How to Build an Irresistible Product for VC Investors 1

You can't buy engagement. You can always buy growth. You can always go raise money, give that money to Facebook or Google or the television stations or billboards or ads, you know, whatever. You can always buy growth. You cannot buy engagement. Engagement must be designed, must be built into the product or else you're never going to get people to come back. Have you ever thought about starting a company and maybe raising millions of dollars from venture capitalists? Well, today we're going to talk about VC investors want. Hi everyone, this is Nir Eyal from the near and Far Podcast and with me, as always, is Nick Gray. Nick, how you doing?

I'm doing great. I'm excited. We were talking about New York City visits on the future and now this is a cool article. I was just at an event with a bunch of venture capital people, so I'm excited to get in. Should I get in and start reading?

Let's do it.

All right. How to Build an Irresistible Product for VC Investors Venture capital, or VC is a great opportunity for new entrepreneurs seeking to bring a product to life. But the funding is incredibly difficult to secure. A 2021 Harvard Business Review survey of almost 900 VC firms found that they consider 101 opportunities on average for every deal they close. Still, the benefits of VC funding are clear. Since it took off just after the Second World War, VC funding has become more prolific, with many large companies now sporting their own corporate VC arm. In contrast to private equity, which is more inclined to fund projects from large established companies, venture capital is designed to fund emerging startups and entrepreneurs. Entrepreneurs don't need to have an extensive business background or enough cash flow or assets to risk debts as a bank loan requires. The same HBR survey reported that 20% of all VC firms and 31% of early stage VC firms don't even forecast company financials before investing. And if a VC backed project fails, the entrepreneur doesn't lose any of their own money unless they put it in. Venture capital is exciting because it's a relatively accessible way to bring new ideas to fruition. Entrepreneurs can get funding for cutting edge products that have the potential to be transformative. But to get funding, entrepreneurs have to convince investors of their products value. And it can be brutal. Have you ever watched Shark Tank? Getting real VC is even harder. Not every business needs to raise vc. But if your business model requires repeat customer engagement, your best chance of attracting outside capital is to ensure your product builds customer habits according to the hooked model. What VC Investors Want While even venture capitalists admit luck and randomness play a role in which projects get funding. VC firms are looking for safer, stable investment. That's why entrepreneurs have to build habit forming products that keep users coming back for more. Customer habits are a huge competitive advantage because they equate to economic value. When considering companies to acquire, former Alphabet CEO Larry Page reportedly used the toothbrush test. Is the product like a toothbrush, something people will use once or twice a day?

So this is a really critical point because what venture capitalists look for is what we call a competitive moat. And this is what makes for any great business. A competitive moat is something that keeps your competitors out. Because what happens is if your business is selling a commodity product, you are basically beating up your competition with price and features. And what that does is drive down margins. So what venture capitalists really want is excess returns. They want the kind of business that can give high profit margins over a long period of time. And the only way to do that is to have some kind of sustainable competitive advantage. So what can that look like? Well, it can be intellectual property. If you have some kind of patent, for example, it can be economies of scale. Maybe you could do something way cheaper than other people have because you have some massive scale advantage. If you think about what makes Walmart or Amazon able to have such cheap prices that pass on to their consumers. If you have some kind of intellectual advantage, maybe you've invented something where you have a patent and of course a brand. So there's all kinds of competitive advantages. One of the most sustainable types of competitive advantages, and the one that I think is the easiest in fact to create, is a habit. If you think about Google, for example, why is it that we go to Google with little or no conscious thought? Why is it that when you need to look up something, you, you don't ask yourself, hmm, who has the best search engine? No, you just Google it out of habit. It's become a verb. Is it because Google is the best?

No.

In fact, we know when we've done side to side comparisons between Google and Bing, the number two search engine, and we show people the search results, people can't tell a difference between the two. It's a 50, 50 preference split when people don't know which results are which. But why does Google own something like 90% of the search engine market? There's a lot of smart thing they've done. I think that today the real reason they have such a sustained competitive advantage and is simply a habit. It's a monopoly of the mind. And so that's why this is so important. This is why VCs look for some kind of competitive advantage. And now we're going to talk about, well, how do you make sure that you can show your VC investors that you have that competitive moat of a consumer habit?

Oh, that's good. In HBR's survey, 74% of VC firms said the business model of the product is an important factor in which products they fund, and 68% said the same of the product's market. So the design and the user experience of your product is crucial. Without a doubt, the most common gap for entrepreneurs is around the use of design research, Irene Au, a design partner at Khosla Ventures and former head of design at Google, Yahoo and Udacity, told me. With design research, we seek to understand what are the user's behavioral patterns and motivations and then how can we anticipate their needs, solve problems for them and build the experience in a way that fits with their workflow mental models and usage patterns? I wrote my first book, Hooked, to offer product makers, designers, innovators and entrepreneurs a framework for building products that solve user needs through long term engagement. The Hooked model is designed to connect the user's problem to with the designer's solution frequently enough to form a habit. Using the Hooked model can make your product more attractive to investors. When Kahoot called me to say it was using the Hooked model, I invested. Today, Kahoot is still one of the top educational softwares. Here's how to get your users and venture capitalists hooked on your product. Get your users hooked the Hooked model is a way of describing a user's interactions with a product as they pass through four phases. 1. A trigger to begin using the product. 2. An action to satisfy the trigger. 3. A variable reward for the action. 4. An investment that makes the product more valuable with use. As users go through these phases, they build habits in the process. Entrepreneurs should ask themselves these fundamental questions for building effective hooks what do users really want? What pain is your product relieving? That's the internal trigger. What brings users to your service? That's the external trigger. What is the simplest action users take in anticipation of reward? And how can you simplify your product to make this action easier? That's the action. Are users fulfilled by the reward yet left wanting more? Variable reward what bit of work do users invest in your product? Does it load the next trigger and store value to improve the product with use? That's the investment. Once entrepreneurs have used these questions to create a business model, identify how the product will create user desire and build the minimum viable product, they can begin Habit testing. The three steps of habit testing enable entrepreneurs to see who the habitual users of the product are, which part of the product is habit forming and and why. They can then learn from that data and take it to VC firms to show exactly why their product is worth investing in. By the way, if you want more entrepreneurial advice, Near's website has three pillars of the most successful tech products. You can search for that by near and far and search for three pillars successful tech products.

Yeah, thanks so much Nick. Yeah, so the real takeaway here, this is a sample or a high level overview of the hook model. Of course there's a lot more in the book Hooked how to build Habit Forming Products. If you actually go to this page on my website, There's a an 18 page deep dive around a workbook if you will, around how to build habit forming products. So even if you don't get the entire book, you're going to be prompted with some exercises to build your own habit forming product. And then of course there are links to many of the things that that Nick just narrated around trigger action, variable reward, investment. You can click on all those. So the best thing to do if you're an entrepreneur out there building a product that needs repeat engagement, that needs to build a hook and therefore you're building the kind of product that people use because they want to, not because they have to, you've got to ask yourself those five fundamental questions in order to design your hook model. And so the easiest way is get the book. But for some reason if you don't want to read the book or don't, you know, short on resources, then then almost all this information is available on my website as well. So please do check out, check out nearandfar.com the link for this specific article that Nick just read is in the show notes and you'll find many, many more resources there.

Have you heard from some of your readers that are that specifically use the hooked processes in this early phase where they're like look, we have this idea but how do we make it stickier? And then do they read your book or send you an email or what happens?

Yeah, so the hook model is generally used in two steps along the entrepreneurial journey. The best place to use it is very early days. So before you've committed any code, before you've hired any designers, before you've raised venture capital, you ask yourself these five fundamental questions before you do anything. That is if your product needs to be habit forming. I just want to make sure everyone understands this is not Magic pixie dust. Right. You're not going to take a product that will never be habit forming and suddenly make into a habit. You have to first ask yourself, wait a minute, does my business model require repeat engagement? And so many products don't need repeat engagement. For example, if you sell car insurance, that's not a repeat engagement type product. You buy it and then you don't use it unless something terrible happens. So you don't really need to read my book in order to figure out how to sell car insurance. But if you're selling the kind of product that needs repeat engagement and you want to pass what, what Larry Page talked about, what Nick read earlier about the toothbrush test, that he wants to invest in products that are used as frequently as a toothbrush. Right. Twice a day to do that, to get that level of frequency, well, you've got to figure out how to build a habit. And so that's really who this is for. So very, very early stage. That's a great place to ask yourself these questions. The other place that people typically use this model is when they already have a product in market and it's not bringing people back. And maybe they don't know why, right? So they have some kind of product or service, they need people to use it habitually. Maybe it's a, a SaaS product, maybe it's an edtech product, maybe it's a fintech product, maybe it's a health tech product, some kind of product that needs people to back online or offline. By the way, this works for either. And they don't know exactly why people aren't coming back. So then it becomes a diagnostic tool whereby asking yourself these five fundamental questions, you can see, okay, where is the deficiency? Where's the problem that might be leading to this ultimate issue of not bringing users back? So again, it doesn't matter what industry, it doesn't matter if it's online offline. What really matters is is it the type of product that will be used with sufficient frequency to form a habit? And if so, how can we diagnose the problem? By asking ourselves these questions to form product hypotheses, then we can test, we can get out into the world and see if it improves our user retention and habituation rates.

That hooked model, by the way, for listeners, I'm sure you know it because you read hooked, but I'll just say it again, it's number one, that's a trigger to begin using your product. Number two, that's an action to satisfy that trigger. Three is a variable Reward for the action. And four is an investment that makes the product more valuable with use. And I think near what you're saying is you gotta bake that in early to really make these cumulative, to make it, what is it? A flywheel, I guess.

Exactly. And this is why it's so important. Back to the point of the article. You see a lot of companies going to VCs with growth, right? And I get literally a call from a VC every week that's telling me about how they invest in this company. Growth was amazing, but after a few months retention stinks. And so we call these leaky buckets. Lots of growth. And we've all seen this, right? There's Silicon Valley graveyards are full of companies that were the, the latest new hotness and then a few years later nobody remembers them anymore. And, and we see this all the time because growth is relatively easy. You can buy growth. This is why you would go to a VC in the first place to raise capital. You, you would say, hey look, I have this product, I need the money to go grow my user base. That's a good use of funds because that has a positive roi. The problem is if you can't demonstrate engagement, then you have what's called a leaky bucket. Users come in and users pour out. So then you're throwing good money after bad. And So a smart VC, sometimes VCs can get tricked and they'll invest money in these companies and then they'll regret it later because the deal's very a hot deal and everybody wants into it, but then they find that people aren't being retained and so then they regret doing the deal later on. So it's much better to make sure as the founder that you have engagement. Why? Because you can't buy engagement. You can always buy growth. You can always go raise money, give that money to Facebook or Google or the television stations or billboards or ads, you know, whatever. You can always buy growth. You cannot buy engagement. Engagement must be designed, must be built into the product or else you're never going to get people to come back.

That's super helpful. Well, you are listening to near and far business behavior and the brain. Nir Eyal is the best selling author of Hooked how to build habit forming products and also how to control your attention and choose your life. You can sign up for his free newsletter@www.nearandfar.com. that's www.nearnir and far far. Com. Thank you for listening and we'll see you next week.