I just read this post about how the startup Level Up has raised $41MM but may now be running out of cash, and according to the article is down to half its previous employee count.  It got me thinking about a big mistake I see startups make, which is over-extending before finding true product/market fit.

I was well aware of this danger at Socialize, and we still made that mistake.  At one point in early 2012, we were up to 16 employees.  When we sold to ShareThis, we were down to six.  It's not that six employees was too few -- it was exactly the right number and type of employees for the stage of our company -- it's that sixteen was way too many.  We didn't absolutely need that many people to build and sell our product, even though we felt at the time that we did.  The six employees that ended up forming the core of our company in the year before we sold it were all very key employees and are incredibly productive, and that's what we needed to find product/market fit.

So if a CEO is acutely aware of the issue and still falls into the trap, I can't imagine what the siren call of rapid expansion does to CEOs who aren't watching out for it.  But it is possible to get around it:  On the opposite side of the spectrum you see companies like instagram that sold for $1 billion with just a dozen employees.

So I've come up with a mental framework to optimize the outcome of a new startup dealing with this issue.

Daniel's Framework For Optimizing Product/Market Fit:

First, be proactive:  This part is easy for hardcore entrepreneurs.  When you're just starting a business, being proactive is how you create the first version of your product, bring on the first investors, and hire the first key employees. Being proactive means things like:

  • Throw ideas at the wall to see what sticks:  Test lots of market assumptions with quick & dirty versions of a variety of solutions to find something that gets early traction.   If something doesn't get traction quickly, then stop doing it and move on to something else.  Don't invest a lot of time making something work, but instead invest your time finding something that works.  This means being disciplined about cutting efforts on things that aren't working, which is a really, really hard thing to do.
  • Make decisions quickly:  Don't spend a lot of time second-guessing a decision, because there's likely no data to support the decision anyway.  So make quick decisions and then gather as much data as possible to compare your decision against the actual results, and iterate from there.

Keep being proactive until you hit on the right opportunity for the startup.  Be ruthless & relentless about moving on to try something else if what you originally thought would work, doesn't.  Oftentimes this process can take a startup 12 to 24 months. Ideally within the first 24 months you'll have found something that has good indications of a strong product/market fit.  How do you know?  You'll know when it happens, just like Justice Potter Stewart defined pornography this way:

"I know it when I see it."

Things will suddenly get easier.  You'll have users coming to you, instead of you trying to convince users to try your product.  You'll have people suddenly wanting to work at your startup.  You'll have people wanting to invest in your startup.

The key in this first stage, before you find the product/market fit, is to take enough angel money to find this "thing" you're looking for while keeping the team lean and small.  Hire no more than half a dozen employees.  Ideally only four to five.  All technical.  One with a world-class design eye, and maybe one "business person," so long as s/he is also technical.  The rest should be top-notch developers that love shipping code (and quickly).

Then, be reactive:  Here's the tricky part.  This is the switch in attitude I'm convinced most entrepreneurs miss because they're initially in this "proactive" mode.  Once they achieve just a little bit of product/market fit, that proactivity becomes a cancer.  Hiring spirals out of control.  Suddenly angels or VCs want to throw money at you because you've got some traction.  It's easy to take their money, which then puts pressure on you to hire more and move faster.

Once the product & company starts getting some traction, I'm convinced that it's important to take a reactive stance on everything but that one thing that's providing the traction. This means things like:

  • Hire super slowly, and fire quickly.  Don't bring a new person on until the pain of not having that employee is unbearable.  Insist on having world-class employees.  Don't settle for candidates that are "good enough."
  • Cut, cut, cut:  Cut out all the secondary experiments that got the company to this tipping point back when you were "throwing ideas at the wall."  If you did the first proactive part right, you'll have one thing that's getting strong traction, along with other things that are getting some traction.  Cut them all out so you can focus on the one thing that's working best.  Having something that's "kinda working" is way worse than something that didn't work at all, because the undead "zombie product" sucks resources away from the real core thing that's getting the traction.

All the pressure in the world will be on the CEO to keep hiring, keep spending and keep expanding -- especially from investors and the board.  But it's important to move into a strong reactive posture with an insane focus on making 'what's working best' even better while slowing down on everything else.

I'm sure some people will disagree with me.  I'd love to continue the conversation in the comments.

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My focus on getting to product/market fit was originally inspired by a 2009 blog post by Marc Andreessen on the topic (which might be going away soon, as Posterous is shutting down on Aprilt 30th.  So go read it while you can!).