I recently had a chat with one of my friends and advisor. He’s a west coast connector who has an passion for profanity, philosophy and throwing hard punches. Talking to him is always entertaining and I always learn.
We discussed what I could do to make my company more attractive to venture capital investment.
Let’s take two fictional companies, Athos Inc. and Porthos Inc. Both are small businesses looking to expand and grow. They both run a similar business placing photographers on demand to events and product hunts and are similar in their finances. Let’s say they’re both valued at $1 million and are growing at a 5% rate annually.
The guys who run Athos had gone bankrupt earlier in their career and were looking to grow at a safe rate while the people behind Porthos were charging ahead and swinging for the fences. Both companies are steadily growing and making a small amount of profit each month.
Skip forward 5 years.
Athos is happily generating a a million dollars of profit for each of its founders and the one angel investor they took on. Each owns 30% with the balance going to employees. The company is valued at $5 million. That sounds pretty great, and it is by any measure. Having a solid profit generating business is the end goal for all of us in this field.
Porthos however, is losing hundreds of millions of dollars each year but for some reason their investors don’t seem to care. They keep pouring money in and Porthos keeps burning through the cash. Sound familiar? Probably. Uber lost two billion dollars last year and they still have people lining up to give them money. Why? Because they have a high valuation. Porthos may be losing money at a rapid rate but they’re charging forward with their growth plans. They used their cash to swing for the fences(free photoshoots, extra bonuses for photographers, marketing, buying out smaller companies, setting up special programs etc etc). They’ve been written up on TechCrunch, they’re household names in the industry and the founders are invited to speak at conferences. They’re now worth $500 million dollars but the two founders are each down to 12.5% of the company.
Fast forward another 5 years.
The co founders of Athos and their investor have each put away $10 million in the bank from profits and are looking to sell Athos and move to a tropical island in Thailand to enjoy the spoils on their hard work. They sell their company for $10 million and each walk away with another $3 million. $13 million pre tax for ten years of work is pretty good.
At this point in time Porthos is approaching unicorn status, the coveted billion dollar valuation. They’re still losing money but less so, their business model has been changed to put them on the path to generate profit. The two co founders are down to 4% each and each investor has been diluted down accordingly. Porthos receives an acquisition offer for $1.25 billion. If they sold now, each of the co founders would walk away with $50 million each. Sounds pretty awesome. They could buy a tropical island almost four times as large as the founders of Athos.
Of course the story describes a best case scenario for both companies. It’s much more likely that Porthos will eventually run out of funding and collapse, with the founders walking away with nothing and the company having been reduced to ashes and the investors bilked of their investments. It’s actually a 97% chance that this will happen. It took eight years for Airbnb to turn a profit for the first time, they’re lucky they had enough money to keep them going for that long.
Not all companies were meant for venture capital investment. With that money comes oversight from an external group, pressure to grow and much more. It’s no longer ‘your’ company, it belongs to other people too.
I was told about a company my friend’s friend had run. I’ll have to keep it anonymous. They had a group of websites that was getting significant traction and they raised $500k from some angel investors in Seattle. They were making profit every year. After 5 years, the angel investors introduced the founder to a VC in Colorado who investment $100 million into the company to grow it. One year later they went bankrupt and closed down. Some businesses just aren’t meant to pursue that hockey stick growth.
So where is my company in all of this? We’re poor Aramis, unable to choose between two attractive paths. Do we follow Athos down the safe path, generating profits and not risk anyone’s investments? Or do we go big and brash and emulate Porthos and his fashionable clothes and his pursuit of fortune?
One thing is clear though, VCs like Porthos a heck of a lot more than Athos.
tldr: a lot of venture capitalists care more about valuation than profit generating.