much more interesting story was hiding in plain sight: the consistent growth in customer numbers; the hugely valuable sales channel that was being forged to small businesses via accountants and bookkeepers; and the remarkably low churn rates, which underpin high customer lifetime value.

It’s curious to me how we mostly celebrate startups when they raise investment.

It’s like we’re applauding the pilot for refuelling the plane.

It’s now so common we’ve all normalised this. Imagine if the airline industry was as excited about refuelling and as blasé about crashes as startups are.

When we fly, the type of jet fuel used, the name of the company supplying it and even the amount of fuel supplied isn’t the story.

Obviously it’s important that the pilots responsible for flying the plane keep a constant eye on the fuel gauge. But that will only be the headline in the news if they don’t.

The thing we should talk about is where we are heading and why.

The lesson for anybody who wants to raise capital to fund a startup and also for everybody who might be tempted to invest (and also for those who argue that we need to continue to subsidise aviation fuel) is:

Describe a clear and measurable unit of progress.

What are the improvements we believe we can make in the immediate next stage of the business; the specific things that will demonstrate our momentum?

We don’t need to predict or even describe our final destination. While it’s important to think several steps ahead and understand how this next step will open up opportunities beyond that, it’s best to avoid getting too distracted by the end game. Smart investors know that great companies are bought not sold, so the immediate goal is to create the sort of business and team that will eventually be attractive to potential buyers rather than focus too early on difficult-to-predict “exit” plans.

Remember, we use evidence to identify problems, but we use experiments to solve problems.

This is why startups are funded in stages (and also why planes are refuelled for one sector at a time).

Each investment into a startup is described as a round. These are given names like: Seed, Series A, Series B etc. Each round of funding typically provides enough capital to cover 18-24 months of expenses.

This time period is sometimes called the runway - another aeronautical metaphor. We hope new funding buys enough time to get airborne, before we get to the end of the runway.

A well articulated unit of progress is a great way to determine exactly how much capital is required. Once we can estimate that, then the current valuation of the business is a simple function, based on how much dilution is necessary to tempt new investors.

Startups usually spend all the money they raise in each round, often faster than they expected, so it never really helps to raise significantly more than required to fund the next experiment - it only increases the dilution for founders and existing investors, with limited additional upside.

The unit of progress will change with each round, each one building on the one before, as the startup moves from early-stage to high-growth.

Some examples:

In a Seed round, we might want to prove that we can build a prototype product and find some initial customers to give us confidence we’re making something that people want to buy.

In a Series A round, we might need to demonstrate a repeatable sales process and a channel that allows us to acquire customers at an acceptable cost.

In a Series B round, we might want to show we can attract the people we need to grow the capacity of the team, especially in engineering and sales and perhaps expand beyond our local market into different geographies.

In later rounds we might need to hire a more experienced executive team, to move beyond the reliance on the founders and generalists who created the foundation in the early stages, and focus on improving unit economics.

These examples map nicely onto the four stages of growth: do it once, do it again, do it multiple times at once, do it at scale. Every stage in this model builds on the lessons from the previous stage.

When we take investment it’s vital that we are specific about the things we hope to prove or disprove in that limited time; that we are confident that we can complete the experiments in that timeframe; and that, if we do, it will leave us in a better position at the end.

Again, the real test of an investment round, once we have the benefit of hindsight, is whether the additional capital created more value than it cost.

We don’t applaud pilots for refuelling. Or for successfully taking off. Or for landing in any random place. The reason we fly is because we want to travel somewhere. The thrill is the journey but mostly the destination.

So don’t be distracted by other founders announcing their large capital raises. Be clear about where we are going and what it will take to get there.

18 months later

If I were a business journalist, anytime a startup wanted me to write about their capital raise I’d ask them about the unit of progress, and write about that. Not the amount they have to spend, but the outcomes they want to achieve with it. If they couldn’t answer or didn’t want to share that, then I’d write about that.

Then, 18-24 months later, I’d follow-up to see if those things were achieved or not.

Anybody doing this would quickly uncover all the important patterns. Who is consistently doing what they said they would do? Who are the investors who repeatedly back those founders? Those are the startups and investors to follow closely. It would be a simple way to get beyond the current situation where founders and investors who make the most noise or have the most recognisable names get the most coverage.

I also realise this is probably impossible, since people are generally only happy to tell their story in those moments where they have just launched their product or raised new capital, when their potential is all ahead of them, than later when they would be judged much more on actual results.

Four questions

Immediately after I invested in Vend in 2010 my role flipped. One day I was being pitched for investment, the next I was pitching to other future potential investors.

We completed three significant rounds of funding for Vend between 2011 and 2014, each much larger than the last.

In 2013 we raised NZ$8 million in a round led by Square Peg. The culmination of that was a pitch to Paul Bassett (one of the founders of Seek) and his team at their office in Melbourne. It was a memorable meeting. I expected they would ask hard questions, but we had nothing to hide. We didn’t need to trick them into investing, we just needed to tell our story. Our “unit of progress” for the round was based on building a new sales and marketing team in Australia. We were confident that we could do what we were promising, provided we could raise the capital to fund it. We were excited we had found the perfect venture partner to work with. Thankfully the terms they offered were good and we quickly agreed.

Less than a year later we closed another round of investment, this time led jointly by Square Peg and Valar Ventures. In the meantime Vaughan and I had spent a lot of time in the US. We spoke with every big fund, but with little success. Valar had followed our progress. We were able to show them that we’d done exactly what we previously said we were going to, which is always helpful in any pitch, and that convinced them to invest. It was satisfying to have a US investor on board, especially one with pre-existing links to New Zealand thanks to their earlier investment in Xero.

We raised US$20 million (NZ$25 million) - at the time, one of the largest private venture rounds in New Zealand. That valued the company at $90 million. The numbers had gotten much bigger but only in proportion to our ambition and potential of the business. We had grown to have more than 10,000 subscribers in over 100 countries. We wanted to take the model that had worked in Australia and do the same in North America, UK and Europe. Even so, our annualised recurring revenue (ARR) was only just over $4.5 million, so there was still a lot of work to do to justify the faith that investors were showing in us.

As it turned out, this was the last round that would be easy for Vend. Thankfully the investors who believed in us in those early days were rewarded for their patience when the business was sold in 2021.

Being on both sides of the table gave me a different perspective of how to pitch a startup and the questions that investors have.

As a potential investor, there are four questions I like to ask founders about their venture:

1. Who wants your product or service so much right now that they will use it even though it’s only half built?
2. How will you overcome your obscurity?
3. What’s hard? (i.e. what have you realised that will be difficult for others to replicate once you’ve done it once)
4. Why do you care that this exists in the world?

I’m always interested in which of these is most difficult to answer.

Of course, the ultimate question potential investors have in mind when considering a startup is always “how will you eventually make money?” But if we have good answers to each of these four questions and we can do what we say we will do, then that will mostly take care of itself.

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