A finance scenario for successful ventures has been more or less as follows. When the business is not much more than an inspired moment and a slide deck, the entrepreneur raises a small “friends and family” round for, say, $50,000, to fund the incubation of the start-up. Once the business has been structurally established and is showing initial progress, even a little bit of traction in its target market, but is not yet sufficiently advanced to justify a full-fledged Series A venture raise, the entrepreneur continues with a “seed” round of, say, $500,000, to fund the company’s evolution to a point that is worthy of institutional attention. At that point, one raises a Series A venture investment – let’s call it $5 million – to hire and expand and become substantial. “Substantial” being a relative quality, and most web ventures burning cash throughout this growth phase, a Series B follows, and a Series C – each for varying sums of additional millions, or tens of millions – and maybe a headline grabbing Series D along the way, up to an exit in the M&A or IPO market.
Ah, the snows of yesteryear, those excellent days gone by… While the amounts required to launch and grow a digital media venture have diminished, in some cases substantially, so also has the venture capital available for such investments. The prospects of IPO exits are a faint shadow of their former selves, and M&A is smaller and more strategic. In short, the trajectory of $50,000 to $500,000 to $5 million to $50 million to $500 million is not what it once was, and the number of $5 billion industry-redefining sensations seems also to be trending down. Whether this trend will reverse, and if so, when it will, is a matter of guessing. Mine is that we are in a new era in which we are likely to find ourselves for a long time still, and I have previously described my reasons here.
If true – and regardless of what the future may be, the depicted market profile seems to be the case for now – entrepreneurs should adjust their models accordingly, and build businesses in keeping with this new corporate finance. Rather than aiming to justify the Series A and B and C that may never be raised, rather than architecting some blockbuster IPO or large M&A exit that comes with a diminishing probability, one should pursue a framework for a reliable cash machine. Perhaps a $500,000 seed round can produce annual profit of $100,000 or more? Perhaps $200,000? If such a business can be constructed, the need to raise venture money diminishes, and the exit strategy for shareholders is built-in: cash flow is itself the exit vehicle. Of course, the scenario is far less thrilling on its surface, but there have been too many failed ventures to count that on their surface were thrilling at the outset. And besides, the issue is only one of scalability: more substantial capital can always be raised, and at more attractive terms, when doing so is interesting but not essential.
I suppose that, on one level, what I am describing bears similarities to traditional media models. Is that old-fashioned? Maybe. But we must not forget that the Internet has always been a media business, and that many little media businesses that did not become Google or Facebook nevertheless became Comcast and NewsCorp and Disney. Some were consolidated into such or similar groups, and some are now grabbing headlines, independently, for the stability and cash flow production these have demonstrated. See, for example, this recent news from Netflix and EHarmony, or the recent success of Groupon and Zynga, arguably the two most successful venture-backed digital media “start-ups” in the sector. As the web matures, as capital markets are transforming, it may be time to look back to our elders for some important guidance and business building lessons. At the same time, venture capital may look to more traditional private equity and adjust its investment framework accordingly.
