One of the most important considerations for any entrepreneur is: How big of a company are you building?
I was asked this question by a top tier VC today regarding Fab.com. Before I discuss my answer, here first is some back-story on the importance of understanding, internalizing, and embracing the answer to this question.
This question particularly comes into play when you are raising capital from Venture Capitalists or Angels.
The simple math consideration is as follows:
VC’s expect a 10x return on their money.
Angels expect a 5 to 10x return on their money. For simplicity purposes let’s say 7.5x.
So, for example:
- If you are raising say $500,000 on a pre-money valuation of $2M, that’s $2.5M post-money valuation, and you’re thus signing up to create a company worth 18.75M to 25M eventual company exit.
- If you’re raising $2M on $6M, that’s $8M post-money, and expectations of $60M to $80M eventual company exit.
- If you’re raising $5M on $20M, that’s $25M post-money, and expectations of $187.5M to $250M exit.
- If you’re raising $10M on $30M, that’s $40M post-money, and expectations of $300M to $400M exit.
- And, if you’re raising $20M on $100M, that’s $120M post, $900M to $1B exit.
The exit expectations in these examples are what educated early-stage investors consider to be wins. As an entrepreneur you — of course — want to be a winner. And, most importantly, you don’t want to be managing a company that’s not seen as a winner in your investors’ portfolio. Not fun.
As such, as an entrepreneur you need to consider carefully what you are signing up for when you raise capital with such valuations. There’s no sense in raising capital at an expectation of a larger outcome than you personally are hoping for and planning for.
Let me put this as clear as can be: It may be change-your-life-money for you to sell your company for $50M but if you signed up for building a $100M or $500M+ company, you better have your personal goals aligned with your investors’ goals. The minute you accept their money at such a high valuation and expected ultimate outcome, you are responsible for guiding your company towards such a lofty result. Which means that you better believe in it and you better be prepared for you investors to push you to go big, as that’s what you signed up for. That means board meetings focused on how to get big fast, not on how to stay lean. That means board meetings focused on efficient growth not just cash preservation. That means board meetings focused on aggressively capturing and winning the entire market, not just being a solid market player. And, needless to say, your team better be with you on this.
Are you prepared for that?
Not all companies are destined to be $100M, $200M, $500M, $1B exits, let alone $50M exits. Many (most) startups will not even come close to hitting such big valuations. As an entrepreneur here are 6 questions you must ask yourself before you raise venture capital:
- What size company do I want to build?
- What will my investors expect me to do with their capital?
- Is it realistic that my company can achieve the expectations of my investors?
- Am I prepared to do everything I can to achieve the return my investors expect?
- Is my team on board?
- Are my personal net wealth growth goals in sync with my investors’ goals?
My best guidance on this is to be as brutally honest with yourself as possible when confronting these questions. Don’t convince yourself that your company can be bigger than it can be just because you’ve convinced your potential investors it can. You have to really, really believe it and see a clear path to how it can happen. And, don’t allow yourself to be put in a situation where your investors want you to go bigger and faster than you do. Know what you are signing up for.
I implore you to also really think carefully about the answer to question #6 regarding your personal net worth goals. When it comes to developing your own wealth, building a bigger company doesn’t always equate to bigger personal gains. From my own personal experience, you can sometimes make more money selling your company for a few million than for tens of million. It all depends on how much of the company you own at the time of sale.
Here are three examples from my previous startup experiences worth sharing.
With my first company, Jobster, we raised $48M. We had a good idea, just too far ahead of its time (social recruiting back in 2004 before Facebook and LinkedIn took off). We never were able to live up to the 10x return expectation. To be honest, I and the team never really grasped what it meant to live up to such a lofty expectation. In hindsight we took too much money too quickly and set the wrong expectations before really understanding how the business model would work.
With my second company, socialmedian, I figured from the beginning that the Company might never be worth more than $10M. We actually never really had a revenue plan, just a product plan that we hoped to iterate into a business over time. As such, we raised less than $800k from angels and then sold (just 11 months into it) for 6x enterprise value + a potential earn-out for management. Management ended up netting 5x and investors 2.2x on a short term investment. Sure, it wasn’t a huge win, but it was a win in-line with my personal expectations and an acceptable/favorable outcome for most of our investors as the company chose to exit rather quickly and during the height of the financial crisis. Footnote: Such a quick and small exit was surely easier to manage with just angel investors than had we have taken VC money.
With one of the companies I have invested in, TweetDeck, I counseled the founder back in 2009 that I thought he had a $30M to $50M opportunity in front of him (don’t ask how I got to that #, I just had a hunch given my sense of the product and the market). I suggested that he run TweetDeck as if that was the goal, and not to take any more capital than would make such an outcome not a win for his investors.
So, how did I answer the question today?
We’re signing up to create a $500M+ company with Fab.com. I’m convinced today that the Fab.com opportunity is well north of $500M as I see a clear path to $150M in revenue very quickly at healthy margins. There are clear market examples of how our model can work and we’ve got good wind behind our sails from the get-go. It helps that our market, design, is a large ($70B+) horizontal market spanning multiple verticals, and that for millions of people design is a lifestyle choice (see Apple, Ikea, Target, and the likes of Jawbone as just some of the many companies/products that consumers actively choose because of design affinity).
Building a $500M company takes a go-big mindset from the beginning. You don’t (usually) get to $500M by thinking small. As such, we’re building for scale from the beginning, on all fronts of the business. There are a lot of considerations that enter when you are building for $500M vs. $10M or $50M, and we are embracing them head-on. It helps that I have the duel experiences of going big and coming up short as well as going small and coming up with a win behind me. Hopefully that will translate into the right blend of vision and realism this time around.
Could Fab.com be an even bigger opportunity? We’ll see. For now we’ve got a solid plan to get to $150M revenue. From there, we’ll see how it goes. But, we’re definitely not building for a $50M or even a $100M enterprise value.
How big of a company are you building?
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