This is a “bonus chapterette” from my book Mindshare to Marketshare.
Think of these Four Gates like a funnel, with lots at the top and very few at the bottom (just like a sale funnel):
Gate #1: Conceptual Clarity.
Gate #2: Prove the Concept.
Gate #3: Scale within Niche.
Gate #4: Expand and Dominate.
It takes totally different skills to go through each of these four gates. Few founders have all the four different skills needed, which is why so many ventures fail as they attempt to pass through these gates. Even harder is the fact that the skills, techniques and attitudes that make you successful going through one gate are exactly the opposite of the skills, techniques and attitudes that make you successful going through the next gate.
Each gate requires a wrenching pivot.
This is like a ski slalom race where you have to change from downhill to snowboard to telemark as you go through each gate.
There is an exit opportunity from Gate # 2 onwards.
Gate #1: Conceptual Clarity.
This is the “fit to the future” phase. This is where you have a vision of “a world where….”. From this you have a mission for the venture along the lines of “in this future world, we will…”. Finally, you have a strategy, as in “we will do this by….”
There has been a lot of fruitless debate about whether concept or execution is more important. This debate is silly, because you must have both. A bad concept that is brilliantly executed will be nothing more than a tough uphill slog with relatively little reward at the top if you get there. On the other hand, a brilliant concept with weak execution is nothing more than “woulda, coulda, shoulda”.
Conceptual clarity must address these 4 dimensions:
- Huge market. A small niche might make for a great venture that can be bootstrapped or flipped, but Unicorns need massive markets.
- Massive disruption hitting that market. This is the kind of disruption that creates an existential threat to the major players in the market – think of Skype vs telephone companies or Google vs traditional advertising or AirBnB vs traditional hotels. If it is not disruption of that scale, the existing vendors will add the features they need to stay competitive (“adding that feature” may mean acquiring your venture, so this is fine for ventures that will be acquired before they go through all these gates).
- You have a 10x proposition. You have to be 10x better or faster or cheaper than the incumbents. That seems like a high bar, but it needs to be this big to overcome the start-up risk that you are asking customers to take. Tactically you may start by offering say 3X knowing that as the technology rolls onwards you have much more in reserve, but you must see where that 10x is coming from.
- Timing. Research across hundreds of startups shows that timing matters more than team or funding or anything else. The world has seen lots of brilliant ideas that were ahead of their time. They could not be executed at the time. Think of Leonard Da Vinci’s inventions. Or more pragmatically today, think of brilliant concepts that just needed bandwidth at mass scale. Or imagine Lending Club before the Global Financial Crisis. You must have a crystal clear point of view on “why now”.
Here are the two things you do NOT need to have at this stage:
- A strategy that seems viable to most people. Most great ventures look totally ridiculous to most sensible people in their founding days. You do need a couple of smart people to believe in the strategy, whether they be co-founders or investors. But get comfortable with the fact that most people think you are crazy (unless you actually are crazy, there will be times when you doubt yourself and when you think most people are right).
- Any proof that any of the three things on that checklist are true. Anybody who asks for proof at this stage does not know how this works and does not deserve to be your partner.
Many great entrepreneurs have conceptual clarity but are weak at articulating it, or too busy executing on the next phase. At this stage nobody cares about your concept. Only after you have passed the next gate does anybody care.
There is no exit opportunity at this Gate.
Gate #2: Prove the Concept.
This is the “fit to today’s market” phase. This is also what VCs call “traction”.
This where you focus on the immediate needs of customers who are ready to make a commitment now, leaving out all the futuristic, big picture stuff which would only scare potential customers.
This usually means you seed the market and prove the value proposition in a tiny little niche; at launch all the market will see and all the entrepreneur is thinking about is that tiny niche.
However, somewhere in the back of their mind, the great entrepreneurs carry a conceptual vision that is a lot bigger than the immediate solution that they offer to get through Gate # 2.
That almost certainly means you get traction in a niche that is tiny compared to the big vision in your concept. This process of digging deep into a niche and focussing 100% on the present day needs is a vital step in turning dreams into reality. It is also 100% opposite to what you do to get through Gate #1.
In enterprise software, getting through Gate #2 means getting the first three paying reference customers. This is a tough job because most customers prefer to wait until you have these three references before committing; one way to drive enterprise software founders crazy is to ask them about this chicken and egg problem. These need to be real enterprise-wide deployments with customers paying 6 figures. A few logos of customers deploying the software in one small area and paying a few thousand dollars won’t make the grade. Lots of enterprise software ventures reach this stage and become cash flow positive without raising any VC, but then stumble at the next Gate.
In consumer or media ventures, getting through Gate #2 means month to month growth rates in attention. I am using the word attention because the specific metrics such as page views, uniques, downloads, active users tend to change a lot as people “game” the old metrics.
At Gate # 2, you typically have three opportunities:
1. The exit opportunity is typically Acquire-Hire. You have some value, but it is very little.
2. A Series A VC round.
3. Grow from revenues (slower than 2 but gives you more control).
You have to assess this based on your age, motivation, connections and the strength of your concept and the offers you are getting.
Some enterprise software vendors that make it to Gate # 2 get acquired for their R&D value with a bit of credit for the quality of your customer relationships. If you raised VC, the acquisition value will be a disappointment to investors. As VCs usually get liquidation preference, this will be an even bigger disappointment to founders and management. If you bootstrapped to Gate # 2, the value you will get from the trade sale will still be life-changing as you don’t have to share the spoils with VC. However the big money, the fame and fortune, is reserved for those who make it to Gate # 3. One way to look at this is, don’t raise VC unless you are determined to make it past Gate # 3.
Consumer ventures can exit for great multiples at Gate # 2 without revenue as deals like Instagram and WhatsApp show. However these deals are the exception that prove the rule. It only ends that way if you get massive growth in attention at a time when a big acquirer is facing massive disruption (think Facebook facing disruption from mobile and thus paying a big premium for both Instagram and WhatsApp). Fortunes are lost trying to emulate this when those rare stars are not aligned.
Gate #3: Scale within niche.
This is the “make it work as a business” phase. This is the point where you will need the skils and techniques that I describe in Mindshare to Marketshare. You will need to scale your sales and marketing with replicable processes without losing the passion and creativity that got you to this Gate.
For consumer web ventures, the big obstacle at this Gate is proving a scalable and profitable revenue model. There are now trade offs and conflicts to be managed between the needs of free users and the different needs of paying customers (e.g. advertisers) and that is often hard for the entrepreneur who won in the last Gate through their self-proclaimed single focus on user experience.
Businesses that make it through this phase are “in the catbird seat”. You have a profitable, scalable model that you can grow with internal resources as long as you like. You will be fending off acquisition offers all the time, both from financial buyers (private equity funds) as well as strategic buyers. You get to choose when and who you sell to. Or you may choose to go all the way to Gate # 4.
Gate #4: Expand and Dominate.
This is the post IPO sustainable public company phase.
The “expand and dominate” Gate #4 is about getting back to that original founding conceptual clarity, of realizing the big picture potential. All the long years of the earlier Gates are simply laying the groundwork to make this possible. This is another wrenching pivot. The skills, techniques and attitudes that got you through Gate # 3 are all about focussing on a niche, constraining ambitions for the future while concentrating on the immediate opportunities. If you have done a good job in the transition through Gate # 3, you will be able to leave the quarter by quarter growth to a highly competent team. That frees the founder CEO to focus on expanding into adjacent markets and dominating the market. Dominate may sound harsh to some ears, but it is what public market investors expect, that is what the high valuations given to fast growth tech companies are based on.
Entrepreneurs that make it through Gate # 2 get the opportunity to exit and that can be a good result if they have bootstrapped to that point. Entrepreneurs that make it through Gate # 3 get the opportunity to exit and that is a good result for founders, management (this is when those stock options become life-changing) as well as any investors who are fortunate enough to be along for the ride. Gate # 4 is for Unicorns with fame as well as fortune (founder faces on the front page and on TV).
The Silicon Valley VC orthodoxy for a long time was that no founder has the right profile to make it through all the 4 Gates. Therefore VCs have usually tried to either sell the business at each of these Gates or find professional management to replace the founder CEO. (I refer to the Founder CEO as the key, because even though there are often co-founders, there is usually one of them who emerges as the leader). That conventional wisdom is being seriously questioned today as we witness the failure of “professional managers” from big companies to drive the growth of start-ups. When you look at the really great success stories, you tend to see one highly charged entrepreneur who takes it all the way through these 4 Gates – think of Gates, Ellison, Page, Zuckerberg, Bezos, Jobs, Benioff. Their ability to pivot and personally change at each of these Gates is the story of their success. It would be crazy to see these entrepreneurs in their founding days and envisage them as the CEO of a multi-billion $ publicly traded company, yet some of them actually do that.
The current VC fund structure, with its need for exits to return money to the Limited Partners, is not conducive to backing entrepreneurs all the way through these four Gates. So we are likely to see some innovation in this area as the rewards for backing entrepreneurs through all four gates is very big.