Before I joined Lightspeed, I was experimenting with five ideas that I wanted to pursue full time. Now that I’ve spent a good part of the last 1 year in the firm (or on the other side of the table at Starbucks Koramangala), here’s where I stand on them: 1) I would still pursue at least 3 of the 5 2) I would not seek venture capital for any of the 5. Here’s why: the interests I want to pursue have a niche following, not enough to build a multi million dollar business. Hence, neither do I think capital infusion will help me attain non-linear growth ($8 app install cost for users, 95% of whom will stay with me for all of 3 minutes), nor will it imply a large enough return for the VC firm backing me.
Diving into the mechanics: Assume a venture capital firm looking for a 10x return on an investment comes in at the seed stage, puts a million dollars for 10-20% equity. In the ideal case scenario that we are talking about, it invests ~$10M cumulatively in the subsequent rounds on a pro rated basis to defend its stake, also getting diluted when growth capital comes in, ending up at 10%. A 10x return implies a $100M return expectation, which means the company needs to be worth $1B. Calculating backwards, based on the enterprise value to revenue ratio (EV/Revenue) of analogous public companies, you can easily get a sense of the scale you need to potentially be at 5–6 years down the line to make a VC investor greedy.
Consider marketplaces as an example: Amazon has an EV/Sales ratio of slightly over 3, while for eBay this ratio is 2. Generally, an ecommerce marketplace would be valued at 2–3X its Gross Merchandise Value. So unless my marketplace company is selling over $300M worth of goods by end of year 5, it isn’t “impact potential” for the VC firm. Of course, this ratio varies by business model: Facebook trades at an EV of ~18X its revenue and Apple at ~3X. For consumer app companies like Facebook and Twitter that primarily monetize via ads, it might be prudent to look at the EV/user ratios. TL;DR – it’s critical to figure out what the model is, the implied scale it should attain and whether it seems reasonable in a 5–6 year timeframe, to ensure all stakeholders benefit in the long run.
Growing up in a milestone-oriented educational setup, we’re used to seeking incentives and rewards on a regular basis for comfort and reassurance. A full score on the weekly math test, 5 point reviews at work, we’ve always associated professional success with tangible tokens of appreciation. Of course, big companies aren’t built in a few months or even years. And if you’re the CEO, there’s little chance someone will give you a report card every few months. ‘Funding’ fixes this need for external validation. It becomes a proxy for success when in the truest sense, all it really should be is a lever for success. And that’s where a lot of us lose the plot. “What’s best for my business?” becomes “what’s most conducive to funding?”
It’s important to think big but it’s even more important to be honest with oneself. Does my business really need VC funding? Is this the right time? All good ideas don’t make for good businesses, and all good businesses aren’t necessarily venture backable. This is a great thread on some really successful companies that did not raise venture capital (Dell, Zoho, ESRI, SurveyMonkey), or delayed it until the business was sustainable enough and never needed to use it (eBay, Tableau, GitHub, Shopify). On the other hand, Gigaom that had raised $22M in 6 rounds is a recent example of a niche business that could have probably survived longer without VC infusion.
And hence, I will not raise venture capital when the time comes to do something of my own. My aspirations don’t lie in building a billion dollar company, they lie in doing something I’m passionate about (even if it has a limited, scattered audience — think investigative journalism, spiritual retreats, gourmet food tours!) while being able to draw an adequate amount of money every month. Oh, and the 100% ownership and decision authority is a bonus.