My colleague and serial entrepreneur, Scot Wingo, of ChannelAdvisor, Spiffy and Triangle Tweener Fund fame, recently posted on LinkedIn, how hard it was to scale a business. He referenced data from a book by Verne Harnish, the founder of Entrepreneur’s Organization, called Scaling Up: How a Few Companies Make It . . . and Why the Rest Don’t.
The core of the story was this graphic:
What the graphic basically says is, of the 28,000,000 businesses in the United States, only 0.061% actually get larger than $50MM in revenues. And 96% of all businesses, never get larger than $1MM in revenues. I was so taken back by the data here, that I thought it was worthy of a deeper discussion.
Why is It So Hard to Scale?
Very Few Best Educated Entrepreneurs. The US News & World Report only lists 39 universities as being the best undergraduate entrepreneurship programs. Let’s estimate that the average class size at those business schools is 1,000 per school and that 10% major in entrepreneurship (or 100 per school). So, there are 3,900 highly regarded entrepreneurship graduates per year. With an average career length of 44 years (from 21 to 65 years old), that means there is a pool of 171,600 people best trained in entrepreneurship. There are 333.3MM people in the United States, and 28.94% of them are “working age”, creating a pool of 96.5MM workers. That means only 0.18% of workers properly knew what they were signing up for in the world of entrepreneurship, before diving in headfirst. Now, all of a sudden, the numbers in the chart don’t look that far off of what should have been reasonably expected.
Worth mentioning, notice I focused on entrepreneurship majors. I intentionally ignored business majors. Most business degrees are pumping out graduates that work in large companies. And the skillsets needed for running a Fortune 1000 sized company are materially different than the skillsets needed for taking a piece of paper idea and turning it into a successful business.
You Don’t Do Your Homework Before Launching. For many businesses that launch, they do so without building a proper business plan, including doing homework on their industry and competition, identifying affordable sales and marketing opportunities, and ensuring there is a good product market fit. Would you take a test in school, without first doing your homework, or studying for the exam? Of course you wouldn’t. So don’t do it when launching a business, especially given the large amount of dollars you will be putting at risk, potentially getting flushed down the toilet with the low odds of success being talked about in this article.
You Don’t Have the Right Skills Needed. You have to be honest with yourself. Are you the right person to actually launch this business and execute the business plan? Do you have the right skillsets required for strategy, management and fund raising? You most likely don’t. So that means you need to hire the people with the right skills or surround yourself by mentors and advisors that have “been there, and done that” before, to help get you up the learning curve. There is very little room for making mistakes in the world of startups, given the capital requirements.
You Don’t Evolve As the Business Needs Change With Scale. The graphic above illustrates four “valleys of death”. These are the points where most businesses “stall out” in their growth curves. Why is that? Go back to the last paragraph; they don’t have the right skills needed for that next phase of the company’s growth. The skills it takes to grow from $1MM to $10MM in revenues are completely different than the skillsets needed to grow from $10MM to $50MM. The bigger you get, the more complexities there are. Bigger companies have to start thinking about things like international expansion and mergers & acquisitions, which were never given a thought for the smaller business. So, as you scale, you really need to re-assess your senior management needs to make sure that new team, has also “been there, and done that” for the skillsets needed for the next phase of your growth. They are materially different.
They Run Out of Money. Some startups run out of money for things out of their control, like a crash in the economy or the financial markets. And other startups run out of money, simply because they under-budgeted for what their entire needs would be, or they were too aggressive with their revenue growth assumptions. Oftentimes, by the time they realize they are out of cash, it is too late to raise new capital, as a fundraising process can often take up to six months. So plan far ahead and keep your eyes firmly glued to your “gas tank”.
When The Going Gets Tough, The Weak Throw in the Towel. Startups are full of disappointments and let downs. You may need to listen to 100 people say “no” before you find that one person that is willing to say “yes”. Not everyone has the “fire in the belly” needed to break down those walls and push the company on to future success in the face of all these headwinds. So, if you don’t like the idea of feeling like you are constantly “pushing water uphill”, you probably shouldn’t consider a career in entrepreneurship. It is not a career for the weak of heart.
Why Do Venture Investors Take This Level of Risk?
With this low level of success in scaling businesses, why do venture capitalists even invest at this stage?
First of all, professional venture capitalists are exactly that . . . professionals! They have done this for a living for decades and have listened to thousands of entrepreneurs pitch their businesses and know what it takes to succeed. So, for many of them, they are confident in their own experiences from their past portfolio companies to “defy the odds”.
Secondly, they employ a portfolio strategy: out of any one fund they make 25-30 investments. They know 90% of them will break even or lose money. But they also know the 2-3 that breakthrough will generate a large enough return to generate an impressive return for the entire fund. For example, if they make 20x return on 10% of the portfolio, and break even on the rest, the fund still yields a 25-30% annual return to their investors over a five-year period. Point here: diversification is key, don’t put all your eggs in one basket.
Lastly, the best venture capitalists know how to game the system. Let’s say they are investing in marketing software companies. The good ones have relationships with CMOs at many companies, that can help them do due diligence on the merits of the startup’s idea and become initial customers for that startup (which is the hardest part of scaling—finding customers). What will be your “unfair advantage”?
Should You as an Entrepreneur Take on This Level of Risk
After reading this article, do you think you have what it takes to be one of the 0.061% that can break through to over $50MM in revenue, which is what investors will be listening for? Do you have a good, well-researched idea? Do you have the right team in place? Do you have the capital lined up to succeed, in both good times and in bad, with enough cushion in place for the unexpected hiccups, for which there will be many? Are you prepared to hand over the CEO reins for the next chapter of your growth? Do you have the intestinal fortitude to plow through all the roadblocks? Do you have an “unfair advantage”, that will help you with customer acquisition? If so, maybe we will be singing your praises in the years to come. But there are very high odds, based on the data above, that we will not. So, be honest with yourself before rolling the dice and putting your life savings at risk. Especially, since you won’t have the luxury of a portfolio strategy, like a venture capitalist has, with all your eggs in one basket. Batten down the hatches, it should be wild ride. Prepare for the worst, and hope for the best.
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