Finding Product-Market Fit

Learn more about what investors really value when it comes to product-market fit.

Last Updated: October 7, 2020

Published: March 12, 2020


The term “product-market fit” (i.e. PMF) is used by both VCs and startups. The definition, however, can vary depending on your perspective. For investors, it’s a key metric—allowing you to remove one risk factor and giving you something to measure beyond intuition, personal experience with a beta version, or the length of a waitlist (or some other loose indicator of demand.) As a founder, it gives you the confidence that consumers value your product or service, letting you focus on accelerating growth.

Product-market fit: Does your company have it?

As a core Series A firm, we measure PMF by considering the following:

Faster traction than a business can support. It’s bursting at the seams and can’t seem to hire or ramp up manufacturing or servers fast enough to keep up with demand.

Traction has been achieved with limited or no marketing. to keep up with demand. Traction has been achieved with limited or no marketing. An unaided trajectory indicates lightning in a bottle: a community of evangelists who found your product organically and love it enough to share with friends. As the famous Stanford professor Andy Rachleff once said, “You know you have fit if your product grows exponentially with no marketing. That is only possible if you have huge word of mouth. Word of mouth is only possible if you have delighted your customer.”

Before you invest significantly in growth, you must establish a baseline proving you’ve reached some level of this fit. We recently invested in Coinmine, a D2C crypto mining business that found this magic. With no real marketing budget, revenue is growing [100% MoM], customers are buying multiple products and are arriving in droves. Who are these people? What’s driving growth? Why are people buying multiple products (at a $799 price point)? When you start asking these questions, you know you’ve found it. Now is the time to find answers and start spending marketing dollars to accelerate growth.

But here’s the trick: Your unit economics have to work without substantially changing the value proposition. If you have a freemium model, the math must work once you start charging for your product or service. If you have not yet initiated a pricing model, you must have data points that indicate a willingness to pay. This includes high engagement rates, glowing customer references, and some NPS-type measurement, etc.

Your unit economics have to work without substantially changing the value proposition.

As an investor, we need to have a high level of confidence that charging or introducing a revenue model does not change the consumer experience or demand. Take a look at Pinterest, for example. Its first years were spent focused on product and user growth. Only after they amassed 100M MAUs in 2015 did they turn to an advertising model.

If you are generating negative gross margins on every sale, you are either subsidizing your growth by trading pricing for market share (i.e. Uber/Lyft), or you have an ineffective business model and should probably try something new. Marketing expenses are typically below gross and contribution margin, but must be considered through a ratio that indicates that the lifetime value of a customer is great enough to justify the customer acquisition cost.

It’s also important to avoid the fallacy of large numbers. TAMs can also fall into this category—a topic for another day! A long list of registered users waiting for a product launch is helpful, but doesn’t meet the definition of product-market fit.

Engagement is key

Engagement is critical—without this, it’s difficult to build a sound business. And it doesn’t matter how small the engaged group is. If there is recurring, organic engagement and the math on a per unit basis works (or we have confidence that it can work), investors will pay attention. We often make investment decisions by extrapolating from early, limited cohort data. In fact, this stage is our sweet spot. Valuations tend to be (more) reasonable when we are required to extrapolate off of a small base of engaged users. We are also looking at the data driving the engagement. After all, not all customers are created equally; the market you find may not be the one you expect.

If there is recurring, organic engagement and the math on a per unit basis works (or we have confidence that it can work), investors will pay attention.

Commerce and marketplace businesses

Are people actually spending money to buy the product or service? If so, why? Is it truly a better offering, or are sales driven by a large marketing campaign backed by introductory pricing?

Rally Rd, a NY-based alternative asset platform focused on democratizing access to hard assets through fractionalized ownership, has reached significant adoption with the average age of a customer being 26. Yes, age 26. I was also surprised—thinking the average age would be much higher given the first offering was collectible cars. I realized the company had found product-market fit. However, the market was different (and more interesting) than one would expect: young people looking for alternative assets. This indicated a larger market for fractional ownership of other unique assets such as trading cards, memorabilia, and art.

Software businesses

How quickly are paid and free daily active users growing? How is conversion from free to paid changing over time?

Slack is an incredible software business that found traction early on through significant word of mouth via the development teams at tech companies. The story of its origin is well known. CEO Stewart Butterfield’s original business was focused on developing multiplayer video games. When this did not succeed, he focused on some interesting messaging technology that had arisen out of the ashes of the gaming business. The business instantly found PMF. It only began to spend real marketing dollars to secure large enterprise accounts after it reached a multibillion-dollar valuation and was ubiquitous among major startups worldwide.

The lesson? Serendipity can play a role. You may stumble upon PMF in the most unexpected places.

In the end, finding product-market fit will feel like a “eureka” moment. You’ll know when it happens. First comes fit, then comes real growth.

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