The Proof of Concept Paradox
by Matt, on 15 Sep 2020
If you’re regularly involved in the entrepreneurial and early-stage business community, you’ll have heard the phrase “proof of concept” (PoC) many times.
PoC is an important investment gateway, with larger sums of capital available – from a wider range of investors – once it has been achieved.
Entrepreneurs, correspondingly, are keen to demonstrate (or at least, claim) PoC as soon as they can – both for the self-validation as well as access to money. But what investors mean by PoC might be quite different with much higher hurdles than entrepreneurs anticipate.
As we will discuss in this week’s SPT, this creates an interesting dilemma. What exactly does each of these groups mean by PoC? How can we resolve these differences so that early-stage companies can unlock capital from investors to further commercialize their new technology or service?
WHAT ARE WE TRYING TO PROVE?
What do we mean by a “concept”?
The word has a very broad definition. Derived from the Latin, conceptum, meaning “something conceived”, it means an idea, a plan, or an invention.
In our context, we should be more specific. Concept means an idea for a new product or business.
Whether or not that idea constitutes an “invention” is another story, and largely irrelevant. Even if the idea is deemed to be an invention, it’s still only a concept. To become a product or business, it must be prototyped, produced, and commercialized.
Many ideas are not much more than the proverbial sketch on a napkin (or the back of an envelope). Those sketches are sufficient to explain how the concept might work but require significant refinement before a viable product is made.
Early on, ideas lend themselves to analytical demonstration. This proves that they can work, at least in theory.
What most investors are looking for, however, is a “real space” demonstration that the idea performs as claimed.
THE EYE OF THE BEHOLDER
Which brings us to the second question: what do we mean by “proof”?
Like most things of beauty, it lies in the eye of the beholder.
According to the dictionary, proof means “evidence or argument establishing or helping to establish a fact or the truth of a statement.”
“Helping to establish” sounds frightfully subjective to me.
The viability of a business idea depends on a multitude of factors – many of which are constantly changing. There’s seldom irrefutable evidence that a concept will succeed.
What constitutes proof depends on who is asking for it, as well as the type of concept that’s being proven.
For example, someone with a hardware idea might perform industry-standard tests to compare the performance of her concept with established products and benchmarks. If the tests confirm superior performance, her technical concept is proven.
However, whether that performance will translate into a viable business opportunity is another question.
Similarly, a piece of software or an algorithm might be demonstrated using historical data. Such concepts are often validated using blind tests where some of the data is held back while the software is trained, then used to assess how reliably it produces an answer.
Once again, demonstrating a reliable algorithm isn’t necessarily enough to ensure a successful product or business.
Both examples illustrate the need for multiple levels of validation to satisfy the burden of proof that’s necessary to pass the PoC milestone.
PROOF OF CONCEPT – BUSINESS EDITION
Proof of a business concept requires much more than persuading someone that a back-of-the-napkin idea is legit.
Demonstrating PoC in a business sense requires (at least) five steps:
- Reducing the idea to practice (i.e. making it work)
- Demonstrating valuable performance improvement over existing solutions
- Showing that early adopters will pay for it
- Showing that a meaningful number of customers are likely to buy it once it is made widely available, and
- Identifying ways it can be produced profitably, at scale
Critically, it can be difficult to complete some or all of these steps without funding.
Producing a working prototype is becoming easier – especially in the software domain and where a physical product can be manufactured using 3D printing.
Nevertheless, in many cases, hundreds of man hours of development and thousands of dollars of manufacturing are required to produce the first working article.
It is in these sorts of cases that high-potential ideas fall into what early-stage practitioners call “the valley of death”.
The venture simply runs out of money before it can deliver the burden of proof that later-stage investors (with pockets deep enough to write the big check that’s needed) expect before they will sign on.
RESOLVING THE PARADOX
There are three keys to resolving the PoC paradox – or, at least, minimizing the number of ventures that fall foul of its trickery:
- Entrepreneurs need to be clear ahead of time what burden of proof investors in their line of business are likely to demand. They can then plan for – and raise enough money to complete – the necessary prototyping, testing, and demonstrations.
- Investors need to be cognizant of the burden they are placing on entrepreneurs. Setting the PoC bar too high risks killing off potentially lucrative ideas before they have a chance to succeed. Investors should decide and clearly articulate which of the five steps described earlier are prerequisites for investment – and what constitutes “proof” in each case.
- Both sides need to have a candid conversation about what PoC is going to mean in their situation. Every combination of entrepreneur, concept, and investor is subtly different, so the definition of PoC needs to be explicitly agreed between them. This will avoid premature claims and unexpected refusals when one party believes PoC has been achieved and the other does not.
We can’t completely resolve the dilemma faced by entrepreneurs with an expensive-to-prove concept who are locked out from capital because they can’t demonstrate proof of concept soon enough. However, following these three steps should help to close the gap and prevent some ventures from ending up in the valley of death.