Over the years at Credo Ventures I have seen plenty of startups across all stages ask something along the lines of: we are already break even, why would we need an investment?
I have a lot of respect for all the founders who are well aware of the pros and cons of taking an outside investment, and choose to bootstrap. It is a lifestyle decision. But the majority of founders I talk to who are against taking an investment are simply misinformed. They might base their decision on misguided notions of what it means to take a venture capital investment (the investors will take control over my firm!) or they underestimate how vital growth is to the survival of their business.
The goal of this post is not to dispel all the myths of venture capital investing, even though I will say that VCs are not out there to steal your firm. The focus of this post is on growth, the risks of not growing fast enough, and the underestimation of how much such growth can cost.
One of the key reasons to take an outside investment comes back to the distinction between a startup and an SMB. A startup is a unique kind of company because of its commitment to grow as fast as possible, ideally exponentially.
I see a lot of companies — especially once they have generated some revenue, say between USD 2-20MM annually — that implicitly give up on the commitment to grow. They will say something along the lines of: well, I will just open that sales office in the new market once I generate enough cash for it.
This conservatism is especially hard to watch in technology startups, where companies seem to be moving on hyperdrive. By the time you have enough cash to open that sales office, your competitors will have already signed first customers on that market, or your product might have lost its appeal of uniqueness.
Even worse, if your competitors start to outgrow your startup, you might quickly find out that they are expanding into your own territory with scale and resources that you can’t possibly match. The unintended consequence of not growing as fast as possible can therefore be the stagnation or even decline of your business. Sure, you will most likely still afford that luxurious car every other year and a nice house, but is that really why you started your own business?
The issue of dwindling ambition to grow superfast as the company gets bigger is especially true in Europe. It seems like a lot of entrepreneurs get the feeling that once they hit 5, 10 or 20 MM in revenue they have “made it”. This mindset just shows the extent to which such companies lack the perspective on real growth, especially when compared to startups in Silicon Valley.
To all the 5-50MM revenue startups that think they have made it big already: on the West Coast, you are just a mid-tier startup that would be looking for a Series B or C to fund its expansion. Compare yourself to someone who is really making it big. Take Uber: founded in 2009, raised USD 300 MM to date and is rumored to have booked over USD 200 MM in revenue in 2013 – in its 4th year of operations. Now that’s startup-like growth.
Do your math right
Compared to CEOs of companies with revenues in the millions, founders of earlier-stage startups tend to commit a different kind of mistake: they underestimate how much it will cost to expand their business.
Let’s use the example from above: you want to open a new sales office — in London. It is not unusual for an entrepreneur’s plan for the expansion to be something along the lines of: I make 50-100k a month in revenue, so I can devote 10-20k to open the office and hire a sales guy. As the revenue starts rolling in from first clients, I will hire additional sales people.
Now some quick math: a good quality sales guy will cost you 8-15k USD a month base. Let’s say you have a nine-month sales cycle, so you need 70-135k for that one sales guy before any revenue starts rolling in. If you are expanding for any other reason besides bragging in front of your friends over a beer that you have an office in London, you will need 3-5 guys to generate some real traction. And you need to pay the office costs, probably hire an office manager, hire accountants, etc. And if you are really serious, you are going to support your sales team with a smart marketing spend, perhaps an account manager as well.
All of a sudden, you are looking at an investment of around a million dollars, and that’s just so you can have a presence. Becoming one of the market leaders is a totally different ballgame. And that’s just London. Now imagine you want to expand further, say the U.S.
The point of this post is not to claim that every company now should take a VC investment or will otherwise be run over by competition or stuck in its home market. But to those who truly want to grow as fast as possible, I would argue that it is almost impossible without an external investment. Heck, even the kings of viral growth at WhatsApp took one.