Venture capital investment shows no sign of slowing down anytime soon. In 2015, VC funding for U.S startups was at $60 billion; by July of 2019, $62 billion had already been invested. By the end of 2018, VC backing soared to $131 billion, the highest spend since 2000, and more than double the figures of 2015. Good news right? Not necessarily.
In today’s climate, this infusion of venture funding has both upsides and downsides. While many of the biggest direct-to-consumer brands have secured significant capital investment within the past few years, the pressure to grow at all costs has left many in “startup purgatory,” with no exit or sale in sight.
As a result, budding entrepreneurs are increasingly at a crossroads, forced to choose between prioritizing the path for fast-paced growth versus the measured path to profitability.
Should you take door number one or door number two?
For emerging brands, there are two potential and distinct paths to walk the road to success.
Door number one: Scale big and drive top-line revenue
This path is for brands who believe in the saying “go big or go home.” They are looking to scale as quickly as possible, and in pursuit, they continue to raise subsequent rounds at higher valuations to fuel ongoing growth.
On the plus side, more investment means greater speed to execute, greater escape velocity from the pack and greater validation for talent recruitment and company morale. On the flip side, heightened focus on continued capital raising means less focus on operational discipline.
In addition, the current precarious capital markets environment is causing investors to be more cautious and startups to be less secure when exits and IPOs aren’t meeting expectations. Just look at how shares of Peloton and SmileDirectClub declined after the companies went public.
Again, as the chase for higher and higher valuations continue, startups have fewer and fewer options down the road for liquidity as their company’s price tag keeps climbing higher and higher.
Door number two: Build for profitability and long-term sustainability
Focusing on operational discipline from day one is another path; and one that enables startups to scale for sustainability, not solely for driving top-line and achieving higher valuations to raise growth capital.
On the positive side, operating for sustainability for the long haul takes center stage and makes investor expectations and accountability less crippling. On the flip side, this approach doesn’t have the “wow” factor of higher valuation rounds and does not generate the same momentum that high-flying revenue numbers can generate. This focus on measured growth can be viewed as lackluster as compared to brands vying for unicorn status.
Which path is the best for your brand?
When it comes to Series A funding, brands must make a critical decision about which door to walk through. Many brands have selected (and continue to select) door number one on their quest to unicorn potential. The Warby Parkers, Caspers and Birchboxes of the world are great examples of this. But as their valuations (and cache) grew, so did investor expectations.
As a result, these brands continue to focus on increasing top-line revenue to keep pace with rising valuations. Birchbox ultimately wasn’t able to raise additional funding at a higher valuation and had to wipe out its entire capital table.
At the same time, there are many brands that have taken (and continue to take) door number two, representing the more traditional way of building a sustainable business. While they haven’t secured the major valuations that other brands have, they are building toward being a long-term player in their industry with more alternatives for an exit.
And with data showing that the odds of becoming a unicorn are about 1 percent, and acquisitions under $250MM accounting for over 80 percent of total deals, this road less travelled may start to see –– and definitely ought to start seeing –– a lot more foot traffic.
Advice for new entrepreneurs
In the current environment, scaling big and fast continues to occur and can still yield major success. So, if you’re already well on your way to that path, buckle in and hope that you’re one of the lucky ones. But, if you haven’t yet committed to either path, you may want to consider door number two. Yes, it may be less sexy than attaining the coveted unicorn label, but the most attractive thing of all is still being around when other companies have floundered.
More and more VCs are advocating that spending fast to grow fast isn’t always the end game. Rather, identifying those companies that can go the distance and turn a profit as they cross the threshold of door number two may be just what the doctor ordered.