One of the harder concepts for entrepreneurs to grok is that even when a startup has product/market fit, customers, employees, and investors, there’s almost no value to the business. Now, on paper, there’s a valuation the investors bought in at, so it feels like there’s value. But, unfortunately, there’s really very little value until the startup has some scale — say $5 million or $10 million in revenue. Similar to the idea that there’s no market for failed startup products, there’s almost no market for barely successful startups.
Here are a few reasons why scale is need for sale or acquisition of a startup:
- For any mid-to-large company that can afford to acquire the startup, the revenue needs to be meaningful, or the potential to be meaningful in a few years (e.g. at least 1-5% of the overall revenue)
- Financial buyers, as opposed to strategic acquirers, are looking to pay based on a multiple of profits, not revenue, and most startups aren’t profitable (financial buyers often pay 4-6x EBITDA, depending on the type of business)
- Transactions costs to acquire a company are high, especially with all the legal and accounting time as part of due diligence, adding considerable friction to the process of acquiring a startup
- Someone within the acquiring organization has to be a champion for the acquisition and stick their neck out — it’s safer to pay more and acquire a startup that’s more established with more revenue
Once there’s scale, many of the risks – customer adoption, value proposition, growth potential – are addressed and it’s more of an opportunity to take something that’s working and make it many times larger. Most mid-to-large companies aren’t interested in acquiring sub-scale startups.
What else? What are some more thoughts on the idea that scale is needed for sale?