A top-down approach to the business plan simplifies decision making while presenting a compelling pitch to investors
A startup business plan is usually developed from the bottom up — here’s our product, here’s the target customers, here’s how we’ll reach those customers, here’s how we’ll grow the business.
The bottom-up approach is great until it gets to the key question: will venture investors fund it?
The answer is surprisingly simple: if it presents a compelling story showing how the business will reach $100M in revenue, investors will throw money at it. If not, it might be a great business, but it’s not an investable business for venture capital.
There’s always exceptions, of course, but as a general rule of thumb, venture investors will only fund startups that present a plan to reach at least $100M within 5 years.
The reason is tied to how venture funding works: investors get nothing until there’s an acquisition or IPO. To make up for the 90% of investments that fail while still generating 20% annual returns, the successes in the portfolio have to exit with at least a 25x return. With a $20M valuation at the time of investment, the company must be acquired for $500M or more.
Reaching those stratospheric heights requires revenues of at least $100M (or be on a nearly vertical trajectory to get there). And it’s not enough just to reach that milestone — to generate the required ROI, the company has only 5 years to get there.
This pushes venture investors (venture funds and angel investors) to look exclusively for startups likely reach $100M within 5 years. When you pitch to investors, you’re presenting your plan for accomplishing that challenging goal.
Having seen a million hockey sticks that show revenues leaping from $5M to $100M in year 5 that have never once materialized, I’ve become a bit skeptical when listening to pitches. I doubt I’m alone.
The biggest reason startups fail is not that they don’t build a wonderful product that customers love, but there’s just not enough of those customers. That jump from $5M to $100M never happens. The company reaches $5M or $10M, growing at 10% or 20% per year. That’s really good, but not good enough to attract a half billion dollar acquisition.
Once it becomes clear the company won’t reach orbit, investors write it off as a loss. When the company runs out of money because expenses overwhelm revenues, it’s shut down or sold off in a fire sale. If expenses can be cut to match revenues, the company can survive but it’s still a total loss for investors.
So when I hear a pitch, I’m not just looking for a rosy projection with big revenues but a viable plan to accomplish it. The pitch needs to answer the following questions:
- Is there a big enough market to get to $100M in revenues?
- Will the initial beachhead market be a steppingstone to the bigger market, or quicksand that slows progress towards the goal?
- What’s the go-to-market strategy to generate $100M worth of business? Is there a single, concentrated market that can be attacked with a team of salespeople or is it a diffuse market that will require millions in advertising?
- Will the company be able to cross the chasm between an enthusiastic group of early adopters to a wider group of users and overcome lock-in with their existing solution?
- Does the team have the skills and experience to manage a $100M business with hundreds of employees or will hypergrowth cause the company to implode into chaos?
- How will the startup keep out copycats once it starts taking market share from the giants?
The need to reach $100M may be a difficult challenge, but it provides a framework for making every difficult decision: What does the product need to be? What markets should we focus on? Who do we need to hire? The answer to every strategic decision is: what will give the us the best chance of getting to $100M within 5 years.
Focusing on the $100M goal also simplifies the pitch to investors. Instead of trying to explain everything, the pitch should focus on the high-level story of how you plan to reach $100M.
As an investor, I know I will lose my investment if the startup fails to reach this magic milestone, so the revenue projection is the the first thing I look at on a pitch deck and colors how I consider everything about the potential investment.
Reaching the $100M goal needs to be the first thing the entrepreneur thinks about when putting together the business plan, the central story of the pitch, and the criteria for every important decision the company makes.
A big downside to the need to reach $100M is it eliminates the opportunity to build a solid, smaller business. It can push startups with niche products to stretch to unobtainable goals to meet financial objectives rather than targeting viable smaller markets and focusing on customer satisfaction instead of growth at all costs.
That is, unfortunately, a built-in limitation of the venture capital system. Go big or go home to reach a huge exit is the nature of the game. A stable, profitable business is nothing but a loss to venture investors.
Fortunately, venture capital isn’t the only way to fund a startup. A business unlikely to reach stratospheric heights isn’t a bad idea or a bad business, it’s just not a fit for venture financing. In this earlier article, I wrote about ways to finance a startup that make more sense for business that aren’t rocketships.
(Note 1: Life science products have no problem reaching $100M for even the most niche product, so for those products, the pitch has to focus on their challenges: technical and regulatory hurdles.)
(Note 2: If the company only needs to raise a single round of funding from angel investors at a valuation of under $10M, then $50M is a viable revenue target.)