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Working with Investors as a Lean Startup

by Ben Linders on Mar 13, 2014 |

Entrepreneurs using lean startup can work with investors to raise capital for their business. Business plans from lean startups often differ from traditional startups and lean startup encourages learning from failure and to pivot, which might scare off investors. Can entrepreneurs and investors together use the lean startup approach to do fundraising?

Jake Spertus wrote a blog post about can lean startups compete in business plan competitions. He explains how lean startups differ from traditional startups:

Instead of a long, concrete business plan, lean startups employ an easily adaptable business model that lays out an overall vision and a series of hypotheses to test. The business model enables a startup to “pivot” when a strategy is not working and products are continually altered and improved based on customer feedback. By anticipating uncertainty and remaining agile, lean startups hope to maximize their chances at eventual success.

Investors may have to change the way that they evaluate and decide upon business proposals from entrepreneurs that are using a lean startup approach, as Jake explains:

As part of their methodology, lean startups tend to deemphasize traditional metrics like cost projections and rigid business plans. Because of this trend, business competitions, many of which require full business plans, may also need to evolve to efficiently serve lean startups.

Jack quoted Diana Kander, a senior fellow with the Kauffman Foundation, who said: “Would you rather vote for a startup that has an untested business plan or one that has gone out and shaped its product based on actual customer sales?”. He describes why entrepreneurs using a lean startup approach may have a better chance at business competitions:

After conceiving of a product, validating it with customers, and writing a business plan, lean startups can be competitive in business plan competitions, perhaps even more so than traditional startups. The problem with business plan competitions is not so much that lean startups are unable to be competitive against traditional startups, but that going through the motions of creating a complete business plan for a competition requires a significant investment of time and energy into a single solution, which runs counter to the lean approach. For this reason, the increasingly popular business model competitions will likely fit lean startups better.

In the blog post lean startup versus raising capital Ben Yoskovitz writes about the needs of entrepreneurs and investors when using a lean startup approach to raise money. He starts by mentioning where lean startup and investing are different:

Lean Startup is about experimentation and learning. (…) Investing on the other hand is about storytelling and big vision. It’s also about proof and hockey stick traction.

According to Ben it is important for entrepreneurs to combine storytelling & big vision with strategy & tactics:

If you can’t tell a compelling story and tug on investors’ heart strings, you just won’t get their attention. A lot of founders aren’t natural storytellers, but it’s a skill you need to work on aggressively, because it makes a huge difference. Paint a great story, emote an immense vision, and you have a chance of drawing investors in.

(…) you need to get into the details–into the strategy and tactics–and show investors how you’re going to execute aggressively and intelligently towards your vision. That’s where Lean comes in. Lean Startup and Lean analytics are all about strategy and tactics. They give us a practical guidebook on how to execute.

Cameron Chell stated that the fundamental activity of a lean startup investor is “to invest into a startup for the purpose of creating prosperity, knowing, understanding, and supporting the Lean Startup Methodology”:

An investor must understand the methodology of a Lean Startup in order to effectively invest in one. The reason for this is simply that the metrics to measure success are different than that of a traditional startup. Lean Startups are focused on customer acquisition, proof, fast moving pivots as necessary.

Lean startups learn from failures early and often, which is something that investors have to get used to when they work lean startups as Cameron explains:

Investors are not traditionally accepting of mistakes and see mistakes as steps closer to failure. For Lean Startups failure is not just a viable option, it’s a way of life. These startups are built to fail, but to fail fast and smart and iterate their product offering. As they change course they get closer to the product offering that will resonate strongest with their customer base. A Lean Startup Investor sees this process as real world testing and learnin’s and steps moving the project closer to success.

Gaurav Jain wrote a guest post on VentureBeat where he talks about why is your fundraising process ‘waterfall’ when your startup is ‘lean’. He starts by describing the traditional approach used by entrepreneurs to attract investors:  

Amazingly, though, most entrepreneurs still follow the “waterfall model” when it comes to raising venture financing. A typical process has the following steps: realize that the company needs money → put together a deck → send deck to many VCs → set up bunch of meetings → hope to close the round quickly.

The blog post from Gaurav describes how you can apply principles from lean startup to the fundraising process:

1. Build-measure-learn. Your pitch is your product and potential investors your market.

2. Value hypothesis. (…) An easy way for you to tell if the investor finds “value” is by the amount of time they are spending on diligence.

3. Theory of small batches. (…) I recommend you segment your hit list into small batches, starting off with investors you feel would provide the most constructive feedback.

4. Validated learning. (…) it’s important for entrepreneurs to understand the various dials and knobs in their pitch, test different versions, and figure out what’s working best.

5. Cohort analysis. In addition to catching issues early, segmenting your pitch meetings into small batches/cohorts will help you analyze and understand how changes you make to your pitch actually impact your success.

Gaurav mentions some of the benefits of applying lean startup principles in fundraising:

The crux of the lean startup model is to reduce waste by not working on the wrong thing for too long. It saddens me when I see entrepreneurs go through 20 VC pitches and then realize that there was some fundamental issue with their pitch they should have addressed a long time ago.

It’s time we stop wasting precious time and resources on pitch meetings that could’ve been a lot more productive for everyone involved, especially the entrepreneur.

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