The Never Ending Road To Product Market Fit — Understanding SAFEs and Priced Equity Rounds

Kazuki

Hatched by Kazuki

Aug 09, 2023

4 min read

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The Never Ending Road To Product Market Fit — Understanding SAFEs and Priced Equity Rounds

Introduction:

Achieving product-market fit is a crucial milestone for any startup. It signifies that a product or service has found its target audience and is meeting their needs effectively. However, the road to product-market fit is often long and challenging. In this article, we will explore the different stages and indicators of product-market fit, as well as delve into the world of SAFEs (Simple Agreements for Future Equity) and priced equity rounds in fundraising.

The Leading Indicator Survey:

To gauge product-market fit, one can start by conducting a leading indicator survey. One popular survey, created by Sean Ellis, asks participants, "How would you feel if you could no longer use [product]?" If 40% or more respond with "Very Disappointed," it indicates a strong product-market fit. However, it is important to note that this survey may generate false positives, and it does not provide insights into the size of the market.

Another commonly used metric is the Net Promoter Score (NPS). While it can be useful, it may not accurately determine the market size or the potential for growth acceleration.

Leading Indicator Engagement Data:

To validate the survey data, it is crucial to analyze engagement metrics that reflect user actions rather than mere views. By tracking events or actions that align with the core purpose of the product, one can gain a better understanding of user behavior and the level of product-market fit.

The Retention Curve:

One of the most significant indicators of product-market fit is the retention curve. Plotting the percentage of active users over time for various cohorts allows startups to identify when the curve flattens off. This indicates that the product has found fit within a specific market or audience. The next step is to determine the characteristics of those who retained versus those who didn't. Key demographics, user source, and time are essential factors to consider.

Qualitative surveys can also help identify differences between retained and non-retained users. Understanding these distinctions is crucial in defining the target audience and market.

The Trifecta:

The Trifecta is a combination of three key factors that contribute to product-market fit. Firstly, non-trivial top-line growth indicates strong traction. Secondly, retention signifies that users are actively engaged with the product over an extended period. Finally, meaningful usage refers to users taking actions that demonstrate the value of the product.

Understanding SAFEs and Priced Equity Rounds:

When it comes to fundraising, startups often utilize SAFEs or priced equity rounds. SAFEs, despite being referred to as post-money SAFEs, actually convert at the cap during a priced round. This means that if the priced round is higher than the cap, SAFE holders receive more shares for the same investment, giving them a favorable position.

It is crucial to keep track of the amount sold on SAFEs and the option pool, which is typically around 10% to 15%. Mixing SAFEs and convertible notes can complicate calculations, so it is advisable to stick with one method.

While it is important to negotiate terms during a priced round, it is not necessary to have a lead investor during the SAFE stage. However, having a lead investor becomes crucial during the priced round due to the complexities involved.

Actionable Advice:

  • 1. Continuously monitor and assess your product-market fit using leading indicator surveys and engagement data. Understand where you are along the path to make informed decisions regarding traction, transition, and growth.
  • 2. Utilize the retention curve to identify your target audience and market. Analyze key demographics, user sources, and time to gain insights into user retention.
  • 3. When fundraising, consider using SAFEs for their simplicity and flexibility. Keep track of dilution and understand the terms associated with the conversion to ensure a favorable outcome.

Conclusion:

Achieving product-market fit is a never-ending journey. As markets evolve and change at an accelerating pace, startups must continuously adapt their products to stay relevant. By understanding the indicators of product-market fit and navigating the fundraising landscape with knowledge of SAFEs and priced equity rounds, startups can position themselves for success. Remember to monitor and assess your fit regularly, utilize actionable advice, and focus on long-term growth rather than optimizing for short-term valuations.

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