The Truth, or What We Want to Hear?

Eric Wiesen

Years ago, when I was a Silicon Valley lawyer, a VC client related an amusing anecdote about being pitched by early-stage companies (I know, VC jokes are always the funniest). The observation he made was that every startup, regardless of sector, business model or average sale price has the same 5-year revenue projection: $50 million, plus or minus a few. The reason, he explained, was that if the 5-year number is much lower than $50M, the VCs won’t be interested, and if it’s much higher than $50M the VCs won’t believe the projections.

Last week, a company that didn’t follow this rule pitched RRE for their Series A round. This was a good pitch – a credible entrepreneur with deep industry experience and network, looking to take a “2.0” approach to a business where the entrepreneur had already had some success back in the 1990s with a “1.0” solution. It was all looking pretty good, and we were progressing smoothly through the presentation, checking off a lot of the boxes I’d need to see in order to start a process internally. Until we arrived at the financial projections.

As a sidelight, the financial projections for an early-stage company are always speculative. Entrepreneurs know it and so do investors. But they help us, if nothing else, get a sense of how a given founding team thinks about the scope of an opportunity. And in this case, the financial projections showed the company quickly ramping up to about $15M and then almost totally leveling off, to the point where the 7-year projection was around $25M. And while I didn’t want to play into the stereotype above, I was professionally obligated to ask why the growth slowed dramatically in the “out years” in the model?

There are a few possible answers to this question, frankly none of them particularly encouraging.

1. You can (and most people, facing this question, do) argue that the assumptions in your model are so overwhelmingly conservative that while your projections say a small number, you really expect a much larger one. That doesn’t do well – while we appreciate conservative projections, it should be at the margin. If you really think this is a $100M business, your number should be relatively close to that.
2. You can tell us that this simply isn’t a particularly big market, and that the slow growth in the out years represent an early ramp to scale, and a tough fight for market share once the original ramp has been climbed. This is troubling, as early-stage VCs rarely want to get involved unless the addressable market is large enough to generate a big outcome.
3. You can tell us that the market is very fragmented, and that growth will be hard to come by as you fight with incumbents for share. This, too, isn’t something we like to hear, as it implies that it will be expensive and difficult to grow, and as Stuart sometimes says, “Some markets are just too hard”.

When pressed, this entrepreneur gave answer #2 – this is a market with a finite number of customers, and the financial projections he gave me reflect his (expert, I agree) estimate of his ability as a newcomer with a superior product, to gain market share – quickly at first, and more slowly in the out years.

The challenge is this – I appreciate the honesty this founder showed in telling me his genuine viewpoint on where the company can go. He also shared that he views this is a “good but not great” exit. A “double” if you like baseball metaphors. He’s doing this the right way, building realistic expectations for his business rather than telling me what I want to hear.

And yet – what I want to hear is that this can be a $100M revenue business that we can credibly see as a billion-dollar exit if everything goes according to plan. Because early-stage investing is simply too difficult to bet on companies where the best-case scenario is a $100M exit, even if that’s a great multiple on a couple million invested. Because best-case scenarios are rarely achieved, and when they are, it needs to be a real event for RRE.

So if I were this entrepreneur’s friend, and he asked me for advice on pitching RRE on this business, what would I tell him? I think the route he chose is admirable, but isn’t going to get him an investor. I simply can’t pound the table at our Monday meeting and insist that we have to do this deal, because even though I really like the team and the product vision, if they don’t think it can be a huge winner, I can’t. And I certainly don’t want him to lie to prospective investors about likely success, because that will simply lead to an unpleasant and combative Board of Directors/Management dynamic, when investors realize they’ve been sold a bill of goods.

No, I think what I would tell him is this: Go back over your plan from the beginning and see if there’s a way to make it bigger. Are there adjacencies you can exploit once you’ve established a beach head in your target market? Are there additional streams of revenue you can exploit? Underlying data assets, lead generation, marketing partnerships, greater distribution? Are there different verticals or other opportunities for value-added services within the vertical you’ve chosen?

If you want to be a venture-funded company, try to find a way to have a $50M business doing what you’re doing. Because while the anecdote at the outset is amusing, the risk profile of early-stage venture capital is such that you are going to get a lot of no’s if you can’t look us straight in the eye and get to some number close to that.