Many startups tend to fall victim to the fatal mistake of misidentifying their PMF. A company’s finances before PMF are all about product experimentation and extending runway until traction materializes. Falsely assuming that a startup has attained PMF when it has not can lead to a slow death by financing the unsustainable. Abdulaziz Hayat, a Harvard University graduate holding expertise in entrepreneurship and finance, cites it as a startup’s deadliest mistake!
What is PMF?
PMF is an abbreviation of Product-Market Fit. It is one of the deciding factors for the success of any startup.
Startups have two crucial phases: pre-PMF and post-PMF. It is how investors tend to classify their expertise and funds, as VCs are either early-stage or growth-stage. PMF is best described as a point at which the startup’s product has acquired demonstrable traction within a defined base of users with sustainable and scalable unit economics.
Numerically speaking, PMF means when the lifetime value of a user (what they contribute to the company’s revenues before likely “churning” or stopping use) comfortably exceeds the cost of acquiring that specific user through sales/marketing methods. Mathematically, it stands as: LTV/CAC > 1 == Product-Market Fit. The higher that number, the better the PMF.
Attaining PMF feels like a sudden, extreme acceleration forward. Apart from the numerical derivation and outcomes, founders typically describe it as a moment of profound enthusiasm and newfound product clarity. As Hayat puts it, “the feeling within the startup shifts from ‘let’s experiment and see how the market reacts’ to a feeling of someone having floored the gas pedal in a car in first gear!”.
Hitting PMF leads to a reallocation of resources to maximise growth prospects of a now clearly viable product; marketing budgets also tend to mushroom. However, those who incorrectly identify PMF end up raising capital and spending enormous amounts on scaling an unsustainable product. Investors and founders need to keep a watchful eye as this can be disastrous for the business when investor funding inevitably dries up.
Hayat further describes how instead of strictly measuring how long it takes for startups to attain PMF by number of years, it is better understood in funding stages in the startup world. Usually, a company’s early financing rounds are raised before reaching PMF. This stage can last for two years on average. Contemporarily, this time period is trending down. For a startup to be able to raise Series A financing, PMF must be clear. The pitch deck must highlight how it is not only achieved but also how it can be actively and readily scaled with additional funding.
The user cohort that ultimately tests the product and provides measurable evidence for the confirmation of PMF is “notably sticky”, as Hayat shares. Success is proven by showing retention on a sustained basis for considerable amounts of time.
PMF and Investors: Where do they meet?
Abdulaziz explains for an early-stage investor, having PMF is not essential. However, he makes it clear that an investor must reasonably expect that the team is capable of reaching PMF within a reasonable time period with the available resources. On the contrary, for later-stage investors, not having begun scaling after reaching PMF is an absolute dealbreaker. “Startups, by definition, would not reach the growth stage without having attained PMF,” says Hayat.
He also takes time to elaborate on what PMF means for new investors. “Less experienced investors must ponder the purpose of their financing of the startup,” he begins. Early on, the idea is to keep the lights on long enough for the startup to nurture a driven (yet small) team. Together, an apparatus is constructed to build great products. Early stage financing fetches them the time to experiment and confirm their thesis. Later, when growth stage financing is put to use to expand on a model that tangibly shows results and generates value, then consequently, the significance of PMF becomes crystal clear.
Hayat extends the fabric of his argument by quoting the example of Airbnb. His thought resounds as how Airbnb did not attain product-market fit (PMF) only while renting out airbeds to executives attending conferences. They accomplished it by transforming into a marketplace for short term rentals and experiences with positive economics for both sides of the platform. That’s when users kept coming back and their growth really took off.
Nevertheless, the concept of PMF is ubiquitously known and is a crucial factor for all startups and investors.
