Five Tips for Spotting Killer Traction Before It Happens: Part 2

During a business trip last week, I stopped in Atlanta.

While standing on a busy downtown street corner, a sleek, ultra-modern streetcar sidled up next to me and came to a noiseless stop.

Its doors opened just a few feet away from me. For a brief second, I caught a glimpse inside.

The car was empty.

Later that day, the Atlanta resident I met with told me why.

To an early investor, it sounded all too familiar.

You Can Build It, but Will They Come?

When Atlanta’s streetcar first became operational in December 2014, people flocked to use it. It was pronounced a success – “a model for the rest of the country.” Plans emerged to extend the service.

But it was all a mirage.

The city of Atlanta offered its streetcar service for free during its first year of operation. On day 366, it began charging customers $1 a ride.

On that day, customer use fell 48%. Ridership never recovered.

Plans to build more streetcars with more stops are now on hold.

The lesson is something that every early investor should be familiar with…

You can’t judge demand by offering something for free.

It’s a mistake that founders make all the time. They think they’re creating an addictive product based on free usage, only to find out that their conversion rates are much lower than anticipated.

I’ve seen it happen time and again. It can be a false and totally misleading signal of real demand.

In an earlier post, I gave you five signals to identify revenue potential in early-stage companies:

  1. Selling seems easy. The market is pulling sales, as opposed to the company pushing sales.
  2. There’s little spend. Are sales growing organically, with little or no budget? It’s a great sign that a real need is being met.
  3. There are 100 “OMG” customers. A startup that has found 100 “Oh my God, what an amazing product” customers is primed for serious revenue growth.
  4. They have powerful partners. Partnerships can have a huge impact on a company’s ability to generate revenue.
  5. They are mature “startups.” They aren’t your typical seed-stage companies. They have years of hard-won growth experience. They just happen to be crowdfunding.

Investing in a company that can grow revenue rapidly is a basic rule. On the other hand, we often invest in pre-revenue companies that have no track record and show little evidence of being able to grow revenue at the time of fundraising.

It’s such a key issue for early-stage investors, I’m visiting it again. So here are five more early signs of future growth to watch out for.

Incipient Growth

This is not the 10 years of growth that Warren Buffett looks for. But if you can replace 10 years with 10 quarters, that’s a revenue track record worth examining. 10 months of revenue generation is also quite useful. I’ve even looked at 10-week revenue records.

If a startup can show rapid revenue growth in the last three to four months, that’s much better than no revenue record at all.

Bootstrapping Growth

This is the opposite of spending a boatload of money to create a revenue stream. “Bootstrapping” means growing a startup on a bare-bones budget. It’s not for everybody. The founders take on multiple roles, including salespeople.

My favorite bootstrapping example? Dealflicks. Its two founders traveled the Southwest in their “Man Van” for weeks at a time. They ate and slept in their Man Van, going from one movie theater plaza to another. They added hundreds of theaters to their discount ticket program this way.

Pipeline Deals

Founders tell investors what deals they’re working on. In the public stock world, you’re not allowed to invest on such privileged information. In the world of startup investing, it’s simply part of the discovery process. My partner Adam and I are privy to “big deals about to close” all the time.

However, this can be a double-edged sword. These sorts of claims can easily be exaggerated. Even if they’re telling the truth and a founder is on the verge of signing on the dotted line, the deal can go south at the last minute.

I’d be a billionaire by now from the deals I thought I had sewn up but never consummated (in my former life as CEO of a global trade and finance company). So be skeptical and ask hard questions.

Stickiness Part 1

I really prefer products that help customers make more money over those that help them save money. For example, selling a manufacturer something that will increase sales is a more “sticky” transaction than selling them something that will cut down their manufacturing costs.

Don’t get me wrong. Saving a customer time and/or money is legit. But, if that’s the case, I look for substantial savings – incremental improvement equates to incremental revenue growth.

Stickiness Part 2

Revenue growth is not a “one size fits all” proposition. Sales of consumer products, especially once they catch on, can expand pretty quickly.

Enterprise-facing companies have a longer sales cycle. But once you capture these companies and they’ve integrated your product into their internal operations, they’re not going to change suppliers on a whim. It’s very sticky.

Startups selling to government agencies face an even longer sales cycle. These customers are the stickiest of all.

Churn – when customers stop using your product – is tough to deal with. I’d gladly trade slower revenue growth for more stickiness.

It’s why we’re so bullish on our latest recommendation to First Stage Investor members, Court Innovations. It’s developed a beautiful platform that allows private citizens to resolve court cases online. It takes a while for the company to get its government customers to sign on, but once they do, these customers don’t go anywhere fast.

Projecting the possibilities of a startup’s future revenue is incredibly challenging. But we have no choice. With scant hard information and little, if any, track record, we have to tackle it. And how well we do it goes a long way toward determining our success as investors.

The above five clues on top of the five I gave you last year will help you peer into the future and see things that perhaps no one else is seeing – even the founders themselves.

Invest early and well,

Andy Gordon
Founder, Early Investing