Early Valuations are Bets on People

Early stage valuations of start-ups are just bets on people – the underlying assumption being that a good team can figure out a product-market fit more easily.

In the early days, when the product is not concrete,  the initial idea can pivot, morph or get completely overhauled within a span of as little as 3-4 months. The initial team is the most crucial element of this, since the composition of the initial team will determine what direction the product takes. Swap the initial founder out with someone else and you will have a completely different product.

When it comes to markets – they should be large/have the potential to be large or you are not in the right space. If they are large, expect them to be crowded with people still trying to “crack it.” Within this large market, your product needs to “fit” into a specific area. An example is how Twitter and Facebook “fit” into the market. Facebook is more for a personal network, while Twitter is more of an information broadcasting service. Though both are in the social networking space, they are still fundamentally very different in how they “fit” within the same market.

Figuring out how your product fits into a market is called achieving product-market fit (… duh!) – arguably the only thing that early stage start-ups need to focus on. This means that initial teams need to iterate, learn, unlearn and relearn, where the initial product basically embodies all the skills, knowledge and experience of the founders to successfully fit into the market.

In the early stages for investors, when both the product and the market are not clear, it just boils down to the founders. Have they done this before? How do they think? Can they build it? Will it get traction? Will users keep coming back? Will it make money? Is it a sustainable business? and countless other issues/risks.

So, this means that if you are a first-time entrepreneur, you often need to go further before you can raise any/much capital. You will probably need to show a working product with some traction before a venture round, whereas someone who’s done it successfully several times before probably just needs to make a phone call with an idea.

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