Lifestyle vs. Venture Scale: Understanding the Difference
As a founder, it’s tempting to think we need to raise money from VCs, especially after watching a show like Shark Tank.
However, given that less than 1% of businesses receive VC funding, it’s important to understand how VC works, and specifically, what categorizes a company for VC backing.
In fact, one of the most common misunderstandings among new entrepreneurs is not realizing that VCs have a very specific and unique set of mandatory criteria when evaluating possible investment opportunities; and that the vast majority of businesses simply do not fall into this bucket.
Those companies which do not fit this criterion are often referred to as lifestyle businesses; and while the term may not sound as sexy as “venture scale,” there are plenty of positives to building a lucrative and profitable lifestyle business.
As it pertains to venture scale, there are three key distinctions worth understanding.
1) Execution over Ideas
First, while ideas are plentiful, execution is the hurdle that separates innate entrepreneurs from those with mere entrepreneurial tendencies.
For example, thanks to the internet and the vast amount of tools we have at our disposal, one can build a mockup or prototype, create a website, and test demand for a product or service, all within a single weekend and for less than a few hundred dollars. It has never been easier or cheaper to test an idea and start a business.
Therefore, for a VC to get excited about a business, they’ll first want to see an entrepreneur who refuses to wait for funding before starting to execute on their vision.
VCs look for resilient & resourceful entrepreneurs who are determined to pursue their vision with or without VC funding. So just get started and build what you can with the resources you have. Don’t wait.
2) The VC Business Model: Understand the Math
Second, if the entrepreneur clears the first hurdle of building & testing a prototype, it’s important to understand the basic economics of how the VC business model works. By doing so, we can determine whether VCs will consider our business lifestyle or venture-scale, and therefore, target the right type of investors.
For example, many early-stage companies build an initial product and then go to market in search of venture financing. Watching a TV show like Shark Tank leads us to assume we need to raise millions of dollars in exchange for equity in the company.
However, what many new entrepreneurs fail to realize is the required scalability of the business in the eyes of a VC.
For instance, let us assume an entrepreneur is trying to raise $1M at a $10M post-money valuation, therefore giving up 10% equity in the company.
Now let us assume a VC firm with a $100M fund is deciding whether to invest $1M.
Since startup investing is very risky (and the vast majority of portfolio companies go to zero), for the VC to invest, they will need the investment to have the potential of returning the entire amount of their fund (or more) within 7–10 years (i.e. $100M or 100x multiple on invested capital, based on the average 10-year lifespan of a VC fund).
Therefore, with a 10% stake in the company and a required 100x MOIC (not accounting for dilution), this means the company must eventually be worth $1 Billion
Furthermore, the company’s valuation will likely derive from a comparable top-line revenue multiple.
For example, assuming the startup developed a SaaS product that sells for $100/year. If comparable SaaS companies are being valued at 10x top-line revenue, this means the startup would require $100M in revenue to achieve a $1B valuation.
For the VC, it’s a simple numbers game. So, the entrepreneur needs to ask themself: does my company have what it takes to reach $100M in revenue and a subsequent $1B valuation within 7–10 years?
Often, the answer is “no”, and the entrepreneur is better off seeking non-dilutive funding (i.e. grants or loans) while building a respectable, revenue-generating lifestyle business at a moderate pace.
For instance, scaling a business to $5M in annual revenue that grows 10% year-over-year can provide an incredibly comfortable lifestyle for you and your family.
Therefore, before reaching out to a VC, first crunch the numbers based on your business model, the size and value of the target market, long-term vision, and determine what it will take to reach $100M in top-line revenue.
In our SaaS example of charging $100/customer/year, it would take 1 Million paying customers to reach $100M in revenue.
Realistically, if our obtainable market is only a few thousand customers, it’s unlikely we will be considered “venture scale” in the eyes of a VC, unless we can show a product roadmap whereby we grow the average account value (ACV) exponentially over time; or can expand into adjacent verticals, therefore unlocking new customer segments.
This is the type of math VCs are contemplating during a pitch, so come prepared to answer these questions.
3) Triple, Triple, Triple, Double, Double
Third, the VC business model is built on the notion of significant cash burn and a high velocity of milestones.
For example, an influx of venture capital often gives the company only 18-months of runway, during which the founders are expected to triple revenue year-over-year.
In fact, YoY revenue growth for the first five years of a venture-scale startup is expected to look like this: 3x, 3x, 3x, 2x, 2x.
If the company continues to achieve its milestones it’ll receive the next round of capital, and so on. Otherwise, VCs are perfectly fine walking away from the business.
As a result, VC-backed founders are under immense pressure to grow and scale their businesses, often wreaking havoc on their personal lives and mental wellbeing.
Therefore, think about the lifestyle you want, and ask yourself: is this the type of pressure I want to subject myself, friends and family to, 24/7 for the next 5–10 years?
Life is precious, so choose wisely.
Final Thoughts
While it’s exciting to get caught up in the high-scale world of venture funding, ultimately, VCs are looking for highly scalable businesses, and most startups simply do not fit the mould, and that’s OK.
There is nothing wrong with building a lifestyle business, but it’s essential to understand the distinction between the two.
Personally, having previously built a lifestyle business and investing in dozens of venture-scale businesses, the allure of VC funding is not nearly as glamourous as it appears on TV. In reality, it’s a high-stakes game of grinding it out and running through walls, 24/7, for years on end.
About the Author
Matthew is the Founder and Managing Director at Allied Venture Partners, Western Canada’s largest angel syndicate investing in early-stage tech startups across Canada & the United States. To learn more, please visit Allied.vc
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