Serhat Pala of Cross Ocean Ventures on churn, CAC and what investors check

Serhat Pala 00:32

Thank you for having me. I was looking forward to this.

Serhat Pala 01:03

Thank you. You know, that was some time ago, I guess, right? Some say I'm on the dark side because I'm on the investor side of things, even though I don't see it that way. I'm an immigrant founder from Turkey to the US, almost 30 years ago. I came here from my graduate school to the US, and I found myself, even though I didn't intend to, being part of a startup right after my MBA, and loved the energy of the startup world so much that after a year, when that startup failed, I jumped in and started my first company, which quickly failed, and then started another one. This time it took a little longer, more exciting, eventually failed too. But I think by the third time I got to a few more things that made this time a successful exit.

02:04 Long story short, between 1998 and 2020 I started a few companies in the e-commerce space, and I like to believe that even though I'm on the investor side, I'm still a founder, at least by heart. Since 2020 I've been more on the investor side: investing as an angel investor, LP to some VCs that I also advised, and eventually I started a fund after I built the thesis around helping early-stage, especially B2B SaaS, companies that originate from Europe come and expand to the US, and ideally raise their Series [rounds] in the US. So that's the very short version of my journey.

Serhat Pala 03:37

I mean, I find myself nowadays, when I speak to founders, speaking a lot more about my failures than my successes. If I was an exceptionally perfect founder who never failed, I don't know what I'd be talking to founders about, since they seem to get more value out of my failures. And eventually, being a founder is about going fast, trying, pivoting, trying, pivoting, learning, failing, and if you do not fail, there is really no startup. As long as you can afford to make mistakes, and your successes end up bringing you more money than you lose with your failures, as a founder you're good. That's all it takes.

Serhat Pala 05:41

That is a very, very big question, a very deep question. People who have never had marketing as their primary function, I think what they fail to understand is marketing is not about just marketing. I think the terminology probably isn't originally defined correctly, because when you talk about marketing, you're talking about the product, you're talking about the customer, you're talking about the logistics, the function, the before and after of sales, you're talking about finances, you're talking about profitability. [unclear @ 06:12] Marketing can be successful and startups might still fail, but hardly ever can you talk about a successful company without a good marketing team. Number one mistake I see in startups is not understanding what marketing is, and failing to give marketing enough attention. And that usually comes from startup founders who do not have marketing in their background. They could be building products, or they can analyze problems and their own solutions, but when they do it, they do it without the lens of marketing, without looking at it holistically. So what makes a startup's marketing successful? It's actually pretty simple: it's giving marketing its due, and understanding what marketing truly is, and what type of role it's supposed to play in the life cycle of a startup.

Serhat Pala 07:44

Number one, and this isn't just marketing, it's bigger than marketing, but one of my pet peeves, one of the most important telltales of a good founder to me, is how much the founder knows about their numbers. When you talk about a startup, you're in fact talking, originally, about the marketing numbers, because there aren't many numbers at the beginning. You're dealing with a company, you don't have a high percentage of overhead, and maybe some of the funds are utilized to build a product, which might make a difference, but originally, at the core of any startup, you are talking customer acquisition.

So how well the founder knows their marketing numbers is the number one thing to pay attention to in a company. How many months does it take for a startup to make their money back on customer acquisition from a customer? What is the churn rate of their customers, and how does the churn rate differ depending on the segment of customers? How do the marketing team and the founder determine the segments, and how do they track the metrics between those segments? Those are all great signs. There's a ton of marketing-related metrics you could look into, but at the core of it, in my view, is how much the marketing metrics matter to the founder. That's the number one sign to me when I'm evaluating a startup.

Serhat Pala 12:24

Really good question. And I have to say, as much as it makes for uncomfortable discussions, it also makes for very comfortable and very bonding conversations as well, with the right founders. First of all, when we talk about any type of marketing metrics, and you're dealing with a founder and a founder team, it is quite straightforward, especially for investors that have operational experience, to understand how sophisticated that marketing team is in how they look at their numbers, because, you shared a great example, a customer acquisition cost might look very reasonable, but when you take out the free, the referral, the repeat, and all that kind of stuff, you might be looking at a terrible customer acquisition cost under the surface.

There are many different [ways a] team might explain their metrics to you, and either things don't make sense to you as an investor, because you know how those numbers come together, and either they, as a marketing team, don't see it, which makes them unsophisticated, which makes me worried as an investor, or they are using the numbers in a way to tell a story that might not be as truthful and honest as it could be. So, as an investor, I don't see my job as teaching, it's more initially analyzing, and then supporting. There's a difference between taking a role as an investor to teach the team so they can be better, it's more about not teaching, but asking the questions that might lead them to look at things differently. I don't think my job as an investor is to help them analyze things the right way, they are supposed to get to that conclusion themselves. So that's the negative side of things. But on the flip side, if you're an investor that understands marketing and understands the metrics, and is caring enough and hardworking enough to go under the surface, multiple layers, to understand what's going on beyond just the simple metrics that might be part of your thesis or part of your experience, then you could find a special bonding with the founder.

14:56 This is what I mean, for example: we had this amazing startup, a small B2B SaaS company from Latin America, and the general momentum of the company was great, they were growing, and they seemed to have a product with momentum, but they were having a really, really hard time raising funding, because their churn rate was on the higher side, not double digit but close to double digit, and they were being rejected by many B2B SaaS investors, because many of those B2B SaaS investors have certain metrics they want you to have before they can invest in you. Because we thought there was momentum, we believed in the founder, and we believed this was a relatively new type of value proposition, and they were coming from a geography that isn't as mature when it comes to marketing as the US, we decided to drill deeper into these numbers, to understand the churn and what made the churn what it was.

16:29 We quickly realized it was the marketing team's and the founders' drive to try as many different marketing methods as possible. There was a bunch of different types of metrics, and their inclination to try a lot of different things made them go and get a bunch of different types of customers, and quickly they'd realize what stuck, what didn't stick. But because they wanted to grow so fast, and they were very resourceful in the way they acquired these customers, they could afford to experiment a lot. They kept losing a larger portion of their customers as churn. But the truth of the matter is, they understood it, and then they let it go, they understood it, they let it go, but they kept doing it over and over and over again. That contributed to their momentum and growth, but on the flip side, that meant a high churn.

17:30 This story was very much under the surface, it was not [visible]. We had to spend a lot of time looking at their numbers, [pulling] the marketing metrics, and doing the analysis ourselves, because we wanted to invest in this company, but we wanted to be careful. And once we were able to tell them, we said, "look, we believe your churn is bad, but we believe your churn is bad because of this reason." They, in fact, learned from their experience, and they changed something. It even impacted them: they were able to use the analysis we did to go and raise more funding from others, because now an investor was able to [help them] solve that puzzle.

Serhat Pala 19:03

With that particular case, we did more than we were probably supposed to as an [investor], but the reason we did that was because the founder was great, the team was great, there was something there, and it was just a churn number that was a major negative. I remember having this conversation, they kept getting rejected by a bunch of really good B2B SaaS Bay Area investors, and we were thinking to ourselves, look, those [investors] are smart, but let's not take it for granted, let's go and see what it is, we'd really like to understand. It took a long time for us to figure that out, but once we figured it out, it became such an easy investment decision, because we said, okay, everything else was good, that's what they were missing, and I think we found it, we can go ahead with it. It's been a great journey so far with that team.

Serhat Pala 20:36

This is actually something you and I talked about, and I think I learned this from you originally, so I'm going to turn it back and respond with something I learned from you: crossing the chasm, when marketing teams mistake the momentum of early innovators, that type of mindset in their customers, for the mainstream, and develop products for the early innovators as they grow that base, but then get stuck [scaling past them].

21:37 Yeah, and I learned from you, and I actually shared this lesson with multiple founders, in a very productive way. That lesson stuck with me, and I was able to share it with others who benefited.

Serhat Pala 22:38

That's a tough question. I don't know if there's one thing, but let me talk about some signs. The resourcefulness in marketing, and I'm not just talking about growth hacking, I'm talking about the resourcefulness, how they look at the problem from different angles, and don't create solutions that are so straightforward. That's one. Number two is how they tackle the product development process. [I haven't come up] with a full answer on this. In fact, I talked about this with another product manager friend of mine the other day, we had a debate about when is a good time for a startup to hire their product manager, because most of the time the first product manager of a startup is the founder, just like any product manager who has never really looked at product management and development as a profession, they break things for a while.

But there's a point where a startup has to decide what its product development and product management plan is. So the way the founder looks at product development and product management, even if they might not have a marketing background, the way they look at that opportunity, how they prioritize it, how they look at the future, how they dedicate their [fundraising] specifically around product management and product development, I think those are all great signs that this is a company that's serious about solving the problem and understanding the customer, and doing it in tandem, rather than just using their funding or technology to force a solution.

Serhat Pala 25:13

I think it's about acquisition-over-retention propensity, because when you're early, when your numbers are small and growing, when profitability isn't the name of the game for you, you have to raise funding, yes, you have to learn, you have to explore, you have to come up with different hypotheses. But if you have a very high propensity to favor acquisition and growth over retention and engagement, that's a bad sign. It's almost like a sign of an addict: yes, they might still be drinking one glass of wine tonight and tomorrow night, but you can tell if that person has a higher propensity to be abusing the substance. You have to look at it really carefully, because it might not look so bad, but even the way they're approaching their budgeting, or their explanation, or [the way they're] excusing some of the things they do, can give you signs about how their mind works.

Serhat Pala 27:45

It's such a common misconception, shared by founders, that I'd like to debunk if possible, and that is: founders, when they try to raise funding, they go around and talk to a bunch of investors, and they try to convince those investors how little risk there is, how good this proposition is, because they're such a great company solving such a big problem. I would recommend founders not have the desire to talk about how small the risks are, or how they don't exist, but rather what those risks are, and what they could do about them, and how real they are.

Because founders make the wrong assumption that investors are looking to invest their money with as little risk as possible, and they come at it from that angle. On the contrary, investors are not stupid, they know that if there is no risk there is no reward, and the larger the risk, the larger the reward should be. They should understand the risk. That's an investor mistake too, sometimes: they take risks without understanding them, or without quantifying them, both the upside and the downside. So what I'd like to debunk is: founders, when you're talking to investors, please be as clear and open about the risks and what you'd need help with, because not only will you get credibility, but you'll have a better chance of talking about the upside of the opportunity, rather than how minimal the risks are.

Serhat Pala 29:50

Know what you don't know. Be around people who have different perspectives, expertise and experience, and learn from them before making investment decisions, because founders, especially founders who have had exits, tend to feel successful, feel like they're doing better, and because they think they know better, they make bigger bets. I think my worst investments were the ones I made in my first 12 to 18 months [as an investor], because I didn't know what I didn't know, and I didn't have the network to go and listen [to others] when I was looking at deals. Of course, we invest with both our minds and our hearts, in combination, but if we surround ourselves with a diverse group of other investors we can talk to and collaborate with, we'll have a better chance of success. So I'd tell myself: for 18 months, take notes. If you're going to write checks, write them, but don't [send them yet]. For the first 12 to 18 months, just learn, don't invest, just listen.

Serhat Pala 31:52

There is a cost to being a good, growing business. If you're not a growing business, you can come to work on a Monday morning and not have any problems, nobody calls you to complain, you don't have employees asking for things, or angry customers or partners. So what I'd tell myself is: if you want success, if you want to build a company, you'd better grow thick skin, patience, and the expectation that you're going to have to deal with a lot of things you don't want to deal with, because that's the only way a company can be successful. And develop that mindset that says "problem, problem, problem" means something is happening, something good.

Serhat Pala 33:27

I'd answer this more as a founder. The question you should have asked me is about personal life, your partner, your support system, what it means and how important it is for a successful founder, because who we are is a combination of what we do and how we live, and how we live and what we do really depends on the immediate support system we have, starting with our life partners. The question you should have asked me was: what do most founders pay the least attention to that they should pay the most attention to? And that's knowing how to find a good life partner, and how to build a life and a communication system to sustain that relationship.

Serhat Pala 34:30

Thank you very much for having me.