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As I delve into my business plan marathon season, and the angel investment group I’m in starts looking in earnest at a flock of new companies, I find myself constantly bumping into several very common myths. This is first on my list. And no, by the way, it’s not an April Fool’s Day joke.
The good startups for outside investment are the ones that can grow fast and get themselves acquired by a larger company, for a much higher price, so the investors can get their money back out of the deal.
Although there are exceptions, most of the good investments have to be scalable. Can you jump from selling 10 to 100 to 1,000 to 10,000 without a proportional jump in head count and overhead? Product businesses usually can. Some web service businesses can. But a lot of businesses can’t.
This is why investors don’t usually like service businesses. They tend to depend on the people more than the product. Key assets walk out the door every night. They can’t scale up.
This is why investors don’t like businesses that can finance themselves and grow forever without needing outside investment. Angel investors and venture capitalists don’t want to be long-term partners in stable businesses. They don’t want to live off dividends. They want businesses that will scale up fast and sell out to somebody else.
One scenario that founders and entrepreneurs love, but investors dread, is having a minority share in a strong independent company that can grow forever without needing big intakes of somebody else’s money. These companies might have happy owners and good financials and no incentive to sell themselves off.
One key buzzword is the exit strategy. The exit is when the investors get money back from the money they invested earlier. Exit used to be going public, meaning getting formally approved and registered to have the company’s stock available on the stock market. These days, although going public is still possible, it’s very rare. So exit means getting acquired by a bigger company.
This means that your business might be a great business but not an investment prospect. That’s quite common. I’ve been there myself, and quite happily, as we ended up bootstrapping a business that now has 40+ employees, multimillion-dollar sales and no debt, and we own it outright. But you should know it, and focus your growth financing strategies somewhere else.
Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry.
