Why is raising pre-launch often easier?

Investors love traction. Even at the early seed stage, almost every investor has “traction” near the top of their list for what they look for in an investment. And for good reason! Even with a great founder, a plausible idea in a big market, and a team to execute on the vision, there is a lot risk that nobody actually wants what the founders are building. A “launched” product with some early growth is considerably less risky than a pre-launch product. Entrepreneurs have heard the call for “traction” many times and naturally assume it is always better to launch before trying to raise VC or angel money.

There are two problems with this assumption. First, launching isn’t the only way to get traction. Second, and more importantly, there are real risks involved in waiting to raise money until after your product is fully launched. In reality, there are two types of companies

• Companies that can and should raise “pre-launch”
• Companies that must launch to raise

That’s it - no third type of company that “can raise pre-launch but should wait”, not even if they could get better investment terms if they did.

When I talk to fellow founders raising a seed round, this question of timing always seems to loom large in their minds. After seeing multiple accelerator classes I’ve either been in or mentored for raise (or in some cases not raise) their seed rounds over the last 2 years, some clear patterns have started to emerge. In this post, I’m going to lay out why it is better to raise money before launching if you can, how to find out which kind of company you are, and how companies that should raise before launching can gain momentum and traction without launching.

When is it better to raise pre-launch #

A lot goes into putting together a seed fundraising strategy (this post is largely about timing), but the whole process must start with an understanding of how investors evaluate early stage opportunities in the first place. At the seed stage, investors are typically looking at four things:

• Market: what is the size of the total addressable market (TAM) this company is attacking? How vulnerable are the incumbents and what are the barrier to entry?
• Idea: What’s the current plan to attack the market? Is it plausible?
• Team: Can the team build a product and execute on a plan to win a big piece of the market?
• Traction: What evidence do we have that the idea is good and the market will adopt it?

Investors want to know the size and quality of the opportunity (market and team) and the likelihood that this company is on the right track for capturing this opportunity (idea and traction). This breaks out into a very rough equation like this²:

(Market + Team) * (Idea + Traction) = Investability

At first glance, it seems like traction is absolutely critical! It’s not only one of four variables in a scalar-y equation, but it also almost certainly contributes strongly to the perception of the idea. It’s true that traction could swing this equation wildly, but there are two non-obvious factors at work here. First, the amount of traction required to positively swing this equation is actually very difficult to attain in a short period of time without significant resources. Second, and most importantly, there is a hidden risk to launching if you don’t immediately see clear early returns. To make this more tangible, let’s plug a couple of theoretical examples into the “Investabillity” equation". We’ll weight each factor in the equation from 0 (horrible or non-existent) to 1 (perfect):

Example 1: Ex-Google employees³ build an AI powered data analysis API for Healthcare

A team of engineers from Google wants to help Healthcare companies make better, data-driven data decisions using artificial intelligence. The idea may sound crazy, but the team has already built a working prototype that has early potential partners in the industry extremely excited. The team seems great to VCs who have seem former Google employees excel as founders before. Their seed investment equation would look like this to an investor who is really bought in:

(Market = 1.0 + Team = 0.8) * (Idea = 1.0 + Traction = 0.0) = 1.8

You may be thinking “wait a second - how can the idea be a 1 without any market validation”? GREAT question! It’s a 1 because people, including investors, can’t help but fall in love with ideas⁴. Remember that this is for investors who have “bought in”, perhaps investors that were already on the lookout for this idea or were just particularly compelled by the pitch. But what would happen if they launched their product and inevitably found that signing and integrating their slow moving clients in the Healthcare industry took longer than they thought. What would happen if they tried to raise then?

(Market = 1.0 + Team = 0.8) * (Idea = 0.5 + Traction = 0.0) = 0.9

Half as good! Why? Because the idea has now been “sanity checked” - it’s still a good idea, it’s just unproven in a very tangible way. Worst of all, they still have no traction and it is highly unlikely that will change any time soon. Here’s the key: even a successful launch wouldn’t have improved their chances of funding by very much. The golden rule of fundraising if only raise on good news and this launch, as with most launches, is actually very unlikely to be good news. This company can not win by launching, but they can lose HUGE.

Conclusion: Raise pre-launch

Example 2: 2 recent grads, one CS one graphic designer, are building an note taking app to take on Evernote

Two recent college graduates have been consistently frustrated by the lack of good note taking apps available to them, and they want to change that. People keep telling them to try Evernote, but they’re not sure why - it’s a horrible product as far as they can tell. They feel that by building for mobile first and focusing on a simple but powerful core product, they can succeed where Evernote has stagnated. Investors like the idea - they too are sick of Evernote, and the team seems promising. However, it feels like a small market with a somewhat strong incumbent and a tricky business model. Their equation looks like this before launching, even to an investor that likes the idea enough to want to use the product:

(Market = 0.4 + Team = 0.5) * (Idea = 0.5 + Traction = 0.0) = 0.45

This team is only 20% as investable as the first team, even with a decent idea, a reasonable market, and a team that has the skills to build the product. The “idea” score in this instance has a cap that the previous idea did not, because it is far more unlikely to generate semi-irrational excitement among investors. This company is not investable right now, and nobody outside of friends and family would fund this company pre-launch. But what would happen if they launched and grew 20% w/w for 16 straight weeks until they got to 50,000 users that love the product? Now the equation would look like this:

(Market = 0.4 + Team = 0.7) * (Idea = 1.0 + Traction = 0.5) = 1.65

This team is now almost as investable as the first team. Why? Because the team now looks so much better, they have a real accomplishment under their belt, the idea is now obviously good, and they’ve got great traction. It’s still early, and it’s telling that even with all of the progress, the fact that they’re attacking a smaller market still puts a significant penalty on the teams overall ability to raise money. Different investors would now prefer Example 1 or Example 2, but they’re both going to get a round done. The difference is, for Example #2, launching was their only chance.

Conclusion: LAUNCH BABY LAUNCH!

Find out which kind of company you are now #

It may seem like I’m arguing many companies should delay their launches so they can raise money - I’m not. You should absolutely never delay launching your product. What you should do is figure out which kind of company you are. Have conversations with potential investors as soon as start working on your project both to build relationships and to figure out what kind of company you are. Don’t ask them directly, this isn’t information they can or will volunteer. Instead, try to pick up on out how excited they are about the size of the market, the team, and the way you’re attacking the idea.

How to get momentum without launching #

If you think you have a chance to raise a seed round or get into a top tier accelerator without launching, then you should start that process as early as you can. However, you will still need to show momentum to get something done. Just because companies raise before launching doesn’t mean anyone will fund you based on an idea on a napkin, those days are largely gone if they ever existed in the first place. Lucky for you, you can generate genuine momentum without launching! My favorite strategies for getting momentum without launching are:

• Controlled launches (alphas, betas, invite only)
• Pre-launch commitments (signups, LOIs, or if you’re awesome pre-sales)

Controlled launches and pre-launch commitments let you get the traction, feedback, and validation you need without exposing your company to being fully launched. Which strategy is best for your company varies based on what you’re trying to accomplish. Hardware products can do well with pre-sales and Kickstarter campaigns, enterprise products do well with LOIs, and consumer facing products will do better with alphas and betas.

What to actually do #

This blog, like most pieces of writing about raising venture capital, should not be taken as advice about how to run your company. In fact, you’ll notice that in every single scenario I’ve mentioned, you will need to build a great product, talk to your potential users/customers to determine market fit, and get early adopters for what you’re building excited and invested. That is MOSTLY what you should be doing, no matter what you’re trying to build. However, raising money is tricky, and companies that implement a thoughtful and nuanced strategy quite simply have a much higher success rate than those that simply react. If you plan to raise venture style capital (VC or angel money) for your company, take some time from day one to figure out whether you’re a pre-launch or post-launch seed round company, and then go build your business. Good luck, and as always feel free to shoot me any thoughts or questions on Twitter.

Footnotes #

1. MAJOR ? ALERT!

2. Every VC analyst reading this just had a mini stroke at how angry the simplicity of that equation looks. CHILL! I’m just making a point!

3. I’m already annoyed enough at using former Google employees as the example of a “great team” so I’m DEFINITELY not going to use the phrase “Xoogler”. Nope, nope, never.

4. I feel like my “investors aren’t perfect” stance is going to get me in trouble but, I’m sticking with it.