to develop test cases for products and audiences and prove some level of validation,” he said. Entrepreneurs should also ask key questions like: “Does the product work? Do customers use the product? Will they pay? Am I actually making money on a revenue-generating product? How big can I scale that? What are my sources of capital?”
Second, he emphasized the importance of developing and releasing a minimum viable product as fast as possible. That at least demonstrates the idea can be made into something and gives users something to test.
The next step is to develop a business model and show people will use and pay for the product. That proves a market exists. Then you can move on to implementing a monetization strategy that will lead to sustainable revenue and has the potential to show the fast growth investors need to see.
McClure also had a few words about the “lean startup” phenomenon that has been embraced by entrepreneurs and investors. He’s a fan but not an acolyte.
“The lean startup is not a panacea. In many cases, we have worshiped at the church of the lean startup a little too much,” he said. “There are many other ways.”
Lean’s focus on customer validation and testing as early as possible is a very useful idea, according to McClure. But when a startup needs to make the big jump to a dramatically different product idea or market, its principles don’t work as well.
Advice for investors: McClure saved some of his harshest words for angel investors and venture capitalists, saying many acted “like sheep” and deeming the model broken. But he still offered advice and outlined how he and 500 Startups evaluated investments.
The key is to spread money around in many little bets in the $25,000 to $100,000 range. Then investors should check back in to see which companies have traction, which they demonstrate by having a functional product that has some, although not necessarily many, users. Only about 20 percent of the companies that make it into 500 Startups will reach this point, McClure said.
At that point, the startup might merit a check in the $100,000 to $1 million range. The next big questions are: can the company scale its customer base, improve the product, develop and test marketing and revenue generation strategies, show a market exists, and make key hires?
After all that, the key is proving that the revenue model works and focusing on revenue and customer growth. An appropriate investment in those companies could be between $1 million and $10 million.
If investors place enough bets—anywhere from 10 to a few dozen—a few should pay off. In the case of 500 Startups, it could invest in 250 or more companies in a fund. Its conservative model projects that about 10 or 20 percent will have small exits in the 5x range, which would return $5 million to $50 million. Five to 10 percent could have large exits in the 20x range, which would yield $50 million or even more than $100 million.
