VCs are interested in finding large, untapped markets. They use startups to do the market research needed to find them.
It’s a strange kind of market research, but then VCs have a strange kind of market research requirement.
VCs have to do market research into solutions for ‘ghost’ problems that maybe nobody actually has, just in case somebody does have them. The problems emerge from the arcane science of reading creative writing exercises called Startup Business Plans.
The market research is done for the VCs by the startups themselves, who imagine that the problems are real and that they are being paid to solve them. In reality, they are being paid to find out if they really exist and are worth solving.
Market researchers’ traditional method is to design and conduct surveys, with the aim of producing a report which addresses unanswered questions.
Startups addressing potentially scalable customer requirements, by contrast, do their VC overlords’ market research in a completely different way.
It all begins with a collection of fantasies that constitute a startup business plan. The VC is rarely under any illusion that the contents of startup business plans are anything but fantasies, irrespective of the degree of conviction of the startup founders.
What hard-nosed VCs are in the business of assessing, is whether the founders are proposing to conduct a research exercise into a market that the VCs are interested in, and whether the founders show sufficient promise as researchers, such that they are a good bet in terms of ‘finding the location of buried treasure’.
The founders themselves operate under hope that the VCs, if they invest, will enable the startup to ‘live out their dream of massively over-fulfilling the plan, generating sufficient revenue so as to liberate themselves from the need to accept further equity dilution or continued investor imposed controls and to go on to become a world-dominating giant’.
Meanwhile, the VC, by contrast, hopes that the outcome of their initial investment, if successful, will, at best, provide them with the market research data that will reveal the kind of scalable market opportunity that will represent an exit with a level of return which will compensate for all the other investments in their portfolio which fail to reveal attractive market opportunities.
Here is an analysis (a kind of ‘bonfire of the startup vanities’) of the fantasies that go to make up a startup business plan.
Startups begin with an idea of a customer requirement (the Customer Requirement Fantasy). This is how that idea is born.
They start by imagining a problem (the Problem Fantasy). The problem may indeed be real, especially if they have experienced something like it themselves. The imaginary aspect may not so much be the precise nature of the problem itself, but instead it might be the extent to which it might affect a wider range of use-cases (the Problem Context Fantasy).
They also imagine a solution (the Solution Fantasy) to this problem. The solution may not exist anywhere other than in their imagination. In addition, they definitely and unquestionably imagine that they could economically build such a solution (the Solution Development Fantasy). They then proceed to imagine what the impact of the availability of the solution would be upon those experiencing the problem (the Solution Impact Fantasy).
They identify a profile of the individuals and/or organisations who they would expect to experience the problem, in terms of factors like geography, demographics and activities (the User Profile Fantasy).
They then proceed to assess the numbers, the ‘population’ from which prospective candidate users/customers likely to be interested the solution would be drawn (the Market Size Fantasy).
They then speculate upon the attractions of the imagined solution to the sufferers of the problem (the Solution Attractions Fantasy).
They then speculate upon how to use this as a basis for devising an offering of the solution to prospective users (the Value Proposition Fantasy).
Then, by means of a subliminal equation which makes quantum electrodynamics seem intuitive, all these fantasies are rolled seamlessly together to form a ‘potential revenue per customer times the number of prospective customers’ (the Scalability Fantasy).
Due diligence on the part of the VC will ensure that the startup founders in question are selected to include at least one decisive individual who, when confronted with revelations regarding ‘discovered practical realities’ which contrast markedly with the fantasies in the plan, will have the resourcefulness to pursue alternative problems and solutions (a hitherto unspoken practice recently dubbed ‘pivoting’ which used to be reported to startup investors at monthly board meetings as ‘and the good news is that we’ve come up with something even better than what we were originally working on’) and to keep doing this, setback after setback, until they finally hopefully arrive at a new, less fantastical proposal.
Instead of resting upon a foundation of fantasies as it did in the original business plan, if the startup does, in the course of this exploratory exercise finally manage to put together the beginnings of a practical solution which reveals strong, genuine, sustainable and monetisable interest, this newly crafted Scalable Business Model relies upon a track record of what amounts to rigorous and carefully documented market research, of a quality which the VC can use as a basis for a less risky investment (and part of the risk reduction may well involve the VCs insisting to the founders that the scaling implementation requires deploying executives with a track record of implementing scaling, rather than doing what the original startup team were doing, which was a kind of market research).
Getting to such a Scalable Business Model will require the VC to actually fund the building and provision of (at least a minimalistic and provisional vestige) of the initially conceived Fantasy Solution, followed by a sufficiently low cost and rapid iteration of a ‘build, measure, learn and modify’ process that allows the various original problem, solution, development and market fantasies to be replaced with realistic and scalable product and service development, deployment and monetisation opportunities.
I don’t think that VCs or startups currently consciously consider themselves to be in the market research commissioning or undertaking business. The equity stake that they take in the startups, combined with the fact that VC performance is exit-driven, obviously reflects the sense that market research constitutes only part of the basis for the relationship between the VC and its startups. Nonetheless, recognising this aspect may give both parties a more realistic (2.0?) appreciation of each other’s perspective.