Product market fit in VC discussions
For early-stage startups “product/market fit” is the elephant in the room at every pitch meeting. It might be addressed heads on by the investor, and it might be touched upon from different angles, but it will never be ignored. I believe it’s best to face it heads on and address it in detail. This will show you both understand the gaps and risks that expect you in your future journey.
What is Product/market fit?
“product-market fit, is the degree to which a product satisfies a strong market demand.”
When looking at this definition, it’s clear that PMF level is not a binary yes/no, but rather a spectrum, because you can have a high degree of fit, some degree of fit, and even low degree of fit which are all higher than no fit.
The entrepreneur MVP PMF assumption
Dave is a young entrepreneur who loves to deal with education challenges and math. Dave is eager to develop a product that will help with the inability of math students to remember math formulas. Dave believes he can solve it with music. It’s easier to remember songs so Dave recorded a catchy music track that “sings” the formulas. He plans to sell my “album” to colleague freshmen.
He goes out of the building and to the nearest college and interviews students on their math issues and music taste. Dave fine-tuned his idea and recorded a light Jazz track that should be listened to while sleeping. It’s on a non-listed Youtube page and once the customer pays, they get the access link. Dave called it MathToSong.
The next day, he got back to the same college and pitched his product to a hundred students. Many even asked to get a taste and he played them a sample on his phone. Ten bought it for the asking price of $9.99 so he got a total of ~$100 selling MathToSong. He also got more feedback so recorded a new track - MathToSong2, this time on as a rap track. He pitched MathToSong2 and was able to sell to twenty students out of a hundred he pitched to.
Now Dave has an MVP with paying customers. His product satisfies what is clearly a strong demand in the market. Did Dave hit PMF and is he ready to raise VC money?
The VC PMF Analysis
VC’s that invest in early-stage startups are looking to invest in companies with some level of PMF. The highest the PMF level, the lowest the risk of never reaching it. This is true for any stage deal, but most deals around the Series A funding. Deals before Series A funding such as pre-seed and seed tend to focus on plans that will get the company to PMF. Later stage deals such as Series C assume a high level of PMF and it’s mostly a question of the market and superb execution. This is why the degree of your PMF will dictate who you are most likely to partner with.
High degree of PMF shows effective results in all three axes (axises) of the “sales interaction stage”:
- Prior to the sales interaction
- At the sales interaction
- Post-sales interaction
We can assume that a product has 3 independent PMF ranges - each in the “low/medium/high” scale. For example, you might have a product with a high level of PMF prior to the sales interaction, low PMF at sales interaction, and medium PMF post-sales interaction.
Let’s look at each independently.
PMF Prior to the sales interaction
The step which is prior to the sales interaction is related to the marketing of the product or any “broadcast” communication. Given the qualification criteria the company has defined for a customer, can the company reach and qualify enough customers that meet the criteria? Can they do it efficiently given the state of the market?
The assumption is that at this stage, the company is communicating with an audience or audiences, but not a single person.
In order to achieve a high level of PMF prior to sales interaction, you would be expected to identify the best performing marketing channel for your audience. Those would have attractive cost, scalable reach and efficiency. In addition, your messaging will be scrutinized as it will anchor your company’s position.
To get better at this:
- Be able to discuss alternative marketing channels and their traits: how many of your targets can you get there? What would be the cost? What is the level of competition on the medium in general and specifically in your market?
- Monitor your data
- Test messaging, both copywriting and imaging
- Show costs per qualified lead are being monitored and decreased over time.
PMF at the sales interaction
Let’s assume that you are a salesperson for a B2B company, and you just got 100 “qualified leads” (a lead that meets predefined criteria) from marketing.
Assuming these are indeed qualified leads (the level of lead qualification is a very tense point between marketing and sales in many organizations), a product with high level of PMF at sales interaction would be able to:
- Provide a high level of positive customer conversion
e.g. at least 10% of the leads will be converted to paying customers.
- Provide a low level of variance around their prediction e.g. if sales got 17 batches of 100 leads, and they expected to convert 10% of each, we expect to see results that somewhat resemble 10%. If the first is 70%, the second is 5%, the third is 46% etc, the results are all over and it feels lucky or random.
To get better at this:
- Show implementation of supportive systems such as sales CRM, coordinated pitch decks with version control, reviewed sales calls etc.
- Monitor your data and analyze it for improvement.
- Craft, test and improve your sales messaging and pitch.
- Test your sales motion - when and how you should strive for a deal “close”
- Have a repetitive, documented and improved sales process
- Show good conversion results and improvements.
PMF Post-sales interaction
Discussing post-sales PMF might be considered blasphemy. You identified an opportunity to sell something people need, we’re able to reach those people and they actually bought your product. That is the definition of PMF. “Crank up the marketing machine and let’s make money”.
Could be. Maybe. Maybe not. It really depends on your market stage.
Let’s assume this is a new market, with the active customers mostly being early adopters and influences. For example,
Let’s look at an example of a company that developed an AR set that helps surgeons.
They identified all the relevant conferences and even managed to hit a benefits-driven messaging that had nothing to do with AR, something similar to “lower your risk and insurance policy”. Most importantly, because they were playing in a niche, their marketing costs were very low which got them many qualified leads. They have great sales leadership and processes and are able to convert many of the leads to paying customers. Overall - a very high level of PMF.
What do you expect will happen if they crank up the marketing machine now?
I’d argue it’s still unknown.
The first sales will be done to the early adopters. These customers like to be at the forefront and actually like the risk of engaging with futuristics offerings. So while they might be bought on the promise, they still structure expectations about the product. Given the product did not meet their expectations, they would be very vocal expressing their negative opinions.
So in a sense, the level of PMF Post-sales interaction is related to how well the product meets the “sold” expectations and what is the cognitive dissonance gap that was created for the customer after they bought it.
To get better at this:
- Show increased usage frequency
- Show positive feedback
- Show switching from other solutions to yours
- Show customers referencing other customers - preferably publicly (customer use case)
The subjectivity of PMF
If you’ve made it here, you might be frustrated with the vagueness of the many of the statements I made above.
What is a “good sales conversion ratio”? 5%? 20%? 50%?
What is “low cost for qualified lead ratio”? $1, $10, $20,000?
It all depends. On the market, industry, echo-system, and hype.
What is important is that you’ll build arguments that tell a good story.
For example - “Our marketing is currently focused on google ad worlds with a CPC of $20, but we’re already testing a partnership with an industry publication that we tested and at small sale reduced the CPC to $10. Assuming the same conversion rates we saw through our sales process, this would improve our gross margins from 47% to 63%”.
The purpose is not to show you remember all the SAAS KPIs, but rather to show what you’ve achieved and acknowledge the gaps you plan to address.