The quest for scale.
How scalable is your company? Maybe you’re blessed with increasing returns to scale, whereby the larger your business, the easier it is to grow even larger. Or the nature of your business and the strategic choices you make along the way could mean growth becomes more and more difficult. In the former case, it’s all about racing ahead; in the latter, it’s about avoiding exhaustion and running out of oxygen.
If you talk to venture capitalists, they’ll assume your ambition is to build a scalable business. Otherwise, why even approach them? The scalability that’s characteristic of tech startups in the Entrepreneurial Age is a key part of the model by which venture capitalists make money. They don’t need to worry about losing money on 5 companies and barely making anything on 4 others if the 10th comes with such scalability that it pays the entire fund back, and more. The fact that tech startups pursue scalability echoes the “power law distribution” that’s a key feature of venture capital as an asset class:
Venture capital returns are not normal. Most investments return a small multiple or lose money, but many return larger multiples. And a few have had outcomes well outside what any normal curve would encompass. Venture returns are best described by a power law distribution.
As a founder, you need to understand the expectations on the other side of the table: the more scalable the company, the higher its valuation. Above all, you need to realize that at the early stage it’s impossible to figure out if your company will eventually scale or not. Maybe your company can reach tens of millions of users while employing only a handful of people, like Instagram once did. Or maybe, like Uber, you need to constantly fuel additional growth using more people, more subsidies, more capital. All in all, Instagram was highly scalable; Uber, not so much. But this difference is obvious only in retrospect.
Fortunately, founders don’t need to forecast scalability from the outset. And smart investors won’t bother you with too many questions about what will happen in the distant future, focusing instead on the challenges you are tackling right now. In addition, financial innovations such as convertible instruments (a SAFE in the US, or its local equivalent in other countries) make it possible to delay discussing your valuation until a later, full round. That leaves plenty of time to discover how scalable your business is, whether it’s an Instagram, an Uber—or a barbershop 😉
When you finally discover the real potential of your business from a scalability perspective, you’ll have key decisions to make.
If it’s not that scalable after all, are you still willing to build this business? You probably don’t want to start out thinking you’re the next Google and end up with the unit economics of a barbershop or a web agency. Better to cease operations and work on a more scalable opportunity!
If you decide that you want to press on with a business that’s less than scalable, it should lead you to think twice before raising more venture capital. Don’t think this mode of funding and the high expectations that come with it are for everyone/every industry/every business!
On the other hand, if you end up with a highly scalable business, this is an opportunity you don’t want to screw up: make sure to talk to investors with the ability to support your business as it grows, and find the right partners from the start.
We at The Family are used to working with entrepreneurs at a stage when they don’t know much about the future scalability of their business, and we’ll be happy to support you either way—even if that means asking the hard questions and making sure you’re pursuing the right opportunity for you!