Is your startup living in the past, present or future?
At the heart of every startup story lies the Problem/Solution thesis. It captures the founder's insight and becomes the framework for everything that follows. It's the reason the startup exists - its purpose.
Difficult funding conditions over the past 24 months have forced many startups to re-examine their purpose. Even though Product/Market fit (PMF) is the most talked about subject in venture, if the 'problem to be solved' is not compelling enough to attract investment, no amount of PMF will compensate.
A little talked-about fact is that different types of problem attract different types of investor. This is linked to the timing of the market and the risk/reward profile of the startup's core thesis. Founders that understand these factors will find better-matched investors whose mindset more closely aligns with their own.
Startups solve problems that fit into one of three categories:
- Problems that exist in the present (emerging market)
- Problems that exist in the past (established market)
- Problems that exist in the future (no current market)
In this week's briefing note we examine each type of problem from 3 key perspectives; customer archetype, startup challenge, and investor mindset.
We incorporate insights from Sequoia's Arc catalyst programme for Seed-stage founders, courtesy of Product Partner Vickie Peng. This highlights the significance of market timing.
And we explain why certain investors gravitate to particular kinds of problem and how this impacts the story founders tell.
Problems that exist in the present
- Customer archetype
These customers have a burning need. They want a solution NOW and they have budget to spend. They are already trying to solve the problem by using other approaches - but without any real success.
This is what Sequoia calls the 'Hair on fire' customer.
The early adopter market may be short-lived. There is already growing awareness of the problem in the mainstream market.
- Startup challenge
As the problem is already manifesting itself in the market, other players will also be trying to address it. The big challenge is therefore competition.
The strategy is to establish clear product differentiation. Not only must you make sure the market knows you are active but that customers immediately understand why you are different. In enterprise sales this must also be in the context of how you will solve the customer's particular problem.
As the market emerges, offerings will be evolving quickly as more contenders arrive. There is a constant threat of losing PMF and low customer retention. As a result there is risk of commoditization, bringing unwanted pricing pressure.
- Investor mindset
This problem type aligns strongly with conventional VC wisdom to make something people want (or to be more precise, what people need).
A big positive for investors is that there is immediate and clear demand. Revenues can ramp up quickly, providing almost instant validation.
A big negative is that this will likely require significant marketing spend and almost flawless execution to gain a strong foothold versus competitors.
Problems that exist in the past
- Customer archetype
These customers appear disinterested in new solutions. This is because they have accepted the status quo and are not looking for something new.
This is what Sequoia calls the 'Hard Fact' problem; it is what it is, just a hard truth.
Customers are habitually using what's already there. But, if alerted to a radical new approach, may seriously consider adopting it. Good examples we all know are Uber, Airbnb, Amazon (online retail), and Instacart.
- Startup challenge
The biggest challenge is overcoming established habits.
Competitors with old solutions will be the default choice. There will likely be many entrenched incumbents including some big, accepted brands - but only low levels of innovation.
Startup strategy: Must have a novel and compelling solution, a real game changer, based on a contrarian view of the world.
The solution will need to be many times better (investors will often say 5 to 10x better) to displace an incumbent, otherwise inertia wins given customer lethargy in B2C and the high cost of change in B2B scenarios.
- Investor mindset
Investors will be skeptical. Will customers care enough to change? Will the solution be contrarian enough?
A big positive for investors is that demand is proven with the old approach. It's a tough nut to crack but if a startup is successful then there is almost certainly a huge market to tap.
A big negative is that the cost of market entry could be debilitating unless there is a radically innovative approach that takes the market by storm.
Problems that exist in the future
- Customer archetype
There are no customers or markets yet but there will be some 'innovators' or 'early adopters' willing to listen, evaluate, and provide feedback.
These startups are led by what Sequoia calls the 'future vision' founders.
Well known examples here include SpaceX, OpenAI (& others pursuing a vision of AGI), and many other DeepTech startups.
- Startup challenge
Startups are thinking about future problems to be solved. They have a vision of a world that others do not yet see.
There will be few, if any, competitors.
The biggest hurdle to overcome in the market is disbelief. The solution appears so radical that most will doubt its technical feasibility or commercial viability.
The classic startup strategy is to create a sequence of intermediate or partial solutions (e.g. OpenAI's ChatGPT) that provide stepping stones to the 'final' product. This approach demonstrates both the ability to deliver and a credible roadmap to the ultimate vision.
- Investor mindset
A big positive for investors is that if right, demand could be absolutely huge. But investors will need to have the capability to understand both the market and the technology to undertake due diligence.
Examples here from recent years include quantum computing, hydrogen energy, humanoid robotics, and 3D printed foods, to name just a few.
A big negative is the uncertain cost and time to get there. The outcome could be a zero or a 'fund-returner'. Bottom line: This is likely to be a big binary bet on the team.
Presenting the Problem
The 3 different problem categories require very different approaches to pitching the investment story in the early stages:
If the problem exists in the present and the market is clearly emerging, a sense of urgency is easy to conjure up. Hard evidence will be building.
This creates investor excitement due to the big wave of need and a sense of 'invest now or miss the boat'.
If the problem exists in the past, this lends itself to a 'old way/new way' plot based on solution innovation. Evidence of need should be obvious but will need recasting for the new paradigm.
This creates investor excitement with the prospect of massive market disruption and the creation of a new market category.
If the problem exists in the future, this story is heavily about the vision, market insight, and technical prowess. This is often a much harder story to tell; there is little or no real evidence and that's why the credibility of the team is paramount.
This creates investor excitement through the potential to create 'a solution that will change the world'.
In summary
Institutional investors naturally think in terms of markets. It follows that they are highly sensitive to market timing and all the consequences that follow.
Founders must be cognisant of how the risk/reward profile created by their problem/solution thesis will be interpreted by investors. This will impact the type of investor they target.
Aligning the problem type with investor preferences will ensure a shared outlook and a higher probability that investor expectations will ultimately be met.
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