1st August, 2021

Week 31/52

Photo: Clarke Johnstone jumping at the Rio Olympics, by me

🚰 Dilute

If you stop and think about it, diluting ownership of a company that is growing quickly and which we strongly believe is going to be worth much more in the future is not super rational.

But this is exactly what we're doing when we raise capital in the early stages of a start-up.

To justify this we have to believe that what we gain will ultimately be greater than the cost of that capital.

So, if this is something you're considering for your venture, it’s really important that these three things are true:

  1. You have some momentum, even the numbers are very small. If you cannot at least show potential investors that you’ve already got some wind in your sails then you’re likely going to spend a lot of time and energy trying to convince them it’s a good investment. And you’d probably be better spending that time on other things, like trying to get the boat moving.

  2. You have a good answer for what you’re going to spend the money on. It’s really important that you don’t answer this in generalities: if the answer is (as it always is) “people and rent” then be very specific about what roles you think you need to fill and how much it will cost you to fill those roles including the total cost of having a larger team, not just the salary costs - e.g. recruitment fees, equipment, office costs or the additional costs of running a useful remote team, software licenses etc.

  3. You have the next milestone in mind - thinking at least two moves ahead...

🛫 Fly

Based on the stories published in the media about start-ups, it would be easy to assume there are only two critical moments:

  1. When a start-up attracts new investment; and

  2. When a start-up is sold

There is a simple explanation for this: those are the two moments when it’s easy to write a press release that sounds exciting.

Unfortunately it doesn’t tell the real story of start-ups at all.

As I’ve written previously, the reality of a successful start-ups is much more grind than glamour - any success is typically the result of thousands of little good decisions rather than one silver bullet. But this doesn’t make for interesting headlines. “Dog bites man” isn’t often news.

For example, during the early years of Xero the two stories that dominated media reports were:

  • Xero announces massive loss

  • Xero raises massive amounts of new capital

The connection between the two wasn’t often explored - all of that capital was funding the losses, but what were the outcomes?

The much more interesting story was hiding in plain sight: the consistent growth in customer numbers; the 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).

I am always curious to see how we celebrate start-ups that raise investment.

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

When we think about flying, the type of jet fuel used, the name of the company supplying it and even the amount of fuel supplied isn’t normally the story. Obviously it’s important that somebody is paying attention to those details - those flying the plane need to keep a constant eye on the fuel gauge. But that will only be the headline news if we run out. Otherwise the thing we should talk about is where we are heading and why.

The lesson here for anybody who wants to raise capital to fund a start-up and also for everybody who might be tempted to invest:1

Start by describing a clear and measurable unit of progress.

(Then use that to determine the amount of capital required. And then use that to calculate the current valuation).

What is a “unit of progress”?

It's the specific things we need to do in order to demonstrate momentum. The improvements we believe we can make in the immediate next stage.2

It’s not a final destination. While it’s important to think several steps ahead and understand how this next step will open up opportunities beyond that, we need to avoid getting too distracted by the end game. The best investors know that great companies are bought not sold, so the real goal is to create the sort of business and team that will eventually be attractive to potential buyers rather than focus too early on "exit" plans.

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

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

Each investment into a start-up is described as a round. These are given names like: Seed, Series A, Series B etc. Each round of funding will typically provide enough capital to cover 18-24 months of expenses (or “runway”3) and dilute the existing owners by up to 20-30%.

In my experience companies tend to spend all of 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 start-up 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.

Those who are paying attention may recognise that these examples map nicely onto the four stages of growth that I wrote about some weeks ago. As I said then:

As impatient as you might be you need to take the time to really absorb the lessons from each stage, because those are what enable you to be successful at the subsequent stages.

When we raise a round of funding it’s vital that we are specific about the things we hope to prove or disprove in that limited time; are confident that we can do that - i.e. that it’s possible to complete the experiment in that timeframe; and that, if we do, it will leave us in a sufficiently better position at the end.

Again, the real test of an investment round, once we have the benefit of hindsight, is: did the additional capital create more value than it cost?

This is what I mean when I say the best founders choose their investors carefully: they should pick those who have consistently demonstrated that they create more value than they capture for themselves. Over time I believe the best opportunities will flow to those investors who consistently do that for founders.

We don’t applaud pilots for refuelling. Or for successfully taking off. Or for landing in any random place.

The reason we take flight is because we want to travel somewhere.

The thrill is the journey but mostly the destination.

So don’t be distracted by the things that the media report on. Be more specific.

Where are we going? And what will it take to get there?

Photo: Trent Jones jumping at the Rio Olympics, by me

📛 Name

There are some great collective nouns:

  • Murder of crows

  • Parliament of owls

  • Hoon of kākā

  • Prickle of hedgehogs

  • Entitlement of boomers

So, what's the collective noun for start-ups?

Some would say “ecosystem” but as we've seen previously that term encapsulates both the start-ups and the derivatives that exist to support them and provide the environment for them.

It would be great to have a collective name for start-ups by themselves, sans derivatives.

When I asked this question on Twitter recently it was a bit discouraging to see how many of the suggestions were negative:

  • Fragile

  • Chaos

  • Scurry

  • Crapshoot

  • Gulp

  • Overpromise

There were a few others that took a cynical investor perspective:

  • Bonfire

  • Hedge

  • Cohort

  • Incubator4

However, some were much more positive:

  • Optimism

  • Enthusiasm

  • Disruption

  • Hope

These are my two favourites...

Firstly, a flounder of start-ups.

Flounders Club was a small group of founders, initially coordinated by Sacha Judd before she worked for us at Hoku Group. They would meet to share stories and challenges and also to hold each other to account for the things they committed to do at the previous meeting. The founding myth of the name is that it was a delightful typo.

Later we hosted several Flounders Retreats, which involved a slightly larger group of founders, but the same format: founders helping each other, with everybody contributing and everybody learning.

The motto of Flounders Club is: Pivot or Die!5

A flounder of start-ups definitely works as a collective noun.

But, perhaps the best is a rabble of start-ups.

Many years ago our team at Southgate Labs built a simple directory of local start-ups that we hosted at rabble.co.nz. It was for a brief moment in time a good list of the varied and interesting things that people were starting and working on in New Zealand.

A rabble is defined as “a disorderly crowd”.

For me that's the perfect description.

What do you think?

Any other suggestions we should have on this list?

PS Are you also wondering why the name badge emoji I've used here looks like it's on fire? It turns out to just be another good reminder of the heritage of emoji. According to Emojipedia:

This tulip-shaped name badge is one of many designs commonly found at kindergartens in Japan.


Top Three is a weekly collection of things I notice in 2021. I’m writing it for myself, and will include a lot of half-formed work-in-progress, but please feel free to follow along and share it if it’s interesting to you.


And for all of those who argue that we need to continue to subsidise fuel tankers!


What Blackbird call the "relentless drumbeat of progress".


Another aeronautical metaphor! The idea here is: the funding covers expenses for a period of time into the future and the goal is to be airborne within that time (ie before you run out of runway).


Thanks Miki! 👋


As it says on the website: "Sort of. Probably not according to genuine Latin scholars.