Ever since Marc Andreessen coined the term Product/Market Fit – which has become a widely-accepted indicator for whether new ventures are likely to succeed or fail – startups have strived to demonstrate that they can achieve it, given how critical it’s considered to be for their journey forward. In many ways, they are correct, but are there also cases where it makes sense to build a product without a real fit to the market? Is it possible to create strategic value with a product that’s completely off?

These questions have been bugging me in the past 2 weeks, especially when thinking about our investments in ad-tech. Ad-tech is out of favor right now, and it’s clearly evident in the market. VCs are staying away, and public markets are punishing ad-tech companies with very low valuations. Just look at Rocket Fuel valuation at $160M, despite an annual Gross Profit of $200M (granted, it’s more complicated than that, but the general sentiment around ad-tech is really negative).

But what about product/market fit? Clearly there is a strong demand for these products. In fact, many of ad-tech companies have continued to sell, and some of them are growing fast. The issue is that their overall destiny is not favorable, and as a result they have minimal strategic value. But that’s not true only for big public ad-tech companies. Last week I met a company with an excellent product/market fit. They are growing fast, and their offering to the market is clear, crisp and in high demand. Great deal? In many ways it is, but I wasn’t sure whether their sales performance will appreciate in the equity markets in the long term.

So I plotted a simple 2×2 graph, looking at Product Market/Fit and strategic value:
Can startups without Product/Market Fit still have Equity Value?

bullet-pink-20x10The left bottom quadrant is easy: Companies that are building a product that the markets don’t appreciate and have no equity value…. I guess many failed early stage startups fall in that category.

bullet-pink-20x10The upper right quadrant is easy too: The great companies fall in that category, the likes of Uber, Airbnb, or even Israeli companies such as Payoneer – a Carmel portfolio company – or Fiverr.

bullet-pink-20x10Analyzing the ad-tech markets and other “out of favor” areas of investment, the bottom right quadrant is easy to understand as well. There are many companies that sell well, but are not appreciated. That happens in over-competitive markets, but also when companies sell without growing or when they sell with a glass ceiling on the market.

All this was a long introduction to my thoughts about the upper left quadrant:

Can there be companies with no product/market fit and real strategic or equity value?

Initially I thought that this must surely be an empty category. Who would ever value a product that the market doesn’t want? But in reality, there are companies that sit in this quadrant. The best example is Oculus. Acquired for $2 billion by Facebook, their product is amazing, interesting and futuristic, but its fit with the market is still unknown. The fact that their product hasn’t been tested with the masses yet hasn’t stopped it from being valued very nicely (it’s not easy to reach a $2 billion valuation).

The “no product-market-fit-yet-highly-valued” category is a temporary one, however, because it’s really just a placeholder for revolutionary companies. In the long term, companies can’t stay in that category forever, they have to move over time. If they are lucky, their products are accepted and their revolution is realized. If that’s the case, they can reach a 10x valuation and become amazing companies like Facebook etc. And in other cases, if it doesn’t work, they drift away into the negative area of “No fit, No Value”.

As VCs, we usually think of our companies as generating high valuations initially based on hope and potential, and then building a successful business on top of it. The natural process for most companies is to move up on the left hand side, and then into the right. But can a company build a great product with limited equity value and only then climb into the desirable right hand corner? I’m not so sure.