This is not a blog entry. Instead, it is a white paper I have produced in my line of work as General Partner at Accelerace Invest. But I post it here to log advances in my thinking.
Startups are defined by growth.
Growth is critical because startups are founded, build, and invested in on the assumption of rapid growth. Few founders, founding employees, or investors would bet on a startup with poor prospects for growth. Nor would the same people bet on a startup with prospects for slow growth.
To pre-seed investors, the potential for rapid growth is challenging to assess. Later stage investors enjoy the benefit of historical performance on actual growth. If a startup has grown rapidly over the past three years, it is reasonable to assume that the startup will continue its rapid growth.
But if the startup is less than 12 months old, meaningful historical data is nonexistent. Growth has not yet set in. What can pre-seed investors do?
Despite the lack of historical data, a startup should still be growing. However, instead of looking at the historical growth, pre-seed investors must look at the Momentum. Instead of asking: how fast has the startup grown? Pre-seed investors must ask: how fast is the startup growing? Or phrased differently: how strong is the Momentum of the startup?
The answer would allow pre-seed investors to use Momentum as an indicator of future growth. Just like later-stage investor use past performance.
But to answer the question: how strong is the Momentum of the startup? we must first define Momentum.
To pre-seed investors, Momentum is complex because in most cases financial metrics such as MRR, GMV, sales are absent. Instead, pre-seed investors must evaluate the accumulation of the resources that are foundational to financial growth. To use a race car analogy. Pre-seed investors must evaluate the making of the race car. Later stage investors can evaluate the lap times of the finished race car.
The pre-seed investors must look at the bits and pieces of the car and evaluate their combined quality to assess the prospects of the car becoming a great race car. The better the different pieces, the better the faster the race car.
Steve Blank argues that a startup is a temporary organization searching for a scalable business model. The search process is focused on obtaining insights and attract resources. Insights and resources are the bits and tools of the race car.
It can be assumed that startups with great insight and strong resources have a higher likelihood of success in the future. Again, the better the bits and pieces, the better the car will perform.
Or put simply, startups that have accumulated the most insight and resources are in a better position to generate growth in the future. Consequently, the accumulation of resources could be a good indicator of future performance.
But what are the resources that define a pre-seed startup?
A startup accumulates resources on four key dimensions. Those are Team, Technology, Customer insight, and Customer commitments. We will do brief reasoning to these four dimensions below:
The team is the driving force behind the startup. Naturally, high quality teams outperform low-quality teams. Consequently, a key dimension of Momentum is improvements to the team. The critical part of the team consists of founders and founding employees. Founders participated in the founding of the startup, while founding employees joined later. Both are critical to the startup and own shares in the entity. Often founding employees are more senior than the founders and are defined by “paying” big opportunity costs when joining the startup. (Danish examples are Jesper Lindhardt in Trustpilot, Mette Lykke in Toogoodtogo, and Thor Angelo in Mymonii). Because of the critical nature of these founders and founding employees, the evaluation of Momentum should concentrate on the expansion of this group. Consequently, a startup that manages to attract the best people should increase the chance of success.
The Technology is the basis of the value proposition. Most startups build their product on technology, and any advancement in the technology should improve the value proposition. Consequently, a key dimension of Momentum is technology. A startup that rapidly advances its technology should increase the chance of success.
The Customer insight is another basis of the value proposition. Customer insight is the information founders use to turn their technology into a product. Obtaining customer insight is a key activity for startups, and deeper understanding improves the value proposition. Consequently, a key dimension of Momentum is customer insight. A startup that deepens their level of insight should increase the chance of success.
The Customer commitments are de-risking the venture. If customers commit to pilot projects, payments, and contracts, the startup obtains proof of business points that can be leveraged when raising funding and attracting team members. Consequently, a key dimension of Momentum is customer commitments. A startup that amasses customer commitments should increase the chance of success.
Now that we understand what defines Momentum for pre-seed startups, we can almost answer the question: how strong is the Momentum of the startup?
However, we still need to define strong. Strength describes the efficiency of the progress. A startup might accumulate resources on the Team, Technology, Customer insight, and Customer commitments dimensions, but the price of this accumulation matters. The price is the constraint and consists of time and money.
Momentum only makes sense if it is related to the time and money that has been available to the startup.
If a startup has spent three years and 5 million to develop an app that has 10 pilot customers, one would evaluate the startup negatively, because the Momentum is unsatisfactory in relation to the time and money spent.
Contrast the above scenarios to a startup that has developed the same app, but only have 2 pilot customers. If this has been achieved in two weeks and 10K, the Momentum would be relatively stronger.
The examples above illustrate the power of evaluating progress relative to the time and money. Only by relating the progress to the constraints, we get a picture of the Momentum.
To stay in our race car analogy, Momentum in relation to the constraint gives us a performance indicator equivalent to km/h1 for cars. Km/h enables us to compare the efficiency of various cars.
Progress per Time or Progress per Money are the two most important Momentum metrics and they enable us to compare the efficiency of various startups. A metric that could be highly indicative of future growth.
Standardizing progress to understand Momentum
To measure Momentum, we must standardize the progress a startup has made. To this end, we propose to use standardized levels for each of the dimensions of progress (Team, Technology, Customer insight, and Customer commitment).
The proposed levels can be seen below:
The team can be classified depending on the completeness and experience of the team and its team members. We propose the following six levels:
|Level 0 team||Single, first-time founder, no industry insight.||The startup is the typical “Startup Weekend” project. One person who has recently conceived a vague business idea in an industry the person does not know from the inside.|
|Level 1 team||Incomplete, first-time team, no industry insight.||The startup has a team. Often the lead founder has convinced a friend to join the project, but they lack real startup experience, and many critical skills are not possessed within the founder team. Also, they do not know the industry from the inside.|
|Level 2 team||Complete, first-time team, no industry insight.||The startup has a complete team meaning that all critical skills are held in the founder team, but they lack real startup experience and industry insight.|
|Level 3 team||Complete founder team, one person with some startup experience, and related industry insight.||The startup has a complete team meaning that all critical skills are held in the founder team. One of the persons has founded or been a founding employee in a startup before. Also, one of the persons has worked in a related but not the same industry.|
|Level 4 team||Complete founder team, one person with some startup experience, and same industry insight.||The startup has a complete team meaning that all critical skills are held in the founder team. One of the persons has founded or been a founding employee in a startup before. Also, one of the persons has worked in the same industry.|
|Level 5 team||Complete founder team, all persons with significant startup experience, and same industry insight.||The startup has a complete team meaning that all critical skills are held in the founder team. All team members have been founders or founding employees in successful startups before. Also, one of the persons has worked in the same industry.|
The team will advance as the startup develops. Often a single founder will bring in co-founders. Also, founding employees with significant startup experience tends to join in the early stages. Any advancement from one stage to another is progress on this dimension. Efficient startups will advance through the stages using less time and money than non-efficient startups.
The technology can be classified according to commonly understood industry taxonomy. We propose the following six defined levels of technology.
|Level 0 technology||Idea||The technology is articulated in writing and verbally. Perhaps the founders have made a slide or document describing the idea. The idea is still rather general and lacks details and specifics.|
|Level 1 technology||Concept||The technology has been sketched out and it can be described in specifics. There are drawings, models, and roadmaps that detail the idea. Typically, the founders have a full slide deck at this point. Often, they have a video using animations and renderings. It is also the stage that is typical for crowdfunding campaigns.|
|Level 2 technology||Prototype||The technology has been created to a level where it can be tested for proof of technology. The key components of the product exist and can be interacted with. This is often the stage for crowdfunding campaigns. Apps are often in TestFlight mode.|
|Level 3 technology||MVP||The technology has been packaged into a minimal product that can be used by users. It includes the key feature(s) and is complete enough for the beachhead to start gaining value. This is often the stage that select pilot users and pilot customers are testing the product.|
|Level 4 technology||Version 1||The technology has been shipped as the first full-fledged product that the startup expects the customers to pay full price for. It is complete enough for the beachhead to put into production and use daily.|
|Level 5 technology||Version 2||The technology has had its first major upgrade. The technology has stood the test of time and use, and the second generation of the product rebuilt to meet the requests of the customers of the first version and to add new features to start venturing outside the beachhead.|
The technology will advance as the startup develops. The startup overcomes technical hurdles and weeds out bugs. In the process, the technology matures and becomes a full product. Any advancement from one stage to another is progress on this dimension. Efficient startups will advance through the stages using less time and money than non-efficient startups.
The Customer insight can be classified using the proprietary Original Insight tool developed by Accelerace2. It is a self-assessment tool provided to founders to help them clarify how well they understand their customers. The tool quantifies the level of customer insight. We propose the following six defined levels of customer insight.
|Level 0 Insight||10 – 30 points.||The founders have no insight and only a vague and over-simplistic idea about their customers.|
|Level 1 Insight||30 – 50 points.||The founders have little insight and only a vague and over-simplistic idea about their customers.|
|Level 2 Insight||50 – 70 points.||The founders have some insight, and but still only general ideas about their customers.|
|Level 3 Insight||70 – 90 points.||The founders some insight and can describe their customers in detail.|
|Level 4 Insight||90 – 110 points.||The founders have the same level of insight as their customers. Perhaps the founders use to hold that job position themselves.|
|Level 5 Insight||110 – 130 points.||The founders have deep insight and know the customers better than they know themselves. The founders can be considered expert to a level that a scientist would be an expert in their respective field.|
The level of insight will advance as the startup develops. Typically, pre-seed startups are operating in the range between level 1 to level 3, to begin with. As the startup performs more customer interviews and get feedback from pilots, they advance their level of customer insight. Any advancement from one stage to another is progress on this dimension. Efficient startups will advance through the stages using less time and money than non-efficient startups.
The Customer commitments can be classified according to commonly understood industry taxonomy. We propose the following six defined levels of commitment levels.
|Level 0 commitment||Interest||The startup has talked to customers and can anecdotally talk about customers who have expressed interest.|
|Level 1 commitment||LoI||The startup has a signed letter of intent from a relevant customer. For consumer startups, people have signed up on a waitlist.|
|Level 2 commitment||PoC||The startup has a signed agreement of doing a proof of concept with customers. For consumer startups, people have signed up on a waitlist.|
|Level 3 commitment||Pilot||The startup has a signed agreement of doing a pilot to prove an articulated business outcome for the customer. For consumer startups, people are using the beta version.|
|Level 4 commitment||Customers||The startup has paying customer that is using the product in “production”.|
|Level 5 commitment||Returning customer||The startup has several customers that have renewed or in other ways shown that they are planning to remain customers for a significant time.|
The level of customer commitments will advance as the startup develops. As the startup begins to prove the value of their product, the commitments increase. Any advancement from one stage to another is progress on this dimension. Efficient startups will advance through the stages using less time and money than non-efficient startups.
Now that we have defined standardized progress, we can measure progress along these four dimensions. In other words, turning progress into two Momentum metrics. Once progress has been converted to a number, we can divide this number with the constraints. Either time or money. This gives us the ultimate metrics for pre-seed investors: Progress per Time and Progress per Money.
Calculating Progress per Time (PpT)
How much progress does a startup produce per unit of time?
Below we will lay out the mathematical model for calculating PpT.
Conceptual equation detail level 1
Conceptual equation detail level 2
The PpT model in use
Example: Imagine a startup that during a period of 10 months has progressed one level on the team dimension. This gives the startup 1 point in our equation. On the technology dimension they have progressed three levels giving them 3 points. On the customer insight dimension, they have progressed two levels giving them 2 points. Finally, they have progressed customer commitments with four levels giving them 4 points. Mathematically the equation will be populated as follows:
Example level 1
Example level 2
Example level 3
Example level 4
Calculating Progress per Money (PpM)
How much progress does a startup produce per unit of money?
Below we will lay out the mathematical model for calculating PpM.
Conceptual equation detail level 1
Conceptual equation detail level 2
Conceptual equation detail level 3
The PpM model in use
Example: Imagine a startup that has spent 1 million DKK and progressed one level on the team dimension. This gives the startup 1 point in our equation. On the technology dimension, they have progressed three levels giving them 3 points. On the customer insight dimension, they have progressed two levels giving them 2 points. Finally, they have progressed customer commitments with four levels giving them 4 points. Mathematically the equation will be populated as follows:
Example level 1
Example level 2
Example level 3
Example level 4
Limitations of the model
Naturally, there are limitations to the PpT and PpM model. The most important are:
- Team progress does not take the quality of the individuals into account beyond requiring the team expansion to be of “critical” people. This means that two startups can score equally many points even though one startup has attracted a Nobel prize laureate and the other a merely skilled industry professional.
- The technology dimension does not take the difficulty of the science into account. This means that two startups can score equally many points even though one startup has made a scientific breakthrough and the other had mere launched their app.
- The customer commitments do not take the difficulty of customers into account. This means that two startups can score equally many points even though one startup sold to SMBs and one has sold multi-year recurring enterprise contracts.
Some of the limitations can be dealt with by comparing startups within the same category. Thus comparing, enterprise software startups to other enterprise software startups. And consumer apps to other consumer apps. Few investors have big enough portfolios to enable a sub-segmentation. But if possible, it would be advisable.
On a more generalized notion, the model does not account for all the factors that affect the likelihood of success. From experience, we know that team dynamics, the growth of the market, timing, competition, and other factors play a significant role in the life of a startup. The model only quantifies Momentum. To most, Momentum is just one of many elements investors assess when making investment decisions.
First, Momentum allows us to compare companies that have had different amounts of time and money available to them. In other words, the efficiency of which they create progress. This matters greatly because as pre-seed investors we are investing small tickets and the efficiency of the companies is critical. Also, in the absence of historical financial metrics, Momentum is perhaps the most objective metric for progress at the pre-seed stage and can arguably be a reliable indicator for the future. Having Momentum available, a pre-seed investor can use these metrics to aid them in the decision making when evaluating various investment opportunities.
Second, the model provides input to the classic problem of making follow on investment decisions. Investors are often victims of the sunk cost fallacy. Often, the urge to support portfolio companies that are in urgent need of money to survive is strong. While this can be the right decision, often it is not. Momentum will provide data about how efficiently the portfolio company is spending the money and time provided with the investment. Startups with high Momentum scores suggest that the money are well spent, and that further investments are advisable.
About the authors
Peter Torstensen and David Ventzel are partners at Accelerace. Accelerace is a startup accelerator and pre-seed investor placed in Copenhagen Denmark. Accelerace was founded in 2009 and have accelerated more than 700 startups to date.
The authors have been aided by their colleagues Claus Kristensen and Mads Løntoft in the conceptual development of the framework.
If you are interested in the model and collaborating further development of the framework, then contact the authors on David Ventzel: email@example.com or Peter Torstensen: firstname.lastname@example.org