Posted on by steveblank

Make no little plans. They have no magic to stir men’s blood…

Daniel Burnham

A lot of entrepreneurs think that their startup is the next big thing when in reality they’re just building a small business. How can you tell if your startup has the potential to be the next Google, Intel or Facebook? A first order filter is whether the founders are aiming for a scalable startup.

Go For Broke

A few years ago I sat on the board of IMVU when the young company faced a choice my mother used to describe as “you should be so lucky to have this problem.” For its first year IMVU had funded itself with money from friends and family. Now with customers and early revenue, it was out raising its first round of venture money. (Not only did their sales curve look like a textbook case of a VC-friendly hockey stick, but their Lessons Learned funding presentation was an eye-opener.)

Staring at us in the board meeting were three term-sheets from brand name VC’s and an unexpected buy-out offer from Google. In fact, Google’s offer for $15 Million was equal to the highest valuation from the venture firms. The question was: what did the founders want to do?

Will Harvey, Eric Ries and the other founders were unequivocal – “Screw the buy-out, we’re here to build a company. Lets take venture capital and grow this thing into a real business.”

The Scalable Startup

Will and Eric implicitly had already made six decisions that defined a scalable startup.

Their vision for IMVU was broad and deep and very big – 3D avatars and virtual goods would eventually be everywhere in the on-line world. They wanted to build an industry not just a product or a company. Their personal goal wasn’t to have a company that stayed small and paid them well. Nor did they think flipping the company to make a few million dollars would be a win. They believed their vision and work was going to be worth a lot more – or zero. They envisioned that their tiny startup was to going to be a $100 million/year company by creating an entirely new market – selling virtual goods. They used Customer and Agile development to search for a scalable and repeatable business model to become a large company. It reduced risk while allowing them to aim high. They hired a world-class team with co-founders and early employees who shared their vision. They fervently believed that only they were the ones who could and would make this happen.

These decisions guaranteed that the outcome of the board meeting was preordained. Selling out to Google would mean that someone else would define their vision. They were too driven and focused to let that happen. A few million dollars wasn’t their goal. Taking venture money was just a means to an end. Their goal was to get profitable and big. And risk capital allowed them to do that sooner than later. Venture money also meant that the VC’s goals of obscene returns were aligned with the founders. For the entire team, turning down the Google deal was equivalent to burning the boats on the shore. (One founder quit and joined Google.) After that, there was no doubt to existing employees and new hires what the company was aiming for.

Take No Prisoners

A “scalable startup” takes an innovative idea and searches for a scalable and repeatable business model that will turn it into a high growth, profitable company. Not just big but huge. It does that by entering a large market and taking share away from incumbents or by creating a new market and growing it rapidly.

A scalable startup typically requires external “risk” capital to create market demand and scale. And the founders must have a reality distortion field to convince investors their vision is not a hallucination and to hire employees and acquire early customers. A scalable startup requires incredibly talented people taking unreasonable risks with an unreasonable effort from the founders and employees.

Not All Startups are Scalable

The word entrepreneur covers a lot of ground. It means someone who organizes, manages, and assumes the risks of a business. Entrepreneurship often describes a small business whose owner starts up a company i.e. a plumbing supply store, a restaurant, a consulting firm. In the U.S. 5.7 million companies with fewer than 100 employees make up 99.5% of all businesses. These small businesses are the backbone of American capitalism. But small businesses startups have very different objectives than scalable startups.

First, their goal is not scale on an industry level. They may want to grower larger, but they aren’t focused on replacing an incumbent in an existing market or creating a new market. Typically the size of their opportunity and company doesn’t lend itself to attracting venture capital. They grow their business via profits or traditional bank financing. Their primary goal is a predictable revenue stream for the owner, with reasonable risk and reasonable effort and without the need to bring in world-class engineers and managers.

The Web and Startups

The Internet has created a series of new and innovative business models. Herein lies the confusion; not every business on the web can scale big. While the Internet has enabled scalable Internet startups like Google and Facebook, it has also created a much, much larger class of web-based small businesses that can’t or won’t scale to a large company. Some are in small markets, some are run by founders who don’t want to scale or can’t raise the capital, or acquire the team. (The good news is that there is an emerging class of investors who are more than happy to fund and flip Web small businesses.)

Scalable Startup or Small Business – Which One is Right?

There’s nothing wrong with starting a small business. In fact, it is scalable startups that are the abnormal condition. You have to be crazy to make the bet the IMVU founders did. Unfortunately the popular culture and press have made scalable startups like Google and Facebook the models that every entrepreneur should aspire to and disparages technology small businesses with pejoratives like “lifestyle business.”

That’s just plain wrong. It’s simply a choice.

Just make it a conscious choice.

Lessons Learned

Not all startups are scalable startups

6 initial conditions differentiate a scalable startup from a small business; Breadth of an entrepreneurs’ vision Founders’ personal goals Size of the target market Customer and Agile development to find the business model World-class founding team and initial employees Passionate belief and a reality distortion field

Understand your personal risk profile/ don’t try to be someone you’re not

Which one is “right” is up to you, not the crowd

Filed under: Corporate/Gov't Innovation, Customer Development, Technology, Venture Capital |