Startups are Sexy. Businesses Make Money.
What makes San Diego Startups not Startups at all.
In the venture world, no one bats an eye at a pre-revenue company raising $1M at a $4M pre-money valuation. This is crazy. In any other industry — real estate, capital markets, even private equity, it would be impossible to have your company or asset valued at $5M with nothing to show.
As I reflect on this phenomenon, I wonder how we got to a place where something so outrageous is so widely accepted.
In the same way that you would differentiate an entrepreneur from a Fortune 500 CEO, a startups is not the same as a businesses. A startup is a big bet. A Snapchat. A Twitter. An Amazon. An organization that is valued on their users, their data, the massive landgrab they are able to achieve with the hundreds of millions of dollars they are able to secure in funding. This is expensive, takes a long time, defies common business sense, and happens so very infrequently. Hence, why we call them “unicorns.”
Unicorns are at one end of the spectrum. What’s at the other end? Businesses. Lots of them. Lots of profitable, sustainable, long-term, value-creating businesses.
What is a business?
A business is a company that addresses a true pain point for customers. In turn, these customers are willing to pay for the cure. Simple enough, right?
The key economics of a business are this: the fixed cost of operating the business does not outweigh the revenue it brings in. If the variable cost on acquiring additional paying customers don’t result in a deficit, you have an economic engine. Only then is it sustainable. Only then is it a “business”.
Steady, stable businesses like these still have risks, but if they are truly identifying a problem and have a captive customer base, the likelihood of 100% failure is very low. Turn over the coin and the same is true: the likelihood such a business will be worth hundreds of millions of dollars is also low. But, that’s ok!
Founders are fascinated with 9-digit exits. What they don’t realize is, more often than not, after they’ve raised 8 digits of funding their portion of that exit is more like 7 digits or less. Think about that. Operate a company for 10 years, raise $20M and sell for $100M only to take home $5M. It beats the opportunity cost of a job, but not by much. All for a very rare 9-digit outcome.
There is a better way
We at SEED San Diego believe there is a better funding model, which helps founders build businesses, not startups. Funding a business as opposed to a startup should also be simple.
The business should be valued at a reasonable amount upfront. The business should scale revenue quickly with customers who want their product because it is truly better and solves a pain. The business has either a path to profitability where it can spit off cash to all shareholders or exit for sub $20M with the founders still owning 50% or more. It should do this in 5 years.
Businesses are less wildly profitable for shareholders/investors, but they are more likely and have better, more bankable outcomes for all the stakeholders, not just opportunistic investors.
Resisting temptation
The model only works if both the entrepreneurs and investors have the commitment and discipline to building a business, and don’t get tempted by the siren call of the Startup.
This is easy to do in San Diego. For one, there is less capital here. Our startups have to be more practical as a result. They have to think and act like businesses very quickly or they will perish just as quickly.
But it’s not all downside here. What San Diego lacks in investment capital it makes up for in intellectual capital and grit. Instead of inventing phantom valuations, San Diego companies focus on real-world fixes.
It’s important to mention that a business could turn into a startup. If the business is scaling quickly and gaining significant traction where it can’t keep up with the demand of interested customers, there’s nothing precluding it from raising big venture dollars to compete with the incumbents. The business even has the potential at that point of turning into a unicorn. This just isn’t the likely scenario, and the business shouldn’t start with that expectation.
For San Diegans who want to build a startup they should go where the venture dollars are. Those dollars will not come here. Not yet. Our community will indeed produce more 9–10 digit exits, but slowly, and only after a groundswell of 7–9 digit exits first.
As a city we should rally behind building businesses. Such a reputation would be laudable. We are “that city which produces high quality tech solutions quickly.” Based on that progress, the big guys will pop their heads in more often to see what innovation we have brewing down here.
