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"Eric Ries serves as a venture advisor for Kleiner Perkins Caufield &amp; Byers and is the author of the blog Lessons Learned. These views are his own.\nRaising money is never easy, but in a recession it gets even harder. With so many bargains out there, a traditional pitch and a business plan just don't make the cut. But there is a different way: if you build a lean startup, you can demonstrate that your business works, even with only a handful of customers.\nEarly results might not sound like much, when compared with the massive scale that established companies operate at. But if you ship early, build a great team, and know your customers well, you can use even modest results to establish credibility on the only issue that really matters: that your company is creating lasting value.\nMy story\nWhen we started IMVU in 2004, we faced a pretty skeptical fund raising environment. I was the technical co-founder, and frankly, I was afraid. Today, IMVU is a 3D instant messaging and social networking product with over 20 million avatars and more than a million dollars a month in revenue. Back then, we just had an early product and a vision that we could make money by selling virtual clothes for virtual avatars.\nThe recovery from the dot-com crash was not yet in full swing. The first investors we talked to politely declined, and I'm sure were laughing after we left the room. And yet, despite those obstacles, top-tier investors believed that we had a product and team worth backing.\nOur experience was different from the traditional VC model, in which funding is reserved for true domain experts, those with deep background in their field solving a problem they personally have experienced. For the rest of us, there is an alternative: to create credibility by building a lean startup. Lean startups are built from the ground up for learning about customers. Over multiple iterations, customer insight becomes business insight. Companies that go through those iterations quickly can prove their business model works.\nBuild a product and team worth investing in\nThe most important thing you can do to improve your chances of raising money in a down economy is to build a great company. A great startup is more than just a miniature version of a great large company. All of its process should be focused on innovating and learning. Today, it's possible to use a combination of free and open source software, community-generated content, and agile software development to bring new products to market with extremely low cost.\nIt's not enough just to build a cool product. The challenge for a startup is to translate the founders' initial vision and insight into a business of lasting value. That means leveraging low costs for greater speed. To demonstrate that their vision works, lean startups use every tool they can: continuous A/B split-testing, extreme rapid deployment, and a disciplined focus on metrics, to name just a few.\nIf you're building a software company, as we did at IMVU, then your essential function is to turn ideas into software, collect data about what happens when customers use it, and then use that data to enhance your next set of ideas. It's because startups can execute this Code-Measure-Learn feedback loop so much faster than big companies that they discover big opportunities.\nShip your product early\nReid Hoffman, founder of LinkedIn and an incredible entrepreneur, gives this advice: \"If you are not embarrassed by the first version of your product, you\u2019ve launched too late.\" This has been my experience as well. You need to demonstrate early results in order to understand what your product is good for.\nAt IMVU, we were terrified by how early we shipped (and charged for) our first product. Frankly, we were embarrassed by how many bugs, crashes, and defects it had. We were even more embarrassed by the pathetically small number of customers we had, and the pathetically low amount of revenue we had earned so far. It wasn't uncommon for advisors and even potential investors to ask, when we would show our results, \"are there some 000's missing from this graph?\" We'd always cringe as we admitted that, no, we really only had a few thousand customers and a few thousand dollars in monthly revenue.\nDespite that, we were able to establish credibility, because we used those early numbers to demonstrate that our customers were getting real value from our product and, more importantly, that we understood how to build more of it.\nCreate (and measure) customer value\nIf you're not clear yourself about whether your startup is creating value, you'll never be able to convince others. As previous bubbles have repeatedly shown, it's all too easy to create the trappings of success around a hollow shell.\nFor example, companies that spend millions of dollars in marketing only to churn out all of their \"customers\" and earn thousands of dollars in revenue are actually destroying economic value. But this is not always straightforward, since some companies don't start to generate decent revenues until they are already at significant scale. So it's important to organize your team around a clear definition of customer value so that you can be sure you're making progress. Here are some possible metrics to organize around:\n\n1. Revenue per customer. My personal favorite, if this option is open to you, is to show revenue growth. What's important, though, is not the total revenue you've generated (which is likely to be small). Instead, demonstrate that each customer who engages with your product generates a lot of revenue for your company. Best is to show the proverbial hockey-stick shaped graph, perhaps showing active customers per month along with total revenues per month. If the two lines go up in tandem, it suggests your team knows how to grow while still capturing value.\nHow do you know if the revenue you're generating per customer is good enough? Compare it to your fully-loaded cost of customer acquisition (including all marketing spend and sales people). If it's significantly larger, you're on the right track. At IMVU, the cost of customer acquisition through our five-dollar-a-day AdWords campaign was less than twenty-five cents. Our revenue from those same customers was more than a dollar.\n2. Increasing retention over time. There are some businesses that really do require significant scale before they can successfully monetize. Many network-effects businesses are in this latter category. If your company is too, you need to find another proxy that can demonstrate that you are creating customer value.\nOne of the best indicators is a cohort analysis that shows increasing engagement with your product over time. Typically, a cohort's aggregate performance will decrease over time, as people naturally drop out. For high-engagement products with strong network effects, after the initial drop-off, you'll see a little \"tail\" upwards. That's a very strong signal that customers are getting pulled back into your product more and more often. In other words, these customers are attempting to churn out of your product, but failing - think of the pull of invites from friends or colleagues in Facebook or LinkedIn.\n3. Funnel averages over time. Even if you see standard retention curves for each given cohort, you can still demonstrate that you are increasing the yield on each cohort by graphing key conversion percentages over time. If those changes in conversion correlate with actions you've taken to improve your product, you still have a good story to tell. No matter what your eventual business model, these funnel averages will be key terms in it, and you can show how improving them influences the eventual profitability of your company at scale.\n\nWhat's your story?\nProve to yourself that your business, in micro-scale at least, creates value. If you believe it, you'll find it that much easier to convince potential investors, partners and employees too.\nSo, to those of you struggling to build a great company in a tough environment, what are you seeing? How do you currently measure customer value? For those who have tried and succeeded, what has worked for you?\n\nEric Ries became a Venture Advisor at Kleiner Perkins Caufield &amp; Byers, after co-founding and serving as Chief Technology Officer of IMVU. He is the co-author of several books including The Black Art of Java Game Programming (Waite Group Press, 1996). While an undergraduate at Yale Unviersity, he co-founded Catalyst Recruiting. Although Catalyst folded with the dot-com crash, Ries continued his entrepreneurial career as a Senior Software Engineer at There.com, leading efforts in agile software development and user-generated content. In 2007, BusinessWeek named Ries one of the Best Young Entrepreneurs of Tech. He serves on the advisory board of a number of technology startups including pbWiki, Bunchball, FooMojo, Causes and KaChing. These views are his own.\nImagery courtesy of iStockphoto, peepo, Nikada, DNY59, spxChrome\nInterested in more resources? Check these out:\n- \"HOW TO: Market a Web Company in a Down Economy\" \n- \"HOW TO: Simplify\"\n- \"Startup Hacks: An Early Stage Checklist\"\n- \"What Every European Startup Should Know: 10 Keys to Presenting Your Startup in the US\""^^<http://www.w3.org/2001/XMLSchema#string>
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