Ask any successful startup founder to narrate a story of their journey to success, and you are most likely to hear about the decision to pivot at a particular point. Tales about startup success are incomplete without reference to the founders undergoing a pivot one time or another. From Honda to Twitter, every successful startup had to pivot or implement multiple pivots to be where they are now.

Interestingly enough, this realization about the ubiquitous nature of pivots in the life of a startup does not deter notions about them being considered last-ditch options employed to transform a struggling startup. Pivots are synonymous with startups and happen all the time. All startup founders are aware that they will have to pivot at some point; however, they are unsure when and how to do so.

What is a Pivot and why is it necessary?

According to Eric Ries, a pivot is ‘a structured course correction designed to test a new fundamental hypothesis about a product, strategy or engine of growth’. From this, we can deduce that it is an activity steeped in experimentation and learning. It is triggered when founders recognize from experimentation feedback that their findings differ from the earlier assumptions that they created at the beginning of the startup process.

All startups must expect to pivot more than once before finally achieving success. For most, pivoting will occur at every stage as the founders realize that their assumptions about customer segment, problem, solution, channels, or technology are not valid.

Startups that cannot bring themselves to pivot to a new direction based on feedback from the marketplace can get stuck, neither growing enough nor dying. If left unchecked, such startups end up failing.

If Pivots are so important, why don’t more startups implement them?

Despite widespread knowledge of its importance to ensuring success in startups, pivoting is still not a common occurrence for many startups.

This is because recognizing that there is a need to course correct for most founders who are emotionally attached to their product is a challenging undertaking. Such recognition goes against the typical human behaviour to admit that the initial course of action was wrong. Doing this takes putting egos and convictions aside to accept that a certain action plan was incorrect.

Other reasons why pivots are not implemented by founders include:

• The use of vanity metrics by startups can allow founders to reach false conclusions about their performance.

This is most common during the product-market fit stage when founders rely on metrics that do not provide a critical reflection of their performance, and as such, do not see the need for course correction.

• Arrogance on the part of the founders.

Most founders tend to have an absolute belief in the viability of their ideas that they become very resistant and hesitant about the need to change their business model. This commonly leads to a situation where products/solutions are created for problems that prospective customers have not validated yet.

• A refusal to approach the startup process as a learning activity.

While there are examples of startups that have been successfully founded with little input from anyone else apart from the founders, most founders tend to approach the startup process and create a product based on their ideas and conjectures.

Thus, there is very little room for them to learn anything as they do not believe the customers know what they want, and it is their job to tell the customer what they want. They see no need to test assumptions about customers, problems, solutions, etc.

When do startups decide that it is time to Pivot?

Executing a pivot is a strenuous activity. It is difficult for founders to recognize their need to implement a course correction and even more challenging to achieve one when they have decided to go for it. There is also no guarantee that the course correction to be taken will be successful or change the direction of the startup.

This notwithstanding, founders must understand that implementing a pivot/multiple pivots is inevitable and must be prepared to do so if the need arises. However, to do this successfully, founders must know when it is the right time to pivot.

The decision to pivot represents a combination of both art and science. Often, most startup founders decide to pivot on the back of a gut feeling or intuition they have that their current course is no longer the right one. This gut feeling can come from prior experience gained from running an earlier startup or from feedback gotten from other stakeholders (e.g., partners, advisors, customers).

In addition to this, founders may also decide to pivot on the back of the metrics/numbers generated from testing their ideas, problems, and solutions with their customers. Key questions to ask when considering this include:

• Are the numbers (e.g., acquisition rate, activation rate, retention, and revenue rates) coming from customers’ interaction with the solution, thus validating the original hypothesis?
• Are the experiments being run (e.g., tuning product features, interviews with customers) yielding outcomes that increasingly deviate from the initial expectation?

If the answer to any of these questions is YES, it is time to pivot!!

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How do you successfully execute a Pivot?

As previously argued, executing a pivot is an arduous activity. A key reason for this difficulty is the indecisiveness or refusal by the founders to accept the need to implement one. Thus, to successfully execute a pivot, the first thing required from the founders is decisiveness.

Startup founders must be aware, recognize and accept the need for a correction in their current course. One recommended approach is for startups to schedule periodic pivot meetings. During these meetings, the startup team reviews the numbers, discusses their perceptions about performance and their current direction, identifies the need to pivot, and obtains all stakeholders’ buy-in regarding the need to pivot.

Once you’ve achieved this and founders have accepted the need to execute a pivot, they must begin experimenting. Since pivots can occur at different stages in the life of a startup, running experiments can help founders identify where the issues exist and how to correct them. A framework based around the principles of experimentation, which will guide the pivot activity, such as the Pivot Pyramid, can be of great use here.

The pivot pyramid is a visual guideline to help founders make changes and run experiments in different business areas to drive growth. The pyramid looks at all the elements of a startup business model (customers, problem, solution, technology, engine of growth, channel, revenue, unique value proposition). It then tests assumptions that founders have made about a particular element with data from either interviews or running usability tests.

By running such experiments, founders can quickly realize whether the problems they have identified are a must-have for their targeted customer segments and, if not the case, recognize the need to adjust it. They can also determine whether the solution they have designed addresses the customers’ problems and, if not so, recognize the need to adjust it or redesign a new solution.

Types of Pivots

When most founders hear about pivots, the first thing that comes to their minds is fundamentally changing the solution/product they are creating. This is, however, not always the case. While a good number of product pivots exist (e.g., Airbnb, Starbucks, Nintendo), there are other types of pivots that can lead to success. These include the following:

1. Zoom-in Pivot: a zoom-in pivot is a type of product pivot that takes a single feature in an earlier iteration of a product and makes it the centerpiece of the new product.

This pivot typically happens when early adopters use a product because of a particular feature rather than the whole set of features accompanying the product. An excellent example of this type of pivot is the photo-sharing startup Flickr.

Flickr started as a massively multiplayer online role-playing game called ‘Neverending’. Back in the days of ‘Neverending’, there was a feature in the game that allowed users to share photos and save them on a web page. This feature turned out to be the most fun part of the entire game’s experience and later became the company’s centerpiece.

2. Zoom-out Pivot: In a zoom-out pivot, the startup realizes that a single feature is insufficient to support a complete product and decides to make the feature part of a larger product or ecosystem.

This typically occurs when the earlier development is not gaining enough traction and customers have requested additional features that enable them to use the product more.

3. Customer segment Pivot: Under this type of pivot, a startup realizes that its product addresses a must-have problem for a specific group of customers (its early adopters) but may not be a must-have problem for its originally-intended or mainstream customers.

This type of pivot is typically associated with startups trying to scale their activities into their proposed mainstream market.

4. Customer need Pivot: This type of pivot occurs when founders realize from their interactions with customers that the problem earlier identified is not crucial to its customers.

However, from its interaction, the startup can identify issues that are actually relevant.

5. Engine of Growth Pivot: In an engine of growth pivot, a startup realizes that its assumed growth engine (viral, paid, or sticky) may not allow it to achieve rapid growth and decides to change this for a new strategy to seek faster or more profitable growth.

6. Channel Pivot: In a channel pivot, a platform realizes that its earlier assumed path to reaching customers may not be the most effective and decides to change this to a different channel with greater effectiveness.

Other types of pivots include the Business Architecture Pivot, Technology Pivot, Platform Pivot, and Value Capture Pivot.

Final thoughts

Pivots are a permanent facet of any startup. It is the rule, not the exception. As such, all startup founders must expect to pivot multiple times throughout their startup process.

For startups to become successful, founders must be willing to learn and experiment. They must go into the startup exercise with humility and the knowledge that their initial assumptions will most certainly change.

They must be decisive in their attempt to execute such change and try to separate themselves emotionally from their startups. Only when they achieve these things will they have a good chance for success.

The Case for the Minimum Viable Product

Conventional wisdom says the startups should first build a Minimum Viable Product (MVP) to test customers’ reactions.

The MVP is a barebones version of the actual product the startup intends to sell. Unlike the genuine product on the shelves (or in the app store), the MVP would provide only the key functionalities – those that make it worthwhile for the clients.

The startup would analyze the feedback from the clients and then refine the MVP into the final product. The process usually takes several phases. Each phase addresses the issues identified by the client as well as new ideas the startup team comes up with. Eventually, the product is polished and ready to sell.

Starting with an MVP allows the startup to save money and time by avoiding developing features the customers won’t need. It also helps the startup find out early on if customers care about such a product.

People often say they would like something, yet when they get it, it turns out they don’t need it badly enough to generate a profitable business around it. Therefore, using an MVP and collecting their feedback goes a long way towards avoiding a costly failure.

The Trouble with the Minimum Viable Product

Sometimes, it takes many months just to develop the MVP. Even worse, it might require some expensive parts. For example, building the MVP for a flying car would hardly come cheap.

In these cases, entrepreneurs sometimes build mock-ups or models instead and use them to extract as much helpful feedback as possible before moving on.

Such models are OK for getting feedback on the product’s looks, but since the models cannot perform the job the client is interested in, there is no way to gather usability data. If the feedback on the looks is positive, the team enthusiastically starts working on the MVP, pouring resources into it.

Juicero, a startup that burned through USD $120 million venture capital, did precisely that: worked for 3 years on a device that was squeezing juice bags. The product ended up having an initial retail price of USD $700, soon slashed down to USD $400, only to go belly up when the clients realized the obvious: that they could squeeze the juice bags manually. So why pay for the expensive bag squeezer?

In practice, Juicero’s business plan relied on selling juice bags at USD $8 per piece.

In theory, the thought process was that people could have continued buying the bags and squeezing them manually. That would have allowed the company to break even and then become profitable. The problem was that once you removed the high-tech bag squeezer from the mix, all that was left was an expensive bag of juice with no justification for the price. That killed the business very quickly.

Was there any way to test the viability of the business without building a Minimum Viable Product?

The answer is yes. There is a way to test if a business can be built around it for any product or app, even without investing in the MVP, and we call it the Butler Criterion.

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The Butler Criterion

Clients don’t buy cars. They buy a means of getting from here to there. A taxi, a bus, a train, or a bicycle can and do replace the need to own a car. Before cars existed, people used horses or porters to carry them in rickshaws.

The fundamental idea is people have needs, and just like in the case of the rickshaw, they are willing to hire other people to fulfill their needs. A butler was such a hire. The butler directly served his master, and in addition to that, he was managing the other servants, each of them providing a particular service like cleaning, cooking, gardening, etc. Therefore, the butler was the most important servant of the household and, as such, received the best pay and enjoyed a lot of other perks (better lodgings, nicer clothes, etc.)

All the modern appliances around the house perform duties that used to be assigned to hired help, which laboured manually, under the supervision of the butler. If the person who owns the appliances is well off, they usually hire someone to operate them, even nowadays. The reasoning is simple: the time spent vacuuming a large mansion has a higher hourly cost if performed by the estate owner than if the maid performs it. The owner could afford the building precisely because they earned more by the hour than the maid.

That brings us to the Butler Criterion: is there a human who gets paid to do the work our product or app would do for the client?

If the answer is yes, then it makes sense to build the MVP, which would replace or improve that specific human activity.

Applying the Butler Criterion to Juicero would have quickly revealed that people willing to pay for somebody to squeeze juice bags for them would rather pay a cook or a maid to prepare fresh juice directly from fruits and vegetables. That meant there was no real market for an expensive bag of juice and even less for a high-tech bag squeezer.

There is always a market of premium juices, but they come in packages that suggest their premium status, not in plain-looking bags. Therefore, since the business was about selling premium juices, there were other ways to do it properly, and none included building an expensive high-tech squeezer.

Let’s apply the Butler Criterion to Facebook. The paper variant of Facebook, the yearbook, existed for 200 years before its Internet version. Students hired photographers and printing shop workers to make them, and local businesses hired copywriters to create ads for these yearbooks, which appeared on certain pages.

So, when Mark Zuckerberg went to build an online version of the yearbook, he was confident the yearbook was something humans were willing to pay other humans to make. Even though he chose to monetize only the advertising part of the yearbook, he knew for sure Facebook passed the Butler Criterion.

The beauty of the Butler Criterion is it helps more than just evaluating the viability of the business built around the app or product. It also helps detect the right market segments.

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Imagine we know how to make a robot which can put clothes on us. At first glance, the robot would replace a 19th-century valet. The thing is, nowadays, people who can afford to hire a valet would find it strange to have somebody dress them.

Yet, even today, people are paid to dress other people, such as those who care for the elderly or differently-abled people. This point relates to our supposed startup because it can identify interested parties by seeing who is willing to pay a person for dressing another person. As a result, they might discover that were a robot to work with the elderly or those suffering from disabilities, some additional features might be needed, which could not have been imagined otherwise. All of that can be achieved before even buying the first screw for the MVP.

The Butler Criterion can be performed through observation or practice as part of an experiment.

For instance, before attempting to build a high-tech-based business platform, it is worth checking if a low-tech version of it can work. Don’t build the high-tech one first. Use manual work to test if there is any need for the platform’s service. If customers keep coming, then build the high-tech platform to replace the “butler” (the manual work). Amazon started that way. So did zappos.com and diapers.com, both later acquired by Amazon.

These examples prove that the method works time & time again and, therefore, every startup should use it before starting to work on the MVP.

If the butler did it, we can (and should) make it using technology.

A vibrant startup ecosystem depends on more than just having all the actors in place (entrepreneurs, engineers, mentors, angel investors, venture capitalists, legal framework, good universities, strong R&D). As the saying goes, quantity has a quality of itself. In other words, the number of actors also makes a big difference.

This is why the WorldSkills Romania Foundation, the operator of Startup Foundry, has partnered with the Romanian-American University of Bucharest and with the Institute for Excellency in Entrepreneurship to operate the first university-level pre-accelerator, RAU Accel.

The pre-accelerator runs 3-months long programs, helping students gain first-hand experience in the step-by-step process of building a startup from scratch.

Our mentors will guide the young entrepreneurs through the ideation activity, validating and refining the product, service, or app. After that, they will look to create a business model, a market strategy, a brand, and a pitch for investors.

The first cohort for RAU Accel will graduate on June 2^nd, 2021.

In the previous episode, “Going From Good To Great – Ideas That Your Investors Will Love“, we’ve talked about the risk of focusing on the wrong features after the prototype is successfully tested. It is now time to learn to get the right features right early on.

One of the most instructive examples of how easy it is to get them wrong and be blinded by the initial success is the story of how MySpace lost to Facebook. What’s scary is MySpace lost almost “overnight”, despite being the dominant social network for four years in a row before that.

A bit of history helps seeing how things unfolded:

• MySpace had been launched in August 2003 and Facebook 6 months later, in February 2004;
• In October 2007, Facebook was still behind by a large margin, with 20 million accounts, 27.9 million unique visitors, and 14.8 billion page views, vs. My Space’s 200 million accounts, 71.9 million unique visitors, and 46.4 billion page views;
• In May 2008, Facebook overtook MySpace internationally, with 123.9 million unique visitors and 50.6 billion page views versus 114.6 million unique visitors and 45.4 billion page views. From then on, things went downhill for MySpace pretty fast.

While it is good to know what happened, the reasons why that happened are the ones relevant for any startup.

It all started with a bug. Back in 2003, MySpace site had been developed in a matter of weeks, in a very agile way, as a clone of another successful social network at that time, called Friendster.

That rushed development resulted in a bug. Due to it, the users could change how their pages looked like by inserting HTML code in places where they were supposed only to write plain text. It goes without saying that was a very dangerous cybersecurity flaw. Fortunately, instead of doing bad things, the overwhelming majority of the users simply exploited the bug to make their pages look unique.

Seeing that, MySpace “listened to the customers” and turned the bug into a feature.

Soon almost everybody took advantage of the possibilities to personalize their pages. That led the MySpace management team to conclude the ability to customize one’s page was indeed one of the essential features for their users.

In the short term, the decision seemed to pay off: musicians and other creative professionals took advantage of the possibility to embed sound and video into the pages and started to showcase their work directly to the public. 2.2 million bands, 8,000 comedians, thousands of filmmakers had their MySpace pages. As a result, MySpace became even more attractive, and membership went through the roof.

Then Facebook happened.

While anybody could register on MySpace, until September 2006, Facebook membership had been restricted only to college students. In addition to that, all the Facebook pages had the same look because the only two things users could do were post text and pictures. Video would only be added in 2007. Audio files have yet to be allowed, 17 years after the launch.

Yet, in spite of all the restrictions on members’ creative ways of expression, once Facebook opened membership to everybody, MySpace lost most of its members to Facebook within the next two years.

Three questions come to mind:

1. Why did the MySpace users leave in such large numbers?
2. Could this have been predicted?
3. Could we learn anything useful for any startup?

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Why did they leave?

The most frequent complaint of those who left was MySpace had a “ghetto vibe”. All the “bling” and photos occasionally revealing a bit too much skin was quoted as the main reason for labeling it “ghettoish”.

However, independent studies done at the time showed the majority of the pages, while very colorful, actually had very decent content. But, as the saying goes, “perception is reality”.

Once the users felt “the ghetto vibe”, they concluded the “aseptic” or “boring” Facebook look and feel was preferable. After they left in large enough numbers, even their “ghetto-tolerant” friends had to follow them. A social network’s main appeal is our friends are also on that network. When our friends leave, there’s little for us left to do but follow them.

What made matters worse and enhanced the unflattering perception was MySpace had a cavalier attitude to spammers and advertisers of dubious products. As long as those spammers and snake-oil peddlers paid the fees, they were allowed to bombard the users with their unwelcomed messages.

This tolerance might be explained by the pressure exercised by News Corp, MySpace’s managing parent company. For instance, in early 2008, News Corp boss and media mogul Rupert Murdoch announced that MySpace would make $ 1 billion from advertising by the end of the fiscal year.

At the time of the announcement, the platform was generating less than 10% of that target. One can easily understand the pressure put on the MySpace management by such statements. They had to monetize the social network by any possible means by the end of the year. Even then, they failed in coming close to the target.

All in all, the combination of “ghetto vibes” and aggressively spamming users with ads for shady products resulted in antagonizing enough members and pushing them to Facebook. And that opened the floodgates.

Could this have been predicted?

Let’s start by looking at the fundamentals:

• MySpace was a social network.
• Its founders knew it was a social network.
• Its founders wanted it to be a social network.

In such a case, one would have expected all the 70+ years of scientific knowledge about social networks would have been used to design the features of MySpace. That didn’t happen!

Sociology and psychology started to study in the 1930s how people network with each other and form groups. By the time MySpace was launched, it was well known social class, ethnic culture, race, and religion are four compelling factors in shaping the connections people form.

People live in specific neighborhoods, go to certain pubs and clubs, take part in certain public events, go to certain places of worship according to their social class, ethnicity, race, and religion. Those are places where people from the other groups don’t go. We may like or dislike such self-segregation, but that is how things are in any society.

MySpace allowed people unlimited freedom of expression and, at the same time, failed to provide an equivalent of the separation existing in the real world. That unfettered freedom of expression made apparent the class, cultural, racial and religious divisions while “forcing” everybody to “live” in the same “place”. This meant most of the MySpace users would leave for a platform providing a better “separation” as soon as such a platform became available.

Facebook, with its limited freedom of expression, offered that equivalent to physical separation. Inside Facebook, people would still group themselves mainly according to class, ethnicity, race, and religion because they would be connected to the same people they know in their real lives. As it’s often quipped, people on Facebook live in their own bubbles.

Nevertheless, their social class, race, ethnicity, and religion would be less “in your face” thanks to the uniform design of the Facebook pages.

The phenomenon of physical separation and social class and racial lines even had a consecrated name in sociology: “the flight to the suburbs”. It started in the 1950s when the upper- and middle-class left the downtowns of the American cities.

The advertisers covet most the upper and middle class, and social networks make their money from advertising. So, when MySpace decided to allow users to do anything they wanted to their pages, they were setting themselves up for a “flight to the suburbs” and the loss of advertising revenue resulting from it.

So, what are some valuable lessons to remember?

1. Users might love our prototype simply because that’s the best available solution at that moment in time. Iteration, by itself, can only confirm a prototype is acceptable. Meanwhile, the investors and we need to know if the prototype is actually good;
2. A good product could hold its own against the competition, buying us time to redress the situation. An acceptable one would be replaced quickly before we have time to react;
3. The iterative process of improving prototypes needs to be combined with other methods, like checking our prototype against the relevant body of scientific knowledge. If we discover discrepancies, we make the corrections and then iterate with the users to see how they like the new prototype. This is the privilege of starting anything: corrections are cheaper to make earlier than later.

If we join the right accelerator, we will benefit from a whole set of methods to sort out the good from the acceptable. However, checking the scientific state of the art should be done first, as scientific knowledge is public and generally freely accessible.

In our previous article, we talked about what investors do to minimize the chances of an unsuccessful venture. In today’s piece, we’ll be looking to go further in-depth on the more technical side of things, analyzing each phase of the funding process to better understand what each one entails.

Pre-Seed Funding

Pre-Seed Funding, also known as Bootstrapping, is the earliest stage of funding and represents the very beginning of the operational processes in a startup. Usually, the investors are the founders themselves, their families, friends, or close supporters.

Depending on where the founders are located and their need to hire additional help, the amount of bootstrap money would vary. A back-of-the-envelope calculation would be the money needed for the team to pay their bills while eating cheap food for as long as it takes until you create a product that a client would pay for. Sometimes this is called “noodle money”, as an allusion to the entrepreneurs surviving on noodle cups while preparing for the stage where they meet their first investors.

During this time, we would work on both the technical side of the solution and the business model under the guidance of our technical & business mentors.

Seed Funding

The name says a lot about what happens in this stage: this is when the “seed” is planted, after which the founders might expect to see the first results. It is when more sophisticated market research and further product development are done to grow the company’s value and attract even more funding.

There are many potential investors in this stage, but the most common ones are the so-called “angel investors”. For a startup to attract angel investors in the US nowadays, for example, it should be valued anywhere between $2 million to $6 million. The startup needs to show “traction”: one or more pilot projects already implemented, lots of adopters, or a high rate of growth month-to-month or year-to-year, etc.

The term “angel investor” is a bit misleading, for it suggests such investments are charitable acts. The actual origin of the term relates to such investments being miraculous, as it would be for an angel to show up in real life.

The critical aspect for entrepreneurs to grasp is that angel investors would only commit money if they were shown a credible plan about how such money could increase the value of the company 10x by the time the exit happens.

What does the exit mean?

All investors make their money when a startup is either purchased by another company or at the IPO (Initial Public Offering) when the startup becomes listed on the stock exchange. Since angel investors are the first to invest, they have the longest time to wait and face the highest risks.

Seed money offered by each angel investor can be between tens of thousands and several hundreds of thousands of dollars. However, a project will only get such money if it showcases a business that generates 10x returns. That is why joining a good accelerator program is essential.

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Series A Funding

In this round, the emphasis is placed on further developing our business model. The previous seed funding stage amplified the initial traction. We know more about our customers’ needs, what it takes to service them well, and how our technical solution should be developed to further grow our business. However, this is all knowledge and theory. We need something more palpable, which is why a new series of funding becomes necessary.

Series A rounds are expected to raise from $10 million to $30 million and are usually led by venture capital funds (VCs). A 2018 CB Insights report discovered that only 48% of seed-funded startups tend to make it to the next round.

Remember our earlier discussion about angel investors’ motivations? This particular report shows that more than half of their investments are spent on companies that cannot attract the next round. It even paints a more gruesome picture: 67% percent of the companies that attract seed funding either die or turn into regular companies, as they never truly take off.

Why turning into a regular company is gruesome for early investors?

Angel investors and VCs take huge risks when funding startups. The average dividend yield between 2008 and 2018 for US companies was 2%. Angels have a whole portfolio of investments, the majority of which will never be profitable. That dividend yield would require them to be right more than 98% of the time just to recover their losses.

This is why they need an IPO as an exit – IPOs are the only ones that sometimes bring them the 10x returns they want, and dividends cannot. A TechCrunch piece of research found out the actual return for angels in the US, and the UK is around 2.5x on average. This is why they must aim for 10x when looking at promising startups.

The same reasoning applies to the Series A VCs. The vital lesson for us, as startup founders, is if we want angels and VCs to invest, we should look to focus on creating a business that gives investors that type of return, the 10x kind. If our company only brings regular rates of return to early investors, as dividends do, then we should finance it through other means.

Series B and beyond

If we have understood that an IPO is what any early investors want from a startup, it is also easy to understand why there might be other rounds of financing after Series A. The purpose of subsequent rounds is to build the business until the IPO happens. Any further round past B would only occur depending on how convincing the possibility of the IPO is.

This is why it is great fun to run a startup. We get into something that will grow huge and can potentially offer us an experience like none other. We learn and expand our horizons beyond just our technical creativity. We learn to connect to our customers and angel investors & VCs. We begin envisioning how to create 10x returns for our early investors, which entices us to start thinking big, changing our worldview forever.

Often, people confuse startups with small businesses. However, one crucial aspect to remember when differentiating the two is that startups aim to bring significant change to the world we live in. They are constructed with one main idea in mind: to become big and impactful.

For our startup to get there, there are a few challenges we need to overcome. The first, and maybe the most important, is understanding how funding works. Following that, we need to understand the type of investors and the difference between them, especially between angel investors and venture capital funds (VCs), since these are the primary funding sources for accelerated growth.

With that said, before getting into the specifics of funding, we must focus our attention on a few facts worth knowing before diving into that topic.

Helping investors help us

As the old saying goes, “the best way to get what we want is to help others get what they want”. Angel investors and VCs are in it for the money they make when the startup’s value grows, and they sell their shares.

Statistics show around 80% of investments in startups end in loss, regardless of how experienced the investors and the startup founders may be. To mitigate the risks, investors do a few things:

1. They only fund startups that look capable of generating 10x the return on investment.

Four out of five startups would generate zero returns, so the successful ones need to cover these losses. Aiming just for 5x would mean the investors would still lose money on their total portfolio.

Therefore, investors aim for startups that look capable of generating 10x the returns. We should apply for funding only after developing our business model to make such returns possible.

2. Funding happens in stages or rounds.

We get to the next round of funding only after we have reached certain milestones. It is important to realize that these milestones have more to do with increasing the startup’s value than achieving some technical results.

Investors are there to witness the value growth. Technology is only relevant in so much as it helps achieve that. Improving the technical quality of the solution must result in the growth of sales, the number of users, or the lifetime value of a customer, just to name some of the more important metrics to keep track of.

3. VCs tend to specialize in certain stages, meaning they know how to best help startups at certain maturity levels.

As the need for financing grows, new VCs must be brought in. Successfully convincing them to invest depends a lot on the quality of assistance received from the existing investors. Therefore, a startup must choose the first investors wisely to help keep the startup on track to achieving those 10x returns.

Most entrepreneurs are tech-savvy. That means that from their perspectives, superior technology would make customers come knocking at their doors. If we want funds from investors, we need to develop a plan to reach the 10x return threshold other than by relying on popularity.

It goes without saying that it’s always an advantage to pursue projects that are in the social limelight, for all the right reasons. However, simply going for a popular project without much to back it up won’t get you very far in an entrepreneur’s eyes.

That is where a good accelerator comes into play – to help guide you through all the hoops that you have to jump in order to make the cut.

While the startup is accelerated, a significant part of the mentoring process focuses on improving the business model and tweaking the technical solution to support the business plan.

A good acceleration program has mentors who boast a significant amount of business experience in the startup’s sectors. They know what it takes for a solution to be successful & popular, and they know what kind of sales effort it takes to get things going with your customers.

Once you’ve considered all of these pre-funding aspects, we can focus on the financial part of the process, which will be covered in our next article.

How it started – a historical brief

When looking to gauge the Romanian investment, funding, and start-up environment, you’ll find that the country has only experienced real, genuine growth in the past two years. After the fall of communism over three decades ago, the country experienced a lukewarm economic development process at best.

Around 1995, the first semblance of a professional rebirthed industry materialized in IT. By 1999 and early 2000s, we saw the rise of a few ISP providers, such as RCS-RDS or Romtelecom, which became long-standing household names.

Why is this important for the topic of our article? Well, that’s because Romania’s modern-day investment environment centers chiefly around IT & software development, which starts making a lot of sense if you happen to know the aforementioned historical tidbit.

Fast forward a few years, and we’re in 2014 and 2015. This period is when we see the first venture capital (VC) organizations take form. Investment phases began being a thing, but the processes of pre-seeding, seeding, or series A seeding were not adequately developed, so investment was very much a wild, wild west area. The sheer volume of investments wasn’t the largest, with approximately 15 investments/year for seeding and around five investments/year for series A or B seeding.

Additionally, since nobody really knew or trusted the system yet, many Romanian start-ups began going abroad for investors. For example, between 2013 and 2015, 6 start-ups from Cluj and Bucharest raised investment funds from Bulgaria.

Moreover, since we’re on the topic of start-up numbers, if we were to further analyze the environment back then, we’d find that the number of start-ups being created was between 300 and 500, with only 100 or maybe 200 of them being considered investment-worthy.

How it’s going – current developments

Slowly but surely, starting with 2017, we began seeing more and more players come into the investment environment, with 2019 and 2020 witnessing an incredible surge, despite the extremely unfortunate Covid-19 outburst.

The major investment hubs align with Romania’s major cities, with the biggest one being Bucharest, followed by Cluj-Napoca, Timișoara, and Iași.

In terms of figures, on the one hand, the number of start-ups receiving investment doubled in 2019 (30 start-ups) and more than tripled in 2020 (54 start-ups).

On the other hand, the number of funding sources has seen unprecedented growth. There are over 14 business angel networks – encompassing over 3,000 business angels and 23 venture capital funds. In addition to this, crowdfunding and bank loans have become staples for start-ups wanting to get their business off the ground.

Now that we’ve caught up to modern times, let us see how the funding landscape looks in Romania by going over the investment phases, what they mean, and some of the average sums floating around.

Pre-seeding

Pre-seeding is the funding phase that occurs before any big investors come into the picture. Traditionally, this phase usually sees a company investing either its founders’ savings or any loans they might have contracted, in addition to any finances received from family, friends, acquaintances, or supporters wanting to help one’s cause.

However, in modern times, we also see several other entities chipping in to help promising start-ups take flight. These entities are either the above-mentioned business angels (e.g., Business Angels Romania, VentureConnect, TechAngels, AngelConnect, Growceanu, RocaX) or business accelerators (e.g., Techcelerator, Spherik, Seed for Tech, Risky Business, Orange Fab, Startarium, Innovation Labs), whose goal is in the name – to accelerate your business.

In Romania, we had 21 pre-seed transactions in 2019 and 2020, with an investment volume of €2.57 – 3.30 million euros and an average investment per transaction of between €122k – 157k euros. A large portion of these sums came from angels, accelerators, or support programs offered by similar organizations, like 0-Day Capital, whose business model seeks partnership within a start-up right from its infancy, offering financial and managerial assistance.

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Seeding

Seeding is the first phase where we begin equity funding, meaning a startup attracts its first big investors, who elect to finance its services/products in exchange for equity. This is also the phase where we begin seeing funding from VC organizations like Gapminder, Gecad, Early Game, 3TS Capital Partners, or Earlybird Venture Capital.

In Romania, 2019 saw approximately 16 seeding transactions, while 2020 experienced a boom, registering 37 transactions. The investment volume for this phase was between €11.37 – 21.87 million euros, with an average investment per transaction of between €591k and 1.1 million.

Other potential funding sources for the seeding phase are equity crowdfunding and private equity funds. The former enables large groups of investors to fund startups in exchange for equity. The latter are investment management companies that provide financial backing and make investments in the private equity of startups or operating companies through various loosely affiliated investment strategies.

It should be noted that private equity groups providing funds for startups is more of an exception than a rule since such groups do not typically invest in startups; however, it can happen!

For example, the Roca group has developed RocaX, a business angel subsidiary that helps out startups.

Equiliant Capital, another group, created by the Dedeman founders, seeks to invest in any industry of any kind, making no exclusions for startups; however, it does exclude the tech industry. While this is a bit odd, it still bodes well for startups in other fields that have what it takes to convince such an organization to invest in them.

When it comes to equity crowdfunding, SeedBlink is Romania’s most prominent source, financing over 26 campaigns worth €8 million euros, out of which more than half came from individual investors.

Series A financing

This phase of the funding process represents the first truly major investments. This is where a start-up has a clean-cut operational framework, has managed to posit itself comfortably on the market, and is making waves among consumers on a large scale, generating a growing stream of revenue and income.

The goals of investors looking to finance start-ups that reach this threshold are the identification and assessment of progress made by a company using its seed capital and the efficiency of its management team. Additionally, investors will also inspect how an organization manages its currently-available resources to generate profits in the future.

Basically, this is the part of the financing process where a VC company goes, ”Yeah, you could probably go global and blast competitors out of the water. We’re on board with that!”.

In Romania, not many start-ups have reached this phase. In 2017, UiPath – a robotic process automation (RPA) company, became the first Romanian start-up to get series A funding. In 2019, FintechOS – an open-source financial technology firm, also achieved the same status. In 2020, TypingDNA – an AI-based solution for risk-based authentication and fraud prevention, was the third Romanian start-up to reach series A, raising €6.2 million euros.

In 2021, UiPath managed to reach series F funding, raising $750 million dollars.

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Success stories

Investment doesn’t usually stop at series A. Typically, especially in larger environments, such as the US, many start-ups enter series B, C, D, and so on. How well a company handles its newly-found influx of income determines whether it will manage to go to the next step or stagnate.

Now, stagnating isn’t a bad thing in this case. Many start-ups want to reach a stage where they can comfortably service a specific number of customers. While this may come as a surprise, not every company wants to go global. Many want to stay local or regional while maintaining good ROI numbers.

• Blugento is an e-commerce platform that has managed to raise €1 million euros from the Polish IT group R22 in exchange for a 31% equity stake. It aims to expand into central Europe, after having grown its revenue ten times in 3 years and is valued at around €4 million euros.
  

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• Questo is a Bucharest-based start-up that created a mobile city exploration game, which features over 40 European cities. Questo is currently valued at $1.5 million dollars and plans to expand its game to include some of the largest cities in Europe, including London, Paris, Berlin, Amsterdam, and Barcelona.
  

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• Jobful is a gamification-based recruitment platform that has completed its first angel investment round, receiving €100k euros. Jobful represents an intelligent middleman between young professionals and companies who want an efficient recruitment process that provides them with an initial test sheet of a candidate’s skill setup and interests. This initial investment will be used to launch a mobile app for the platform and further develop its capabilities.
  

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• Beez, a cashback service company, received a €1.2 million euros investment from RocaX and Gapminder to facilitate growth and expansion beyond their current cashback service.
  

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• Flip, a second-hand verified smartphone marketplace, received €250k euros investment from Gapminder, V7 Capital, and a group of private investors. This is the second round of investments that Flip raises. The first one raised €120k.
  

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• Telios, a telemedicine start-up, received $200k dollars investment from Transylvania Angels Network, Growceanu, and TechAngels.
  

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Final thoughts

Raising funds for your start-up has become more accessible and more difficult at the same time. On the one hand, companies now have access to an ocean of funds available to them compared to previous years. Money is no longer a stopping point.

On the other hand, you only get access to the funds you want if you have a well-laid-out plan for your ideas.

The Romanian investment environment has much of the same characteristics as any other investment environment. You follow the same steps, and you generally have access to the same funding sources, whether we’re talking business angels, accelerators, support groups, or VCs.

The actual difficult part is finding those people who possess both the funds and the knowledge to help you grow sustainably, enabling you to reach seeding easily and potentially even series A funding.

Our team has come up with this fantastic idea. Even better, we know how to both build and sell it. The catch? In order to actually build it, we need more money than we currently have. In addition to this, we will need more money to set up the business, which would sell, deliver, and service it until we break even.

Since that’s a great idea and we have a great team committed to making it happen, finding funding should be easy, right?

Except it’s hard. It’s hard despite being an otherwise great time for startups in the early stage, with $6.8 billion dollars seed money invested in the first three quarters of 2020.

The good news is being at the very beginning makes it much easier to pivot. Changing is easy in the early stages. Altering the features of the product or service, changing the market segments we target, shifting the pitch to the investors are all less complicated if we’re just starting.

However, pivoting aside, what’s the first thing we should analyze when looking to create a company worth investing in? Well, naturally, the first thing we should look at is the idea itself. We know it is great, so we should first explore what prevents others from investing in it.

Seeing is believing

As the running joke goes, the fastest way to tell the difference between Machine Learning and AI is to look at what it is written in: if it’s written in Python, it’s probably Machine Learning. If it’s written in PowerPoint, it’s probably AI.

If we are to convince others to invest in our idea, we need to first invest ourselves in it. That means more than just taking the time to create a bunch of nice PowerPoint slides. Here is a 2-item checklist we should go through before we even consider pitching our idea to investors.

I. We have a product/service/software to show

Since what we show was developed without external funding it will miss lots of features.  We will have to use our spare time, our savings, and money from family, friends, and whatever else we have as resources until we have something else to show, in addition to a PowerPoint.

II. The product/service/software does the right thing better than the existing alternatives

Since this iteration will be missing many, if not most, of its features, compared to the final version, we need to ensure the important ones are already present in the prototype.

On the one hand, the lack of resources at this crucial stage could be a blessing in disguise, for it could motivate us to focus on what matters. On the other hand, we might run the risk of spending those few resources on the “nice to have” instead of on the “must-have”.

Therefore, one excellent piece of advice is “fail fast, cheap, and often”.

What that means is:

1. get the prototypes as fast as possible into the hands of the users;
2. get feedback on what needs changing;
3. implement the required changes as cheaply and quickly as possible;
4. test the prototype again;
5. repeat the process until the majority of the users are happy.

The merit of this approach is we get a prototype that we can confidently showcase to investors. We will also show footage of how happy the users are with the prototype. That works wonders convincing them to write us the checks.

Nonetheless, there are two critical challenges we must solve when taking this approach:

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1. It might take a lot of iterations

The first Dyson vacuum cleaner took 5,126 iterations before it was production-ready. All the venture capitalists refused to fund it, so Sir James Dyson had to mortgage his own house to cover the expenses.

In 1980, Edison stated he had made at least 3,000 iterations before finding a satisfactory material for the light bulb filament. However, unlike Sir James, Edison already had a successful business and a modern, well-staffed lab where he could carry out his experiments. So, he didn’t have to seek funding for the development stage.

Both Sir James and Edison were already experienced inventors by the time they managed to put together a finalized, working version of their product, yet they still had to refine it a lot before being investor-ready.

We should indeed fail fast, cheap, and often because we very seldom get it right from the first try. Furthermore, we need to do so in ways we can afford, which implies we need to innovate two things at the same time:

• our product/service/app;
• our way of iterating without running out of the initial resources. That’s usually something much more personal, like commitment, which can also be sapped by having to redo things again and again.

Joining the right accelerator helps with both. It provides us with the necessary guidance and creates the supportive environment we need in difficult times. Picking the right one can be tricky but not impossible. We simply have to look at what happens in the programs they run, and we’ll get a good idea of what’s in store for us.

Beyond this, we’ll also have to create a series of blog posts about making iterations more effective. That way, the teams working on these iterations can develop a better prototype before applying for an accelerator, increasing the chances of being accepted in the good ones.

2. We may latch onto the wrong features when our tests show users loving our prototypes

There are several reasons why that might happen:

• The users who accept to test our prototypes might not be representative of the market we would be targeting;
• The idea might be so new that users are enthusiastic about our proposal only until a better one shows up.

While the seeds of our idea’s demise could have always been identified beforehand, experience shows they become “obvious” only after the fact. The initial success of the prototype masks them or makes them seem unimportant. On top of that, human brains are hard-wired by evolution to seek confirmation instead of rejection. “Think positively” and “see the glass-half-full instead of half-empty” ring a bell?

Experienced VCs have seen this happening many times before. As a result, they might be skeptical even when we show them both the working prototype and the testimonials of the happy first users.

We need to go the extra mile of showing how we have investigated what could go wrong and how we can adjust quickly in the future, should a competitor come up with a better approach or if hidden problems surface. Or better yet, we should do both of these things! If they feel secure about their investment, they will be more likely to fund us.

That’s where a good accelerator can help. The accelerating programs worth participating in help startups avoid the pitfall of choosing the wrong features (even if they show early signs of success) and create a very agile business that can adapt quickly when conditions change.

Final thoughts

As we can see, coming up with a good idea and finding funding feels like cooking at rush hour – you have to be ready for anything your customers demand.

Summing it up, in order to be successful when seeking funding:

1. We need to have a prototype to show;
2. We need to have the prototype validated by a sample of everyday users;
3. We need to have a convincing method for future-proofing the product/service/app;
4. We need to have the three aspects mentioned above before drawing the business plan.