I'm sure you're familiar with the Pareto law (the 80/20 law). 20% of actions produced 80% of results, 20% of people drank 80% of alcohol, etc.
However, have you ever wondered on what basis this law is based? I have, and it obsesses me.
If 20% of M&A dealmakers extract 80% of value, what do I need to do to belong to this 20%?
Wealthy people get wealthier because they can borrow (cheap) capital against assets they already have to buy new assets.
The 80/20 law also applied to fundraising, where 20% of entrepreneurs get 80% of the capital.
After meeting hundreds of entrepreneurs, I've noticed that successful entrepreneurs in fundraising have one asset in common.
If you are in the tech equity financing ecosystem, you have inevitable heard something like this:
"I need capital to execute a winner-takes-all strategy to hit first a critical mass. Network effects then kick in and my startup will have defensible moats."
It's an equity story: a combination of all the compelling reasons investors should buy your equity.
Those equity stories, composed of buzzwords, were music to my ears when I was a newbie in the ecosystem.
However, several painful personal experiences (that made me look stupid) turned me into an adept at recognizing when music sounds phony.
It gets more manageable for me to distinguish two types of entrepreneurs:
- Those who articulate buzzwords in a superficial way - Those whom equity story are rooted in mature mental models.
Anyway, let's frame the above equity story in a fundraising situation where you, a SaaS founder, are facing a veteran tech investor.
We are in the Q&A phase, and I'm sure you did an excellent pitch using this.
Tech investors: Thanks for the presentation. You used a lot of keywords; it seems you came prepared! However, one question remained. Are you really in a winner-takes-all market?
You (confident): I am!
I'm sure you know that winner-takes-all markets have occurred in consumer markets where the first company developing a new behavior as Uber or DoorDash, wins.
My SaaS product is also about developing a new behavior. I have outstanding metrics showing its stickiness. The more a person uses my product, the more it becomes a habit!
Tech investors: Indeed, it's exciting but are you sure implementing a growth-at-all-costs strategy, like seen in consumer markets, to build a user base is the right strategy for your SaaS product?
You (offended): My mission is to spread this new habit to my entire TAM. I have a sticky product, plus it has built-in network effects. Look at my retention metrics!
I am one step ahead of the competition, but I'm sure my competitors are also talking to people like you.
That's why it's instrumental that my product hit first a critical mass. Network effects will kick in, and my startup will be the winner of its category.
Tech investors: Do I need to understand that because your product has network effects automatically means you are in a winner-take-all market?
You (surprised): What do you mean? I'm sure you know that most tech markets tend to end up with one company capturing the most market share, thanks to network effects!
Tech investors: If network effects were the only thing, then why do you think we have hundreds of CRMs apart, tens of enterprise instant messaging, multiple browsers, and multiple OSes? But only one dominant professional network or only one dominant video updating website, for example?
You (embarrassed): Euh… I think…I don't know…
Using keywords learned in articles like this won't make an equity story stand out. It's easy to use, and everyone can use them.
However, going deep in understanding the structure of your market and your network effects is not a piece of cake.
It demands time and effort, but it's worth it, as you will be able to articulate a differentiated Q&A-proof equity story.
In my example, the equity story was based on the assumption that all network effects are identical.
However, not all network effects are created equal. They fall along a spectrum of different types and strengths.
Every product has different network effects that mature and develop differently over time.
Instead of using the network effects term loosey-goosey, focus on acquiring a deep understanding of network effects as a mental model.
It's a fundamental mindset shift because it will redirect your resources to building fundraising assets.
Building a rock-solid equity story is the asset shared by all the successful entrepreneurs in fundraising I know.
It'll give you an advantage while fundraising as VCs are masters in building compelling investment thesis, a form of equity story for the LPs. If not, they won't have any capital to deploy.
It's only natural that VCs choose entrepreneurs who can also build compelling equity stories!