Communicating with Sophisticated Microcap Investors Part 1: Product-Market Fit

A version of this story was published in The Microcap Newsletter.

Snowflake’s CEO, Frank Slootman, is among the most celebrated executives in the world. In fact, he made headlines in 2020, when he was earning an estimated $95 million per MONTH, according to Fortune. So, when he takes the time to write a book, Amp It Up, it would behoove many of us to read it. In particular, there is one chapter of immense value to microcap executives, both for their companies strategically and also their ability to attract the right investors.

In the chapter, “Stay Scrappy as You Scale Up,” Slootman describes three distinct phases of an emerging company. They are the “Embryonic Company,” the “Formative Company,” and the “Scaled-Up Company.” We’ll explore each in more detail below, but the key for executives, according to Slootman, is to understand what type of company you’re running and to be honest with yourself about having the right skill set to be successful. He writes, “One trap that leaders often fall into is failing to adjust to the natural life cycle of a company as it grows and evolves. If you try to run a mature, 500‐person company like a 10‐person start‐up, you will almost certainly fail. But, paradoxically, if you lose all the scrappiness of a 10‐person start‐up, your mature company may never reach its full potential.”

This is of critical importance to microcap executives, whose companies are usually either at the Embryonic or Formative phase. Typically, their meager revenues result in small market capitalizations because they’ve yet to achieve “product-market fit” (PMF). Otherwise, their income statements and, subsequently, their company valuations would be more robust. For this reason, most microcaps are effectively publicly-traded startups. 

According to esteemed venture capitalist Marc Andreessen, PMF is when “you have a product that the market wants and you can tell because the market is pulling the product.” This is precisely what Slootman articulates as well. Emerging companies are either searching for PMF (Embryonic), proving it (Formative), or growing it as fast as possible (Scaled-Up). At each phase, it’s important for microcap leadership to properly communicate with shareholders, for misdiagnosing the company’s stage or failing to accompany it with the right talent can be fatal.

For microcaps wanting to attract sophisticated long-term investors, here’s how to identify and articulate each phase:

What is the Embryonic Company?

Slootman: In the embryonic stage of a start‐up, seed capital is applied to assess the feasibility of an idea, followed by subsequent rounds of funding to build the initial product. The team is usually a small, close‐knit group who are laser‐focused on building that first product. 

At this point, the CEO job is more or less a part‐time position for someone who is also the leader of a key function, such as technology or operations. Everyone is working, not managing. It's also not uncommon to see part‐time outside CEOs, such as venture capital firm partners, because the demands on leadership aren't massive yet. 

At this phase, a microcap should communicate the strength of the team, while showing how it is extremely focused and disciplined in developing its minimum viable product (MVP). The microcap should avoid unnecessary spending and articulate how much time/cash runway the company has to build an MVP, accounting for the fact that it will likely require extensive iterations. Red flags to sophisticated investors at this stage are lavish spending or trying to pursue too many markets simultaneously, often referred to as attempting to “boil the ocean.”

What is the Formative Company?

Slootman: The formative stage starts when there is enough product to begin testing the market. You can finally connect with potential customers, letting them see, touch, and smell the product. You can get valuable feedback and experiment with pricing and support models. The goal at this stage is to find out if you really have a viable product or merely a technology in search of a problem to solve. 

At this point the leadership challenge is bigger because you have to make huge decisions about how to price, position, sell, and promote your product. Headcount is starting to climb, which will introduce HR challenges. A rapid expansion of resources will accelerate your cash burn, often too quickly. 

The formative stage is treacherous and the subject of much study and analysis by management experts. Notably, as previously mentioned, consultant Geoffrey Moore coined the term “crossing the chasm” back in 1991 to describe the unique challenges and activities associated with this phase of a start‐up's evolution. Lots of companies make it far enough to attract some early adopters, and they have enough funding to pursue a much bigger market. But then they fall into the chasm between appealing to a narrow niche audience and building a large and sustainable customer base. 

The key thing to remember is that you cannot brute force your way into any market. If you are met with lackluster response in the early going, it's time to go back to the drawing board, make sense of the feedback, and figure out your next set of moves. Trying to double down or triple down on spending to cross the chasm is a recipe for disaster. 

Often a tantalizing phase for investors, a microcap should communicate the traction it has found in the marketplace and show how the business could potentially scale going forward. There should be delighted customers willing to provide testimonials and a strong net promoter score (NPS), highlighting their willingness to recommend the product to others. There should also be an early understanding of unit economics and if the business model is strong (e.g. customer lifetime value vs. customer acquisition cost). A reg flag to sophisticated investors is a company that is getting traction but doesn’t have good unit economics or can’t ultimately attain mass adoption. Adored products with bad business models can prove to be false positives.

What is the Scaled‐Up Company?

Slootman: Scale is about maximizing growth by building repeatable, efficient processes and models of execution. We are no longer learning the basics; we have successfully reached adolescence, if not adulthood, and now we need to start acting like it. 

For some companies, such as Data Domain, the formative stage takes years until the product improves enough to attract a large market. But because we had spent plenty of time to prepare for scale, our management team was solid, our culture was well established, and we were ready to throw the big switch and begin applying massive resources to fuel our growth. 

For other companies, such as ServiceNow and Snowflake, the chasm was scarcely a speed bump. The products were so well fit to their respective markets that they saw rapid adoption almost from the beginning. Perhaps too quickly because the staffs of those companies were ill‐prepared to enter the scaling‐up stage. Both ServiceNow and Snowflake initially struggled to make this transition. 

Sometimes the formative stage can be so enthralling that it's hard for leaders to move on. We don't want to let go of the romance and excitement of those early days. It's almost like wanting to keep hanging around your idyllic college campus after graduation instead of confronting the responsibilities of the real world. 

At this phase for the company’s financial metrics, it can feel like taking a test when you know all of the answers, but it’s critical to maintain a strong culture. There will inevitably be growing pains, as the status quo is transformed, which can upset the longtime employees who have led to the company’s success. A common red flag to sophisticated investors at this phase is having the wrong leadership team, for sometimes the entrepreneurs who start the company aren’t best suited to scale it.