A proof of concept refers to the conception, development and execution of a business idea that has a demand for it.
This term is mostly used in the world of startups to describe that a company has successfully developed an end-product or service, and is already serving the market with it.
Before a proof of concept can be determined, founders work in the seed phase to design, develop, build and improve upon prototypes to create a working product.
Once the product or service is ready, it is released into the makes to test for demand.
Theoretically, startups commence series A funding activities after the proof of concept as they seek more funding to scale the business.
What determines proof of concept
The variables that determine whether a company have proven it’s concept will depend on the nature of business.
Often times, the completion of a product that does what it is supposed to do can be all that is necessary.
This can be true for companies that are just hired by others to build something new. The demand is already secured.
For example, a factory hires an automation firm to build a custom system for their production line.
For businesses that work with consumers and end-users, venture capitalist often want to see not just a working product model, but also a demand for it.
This is because for every one successful product created by innovators, 9 other products never make a profit.
For this simple reason, building a product that works is often not enough. There needs to be a demand big enough to enable the company to be profitable.
Even when a startup’s product turns out to be profitable, investors might still want to see how big it can grow to so that they can attain a target return on their investment.
It is not uncommon for investors to turn down profitable companies as they view the potential revenue and profits too little to be worth their time.
Especially with cold starts running with unique ideas and totally new disruptive products, the demand for it backed up by sales numbers, is one of the most critical elements that make such a young company investable.
Why proof of concept matters
Investors of startup companies can enter the fold and invest in a stake of equity during various stages of fund-raising.
The earlier an investor provides capital for equity, the cheaper shares of the company would be as there is a high risk of the business never getting off the ground.
This is because the product might never be completely built, or that there is always a chance that the vision of the product is unable to materialize.
To entice investors and venture capitalist to invest in a young upstart, low share prices are offered.
However, as the company progresses and achieves a proof of concept, the risk of the company never completing the product is eliminated, and the market has shown that there is a demand for it that is huge enough for the company to make a profit.
A lack of demand is a lack of business feasibility.
On the contrary, if a startup has spent an extended time developing prototypes and has been reasonably overdue with delivering a working product, it would find it tough to get to the proof of concept.
This might result in needing to raise more funds in increase the runway so the research and development can carry on.
In this case, the slow progress of the startup business might even cause a down round as investors lose confidence in the ability of the entrepreneur to bring success.
Venture debt might be an alternative that has to be considered.
The gist is that if a startup company is able to achieve a proof of concept, it should have no problems finding investors to provide it with more capital to scale.
