Category: Articles

So you have started up recently, have just launched the product six months back, have a few paying customers, good margins, and a clear plan for the next eighteen months! You recently got introduced to this venture capitalist through a common friend and are excited to meet and pitch for a seed round.

For the last couple of years as a venture capital investor, I have had a chance to interact with hundreds of entrepreneurs. Most of them were with solid ideas, great teams and a passion to build something out. 

One of the most difficult things that I have had to do is to say ‘no’ to a lot of ideas with great founding teams which had a solid underlying business, revenue and even path (sometimes imminent) to profit. Still, that business is not a great fit with the venture capital model. 

There has always been a lack of clarity in the mind of a lot of entrepreneurs about what exactly is a ‘venture fundable’ business and why venture capitalists say no to profitable ideas while pouring millions of dollars into (seemingly) loss-making, cash-guzzling businesses!

Most of the founders do not fully understand how the venture capital business model works, (although the share of founders, who understand it is much higher than what it was 5-10 years ago). I always recommend founders first understand the venture capital business before engaging with one. A lot of good reads are already available on this topic. What I really want to convey is a simple actionable framework that can help entrepreneurs to think through before approaching venture capitalists, especially from the perspective of scale.

A <TLDR> from all the stuff that you will find about the venture capital model is that the returns follow power laws and hence first and foremost, scale matters. You will see venture capitalists can (and almost always will), take bets on seemingly difficult businesses (with a higher chance of failure) but the ones which can grow very large. Simply put, high risk but high-reward models. 

Ten minutes into a pitching session, the first question is ‘Can this become large? How large should you be thinking?’
That’s the real (100) million-dollar question.

A rule of thumb that we follow is to try and answer ‘can this business reach a $100 million, high-quality annualised revenue, in the next 7-8 years’. If the answer is yes, you have got (our) attention!

Now let us dissect each aspect of this question and flesh this whole out a little, shall we?

1. Revenue: It’s important to emphasise here on ‘revenue’. This is not GMV, not GTV, not LTV. In case you are into an intermediary business, (for example, a marketplace), then you should think of this as the commission/take rate or gross margins. This is essentially the price, customers are paying for the value that ‘your business’ is providing.
   
   
2. High quality: This is super important! A good quality revenue is high gross margins (usually software margins of 70 to 90%), strong predictability/repeatability (nothing like a long-term subscription revenue model), and good cashflows (generate positive cashflows with growth and you are golden). This is why SaaS (software-as-a-service) businesses are highly valued — that is as high quality as you can get.
   
   
3. 7-8 years: Are you going to grow fast? Are the conditions (both business as well as market) conducive now for you to quickly scale? Most of the fast-growing businesses can do that because they ride some ‘wave’. New technologies usually change customer behaviours and enable businesses to grow fast.

An important point to also think through is if capital is really going to help your business grow fast. As an example, most B2B businesses traditionally could not grow very fast because of structural reasons and so even though they were in a large market, they were not as attractive to investors. The SaaS wave has changed all of that, as now companies selling to even SMBs can scale very fast.

Having understood the question, before you answer a yes or a no, take some time to also nuance some finer points and visualise how your business and the market look at scale.

First, it is critical to see if you are attacking a market where the ‘target addressable market — TAM’ is large enough to support such a business. When looking at the TAM, most of the founders go with public data and a top-down approach. The usual gist is — billions of dollars in market size and only a 0.1% market capture yields 100s of millions in revenue. This almost always doesn’t work — you wouldn’t be able to find many valuable companies with a 0.1% market share in a large market, it’s usually a larger percentage of a much smaller but highly targeted market.

While calculating ‘TAM’, I always encourage founders to do a ‘bottoms up’ market sizing to go with a top-down approach. It usually will start with you being able to define your core customer segment. The total universe of your core target customer and the price per customer will give a good estimate of the market size, at scale assume that there would be two-three large competitors eying for most of the market share and make reasonable assumptions.

It’s important to also remember that the best companies always end up increasing the TAM! Especially if you are riding a wave, it is difficult to estimate the market size ten years in the future. Still, when you are looking to bet the best part of your productive career, it is prudent to start with a large enough TAM rather than depending only on expanding market size.

There are a lot of other things that go in while evaluating a business for an investment – team, competition, business model, technology and so on, but the deeper dive is contingent on crossing the line on ‘team’ and ‘TAM’.

Now, what if after this consideration, the answer to this question is a ‘no’? In that case, you go with the good old way of building businesses — profits and cashflows. Although this way is less glamorised, this is how most of the large businesses in India (and globally) have been built. They have been financed by conventional debt and public and private equity financing. Family offices and HNIs (with patient capital) are good partners for such a business in the early days, a lot more options open up with a scale.

If the answer to the 100 million dollar question is a ‘yes’ for you, go ahead — a lot of VCs including us at Kae Capital are waiting with (our) chequebooks!

Founders are often tempted to capture as much value (or revenue) as possible from different types of customers. To do this, they often wastefully spend their energies and company resources on capturing multiple types/avatars of customers and therefore lose sight of the company’s core value proposition and focus.

At Kae Capital, I’ve seen maximum value and growth generated when founders have a laser-sharp focus on one customer avatar. These founders then go ahead to build every aspect of the company around that one customer avatar (be it marketing, branding, value proposition, any hooks of engagement etc.)

This is my take on what you could do:

Defining core customer avatar: Go deep in defining the customer avatar – age, gender, ethnicity, behavioural traits and habits etc. The idea is to build all aspects of the company around the avatar and what appeals best to that customer

Firing your customer: Anyone who does not fit the above profile is not an area of focus. Fire the customer!

To help you build further on this, at Kae we came up with a framework. I think it’s a great exercise to work as a team and come up with answers to these 8 key questions.

Defining core customer avatar:

Q1. Hypothesis – Who is your core target customer? 

Be as detailed as possible in defining your core target customer. In certain B2C cases, this would be a “user” which is different from the “customer” e.g. social networks / audio platforms where the users are part of the network/consumers of content

Q2. What is your company’s core value proposition for your customers?

It’s also important to define the core value proposition of your company. What makes your offering so compelling for the customers? Why would you win against the competition? Is the core value proposition really valuable for the core target customer?

A good way to summarise the core value proposition for the core target customer is coming up with a one-line ‘positioning statement’

Q3. Validating the hypothesis – Is your core target customer deriving maximum value out of the offering?

Once you have defined the core target customer and the core value proposition, it’s critical to validate that thesis. Go deep into the customer mix and the value derivation by the customers, and look for evidence of who and in what way is deriving the maximum value out of your offering. There are a few tools that you can use to measure the value derivation and to find/ identify core customers

• Usage/Engagement trends – Look through the usage/engagement data and notice the trends. Looking at the power user curve is a good tool for this.
• Customer Retention/Renewal/Churn data and trends
• NPS – Segmental NPS data can give a lot of ideas about core customer
• Sales process and conversion data

If you do find a mismatch in the answers to Q1 and Q3, it is time to go back to the drawing board and iterate till you reach a broad match in Q1 and Q3.  

Q4. Aligning efforts – What percentage (number and revenue) does the above core customer occupy of your entire customer base?

This will help you understand how focused your energies truly are today.

Q5. Once you’ve identified your customer, what has your company done to build around this core customer?

List down 3-4 initiatives your company has taken up (in the last 6-9 months) to build a value proposition that resonates with the customer 

Q6. Going forward, how do you plan to further strengthen your value proposition for the identified customer?

As a team come up with 3-4 levers you plan to implement in the next 6-9 months which would strengthen your value proposition

Focus, focus, focus!

Fire customers who do not fit the core avatar!

Firing your customer:

Q7. Who have you fired in the last 6 months?

One of our health-tech portfolio companies fired customers who were above the age of 65 as it was a herculean task to onboard them and their ability to pay for services was low. Which avatars have you fired in the last 6 months and do you have any key learnings through this exercise?

Q8. What efforts are being taken to fire the remaining customers?

What steps are you undertaking to fire the remaining customer avatars (avatars that are not core to the business) in the next 6 months

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We ask our portfolio founders to document these answers and share them company-wide – this helps every team member to align and work towards the goal.

If you are working on a consumer internet idea – I would love to discuss and brainstorm over a cup of coffee. Hope this helps!

Also, thanking Gaurav Chaturvedi and Vidushi Kamani who helped in creating this framework.

We concluded a wonderful event in Bengaluru at Axilor Transit.

We started with a fireside chat with Mr S.D. Shibulal (Co-founder of Infosys and Axilor Ventures). He talked about his journey throughout 33 years in Infosys and what it takes to build such a large company.

Praveen Rajaretnam (Co-founder of Wooplr) also took a very insightful session on “How to make better ads”.

Here is the presentation he used:

How To Make Display Ads That Work from Praveen Rajaretnam

Here are some of the glimpses of the event: