Sub-Ventures (Part II): Capital Requirements and Exit Strategies

The second tenet of the sub-venture model is that it should require only about 10% of the average venture capital outlay to get to profitability.  As such, it will fall under the radar of normal venture capital firms and put your squarely in need of angels instead.  This makes it a little less sexy to most entrepreneurs, but a lot more practical for those who can settle for making a lot of money instead of making sexy amounts of money.

If we follow the other tenets of the sub-venture model, then most of the money can be spent on marketing, with little going to development, network engineering, servers, trade shows, and free catered lunches for employees.

So what level of funding am I talking about? I’m seeing the sub-venture model as something that requires between $50-300k to get to profitability.  Venture capital deals run about $500k to $3 million to get going, and that’s usually not expected to get the venture to profitability, so maybe 10% is on the high side of what it will cost in the sub-venture model.

Getting to profitability with just $300k means a lot of possibilities are open to you at the end of the start-up cycle – when you’re looking for the exit strategy everyone likes to think about.  If you take venture capital, then the VCs are generally thinking you will be acquired for 10x the total funding you take.  So, if you go after $3 million, then you need to be acquired for $30 million or more.  If you have follow-on rounds that take you to $10 million in funding, then you’re up to $100 million as a necessary exit.

Now, let’s be clear, a lot of acquisitions these days aren’t based on making a profit.  They’re much more based on acquiring eyeballs or capabilities.  Twitter just completed a round of financing that takes it to a valuation of $1 billion.  It doesn’t have any obvious revenue at the moment, though it would be easy to monetize the site with search ads almost immediately.  Instead, the valuation is based on growth and potential and traffic.  It could be acquired anytime, as could Facebook and others, without ever showing a profit.

These companies are the ones you’ve heard of, and I hate to say it, but if you’ve heard of it and you’re not a tech geek, it’s a very rare bird, and your odds of creating something similar are near to nil.

In the sub-venture model, an exit of 10X means you could sell the company for $3 million and keep your angels happy and ready to finance your next venture.  And at $3 million, there are a lot more buyers out there.  Of course, you could hit it big and sell it for $30 million, which is what I’m shooting for with most of my ventures.  Then you’ve got some very happy people all around.

If you figure that you’re actually shooting for profitability in the sub-venture model, and you can sell for about 10X earnings, then you’re talking about a business that spits off $300k to $3 million in profits per year.  That doesn’t seem so out of the realm of possibility if you can buy and sell the traffic you’re getting at even a small margin.

Essentially, then, the lower capital requirements methodology of the sub-venture model can include the following advantages, among others:

  1. Less time spent raising money.
  2. Greater chances of actually getting the financing.
  3. An order of magnitude less pressure to be acquired.
  4. More buyers available.
  5. A business that will be profitable even without being acquired.

Those seem like pretty good things to me.  If what I’m giving up is more sex appeal, well, I’m old enough to know that’s not all it’s cracked up to be anyway.

Next we’ll cover open source versus proprietary software, which is *big* in the minds of venture capitalists.

Leave a Reply