Bursts of Color - What is "Venture Scale?"
Many entrepreneurs have been turned down by VCs with feedback that sounds like:
“We are impressed by your business results and team, but we are passing because we are not convinced this business can get to venture scale.”
What is this venture scale, you ask? Certainly the answer will vary with all kinds of factors like company stage, venture firm, market conditions and so on. But in the interest of simplicity, I posit that:
In 2024, Venture Scale means a plausible path to $1 billion revenue.
Here's the TL;DR version of how I get there (longer form down below):
Wait, What? My Business Only Does $1m Revenue Today
I know, it’s nuts to be talking about some far-off $1b revenue target for an early stage startup. But… to attract the most ambitious teammates, investors and capital, it’s worth spending a little time squinting into the distance to think about “how big could this get if everything goes perfectly?”
How to Demonstrate A Large TAM
If we hope to build this $1b business, it sure helps credibility if our Total Addressable Market (TAM) is well over $10b. But how to prove that? Here’s my stack rank of preferred ways to demonstrate your large market size:
Direct Comps. A new car company can point to dozens of existing car companies, each with billions in revenue.
Indirect Comps. Ten years ago the electric car market was small, but they sought to steal share from a bunch of large gas automakers.
3rd Party Market Reports. Before cars were mainstream, an early automaker might have shown a report of annual consumer spending on transportation.
If All Else Fails. If none of these options work, then a fall back is an estimate of [(# addressable customers) x ($ your ideal price point)].
What About “Focus on Winning Our Niche?”
Yes, near-term results are the most important thing. A giant market opportunity doesn’t matter if we fail to delight today’s customers. There are lots of former car companies, after all.
But in the end, the enduring companies are those who manage to hit the short-term milestones while also marching towards the bigger vision.
Longer Version For Those Not Bored Yet
More back-of-napkin math on that $1 billion bogie…
For a VC, a big win means liquidity at >20x entry price
To stay in business, the VC will need to >3x their investors’ invested capital
Each VC fund has 20+ companies, most of which will generate small returns
So for a fund to 3x, it needs at least one company to have a >10x return
The original investment will likely be diluted by >50%, so a 10x return requires a 20x multiple from the entry price (e.g., invest at $15m post → exit at $300m)
Thus before a new investment, the question is “could this company be the one?”
M&A outcomes above $100m are very rare
The big headlines are usually public companies buying other public companies
When a private company is acquired without a disclosed price, we can assume it is low (sometimes the founders and investors get a return, oftentimes not)
When one private company buys another private company, the sellers usually get more private stock… which is still illiquid
Big Tech has been under regulatory pressure to buy less companies — and they have been under investor pressure to be more profitable
Bottom line: there have been very few recent examples of big M&A exits like Instagram, YouTube and WhatsApp from an earlier era
Thus, an outcome above $100m likely requires an IPO
So assuming we want an exit valuation well over $100m, and M&A is unlikely… going public is the most obvious way for the stock to get liquid
There just aren’t a lot of other good options
A strong IPO requires >$200m revenue with fast growth
This bar is up from ~$100m when Yelp went public for a few reasons including:
There are far fewer research analysts covering more companies, so the smaller companies get ignored and end up trading at very low prices
Rob estimates that being public costs about $10m per year in admin burden, so this just doesn’t make sense below a certain revenue threshold
The company also needs to be growing fast to command a strong valuation; otherwise it will likely trade at some low multiple of earnings
Thus, venture scale means a plausible path to $1 billion
If getting public requires $200m and fast growth, the company still needs serious headroom to keep growing
Example: if a company at $200m revenue can grow 50% per year, it will hit $1b revenue within just 4 years
By contrast, if an investor believes a market is just too small to support a new company with $1b revenue, she will likely conclude “this is not venture scale”