Separating a Cash Flow Business from a Venture Backable Startup

One of the on-going debates is whether a particular company is a cash flow business or a venture backable startup. Often, investors will pass on a startup because they feel the market is not big enough. Just this past week, Airbnb released seven rejection letters they received from investors when they were trying to raise $150,000 at a $1,500,000 valuation (today, that same 10% would be worth $2 billion). Here are a few thoughts on venture backable startups as different from cash flow businesses:

  • Small, fast growing markets can be the best when it’s clear that there’s a big opportunity ahead
  • Large, established markets work well if the product is truly 10x better, faster, and cheaper (if it’s only 2x better, the friction to switching is often too high to get much traction)
  • VCs want to believe that their portion of a potential exit is big enough to return at least 10% of their fund (so, the market opportunity must be 10x larger when taking investment from a $50M fund vs a $500M fund assuming the same round of financing)
  • Almost all new companies are not venture backable as the market size and dynamics aren’t conducive to the scale and value creation needed

The next time you hear an entrepreneur say they want to raise venture capital, ask if the business truly warrants it based on the market opportunity and current traction. Most companies are cash flow businesses, and those are often some of the best out there.

What else? What are some more thoughts on separating cash flow businesses from venture backable startups?

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