Monday January 12, 2015 2 comments
By Peter Adams
The first "go/no-go" decision that investors make when looking at your deal may be "how big can this get?"
There are a lot of great small businesses that can make good returns for their owners, but which don't have the potential to get big enough to return money to investors. How do you know if your company is a "venture company" or just another small business?
Venture companies have the ability to scale big and fast. If you have a super-profitable lawn care business that needs more money for equipment and expansion, it doesn't have the kind of growth that venture investors are looking for because it's not likely to be able to scale beyond a regional scope.
There are always exceptions who can go big, like Starbucks did with moving coffee houses from local enterprises to international chains, but these big scale plays are risky and need to be accompanied by a rock solid rapid expansion strategy. As a rule of thumb, fast growth companies need to grow by at least 100% every year until exit.
Big companies need bigger companies who can acquire them when it comes time to execute the exit strategy. Sure, you can pursue the IPO (initial public offering/going public) option, but this is only realistic for a small percentage of high growth companies.
In most cases, a company will look for an acquisition to continue their growth and return capital to investors. If your plan is to be acquired, you need to be in a market that has plenty of large companies who can compete to acquire your business. If you're in a $100 million market, that means there aren't likely public companies big enough to acquire you.
Some VCs look only at companies that can be acquired for $1 billion or more. Angel investors can make good returns with exits at $25 - $250 million. To find out if your market is big enough, take a look at who is acquiring whom in your market and for how much.
Companies that grow fast and are attractive to acquirers have an "unfair advantage" that lets them grow fast and take over new markets. These companies aren't "me, too" offerings, like yet another coffee house chain, they have something unique and hard to replicate, so that competitors can be kept at bay and incumbents cannot easily copy your strategy.
Your unfair competitive advantage is what makes you attractive to acquirers who are willing to pay large multiples for your company.
Thinking Big is important for early stage companies seeking funding. Angel and venture capital investors are not there to buy you a job and investments that offer a royalty or percentage of profits can almost never return the kind of profits that these investors need to offset the huge risk that they are taking in investing in your business.
The risk to invest in a fast-growing company with an unfair competitive advantage is not much higher than investing in a local or regional small business, but the potential for high investor returns in big growth businesses are much higher. When you consider that as many as half of the businesses that an investor may invest in will return less than 1X on each dollar invested, investors need to target for a return of 10X or more within five years to be able to survive.
If your company can't return 10X in five years, take a look at your strategy and ask yourself if you're thinking big enough, or look to more appropriate sources for small business funding like SBA or other loan programs that support small businesses that are likely to stay that way.