Secret #4. Don’t Dream Big. Design Big.
(This is the fourth in the 12-part series, “12 Secrets To Attracting Investors To Your Startup”)
It’s February 2013, and I’m at the Kellogg Private Equity and Venture Capital conference at the University Club of Chicago. I’ve been a venture investor for all of one month, and I can’t help but get the feeling that I need to buy a nicer suit. About 500 of us are gathered in an amazing oak and stained-glass hall that I’m convinced must have been Rowling’s inspiration for Hogwarts. We’re listening to words of wisdom from superstar investors Dick Kramlich and Bruce Rauner. I’m taking impressively detailed notes, via one thumb, on my phone. After the plenary, the VC and PE communities split up into two groups, heading toward their respective breakout sessions. A herd of young MBA students is looking lost, so the facilitator steps back to the mic and brilliantly clarifies things: “If you’re interested in analyzing spreadsheets for a living, go to the PE breakouts. If you’re interested in analyzing people, head to the VC sessions.”
Up until now, this series has leaned in that same qualitative direction. I’ve told you a bit about my firm’s fondness for passionate problem solvers with clear and elevating solutions that they’re uniquely well positioned to bring to market. Most of our time spent with startups is, indeed, less about their current numbers and more about the entrepreneur and their vision. Eventually, however, even the most philosophical investor turns their attention to the central question: What kind of return am I expecting to get on this investment?
For a venture investor, the answer is plain: A big one. Venture investors are looking for serious returns in exchange for the serious risks they’re shouldering by banking on your unproven, new-to-world business.
So the…big…question facing you, the entrepreneur, is this:
How is “big” measured, and how big is “big enough”?
The Other Side Of The Table
I actually like to encourage entrepreneurs to think about this from the investor’s point of view. Let’s call our hypothetical investor “Abby.”
Abby is an accredited investor, and has $10 million to put to work. Most of her money is sensibly invested in traditional asset classes: stocks, bonds, funds/ETFs, real estate, etc. Let’s assume (broad strokes) that Abby expects to achieve the “usual” 7 percent annual return across these traditional investments. All things being equal, Abby therefore expects her traditionally invested money to double in 10 years.
If you want any of Abby’s money, you need to be able to show her a sober, sensible plan that explains why your company value will at least double in 10 years. If your business model, well executed, can’t even match her traditional investment options, she’s not going to invest in your business for reasons beyond personal charity.
A Traditional Success Is A Venture Failure
Here’s the thing, though: To aim to double your investors’ money is to aim for failure. You need to be thinking exponentially if you’re designing a venture-backed business. You’re not going to survive with a startup that’s 10 percent (1.1x) better than the next guy. You’re not even likely to succeed with a business that’s 100 percent (2x) better. If you’re going to change the game, you need to be cooking up an innovative (read: new and better) business that’s a good 10x superior to the status quo.
Likewise, if your startup doesn’t expect to grow in value 10x in 10 years, it’s not much of a venture story….it’s a traditional small business. And while there’s no shame at all in spinning up a great small business, you’re probably much better off seeking bank financing than venture investors.
My advice: You want to thoughtfully design a 10-year business model that “reaches” for 100x growth and “settles” for 10x growth. It might sound harsh, but the truth is this: Three in four venture-backed businesses fail. You need to convince your potential investors that your company’s winning 10x plan will singlehandedly make up for those other three losers.
In computer science, we talk about a concept called “Failing Gracefully.” The idea is simple: If your software crashes, does it toss you a “blue screen of death” and delete all your work, or does it autosave your work and gracefully restart the program where you left off? (I’m saving now btw, just in case.)
Businesses, like software, can be designed to fail gracefully. If sufficient energy is put into developing the quality and usefulness of the underlying technology assets, even a “failed” business can be designed to be sold for at least twice its investment value.
Perhaps no single quote better captures the idea than this gem from comedic genius Mitch Hedberg:
“An escalator can never break — it can only become stairs. You would never see an ‘Escalator Temporarily Out Of Order’ sign, just ‘Escalator Temporarily Stairs.’ Sorry for the convenience. We apologize for the fact that you can still get up there.”
The Left Side Is The Right Side
Pop quiz: What’s 1.69cm x 2.09cm? Go ahead. Figure it out.
Did you answer 3.5321cm2? If so, you’re wrong. Or rather, you’re “too right.” From a significant figures perspective, the answer is just 3.53cm2 because we don’t have enough confidence in the initial figures to justify the extra “.21.” That “.21” is false precision.
Here’s the analogue: Startup business models are typically swimming (drowning, in fact) in false precision. If YourCo plans to sell 46,500 widgets at a price of $4.95 per widget in year one, you could estimate your first-year gross at $230,175.00. Don’t. Resist the urge to impress the investor with a veneer of detailed, but ultimately false, precision. We’d rather hear that you plan to sell “about 50,000” units at “about 5” bucks a pop and collect “about $250,000.”
Call me cavalier, but I’d rather see you spending your scarce energies refining your 2xà10x strategy than your 2.043xà2.132x strategy. A venture business will live or die by the number of digits on the left side of the decimal, not the right.
Bottom line: We prefer to invest in founders who are intentionally designing their business for exponential growth. We look for 10-year plans that “reach” for 100x growth, “settle” for 10x, and “fail gracefully” at 2x. We believe that overly detailed financial projections signal wasted time that could have been better used designing your 100x.