Six reasons why taxi drivers (and other startups) should not take venture capital

I just got the following email.

Subject: Small taxi company looking to expand

Hello,

I run a small taxi company outside of Boston Massachusetts. My community has been targeted for casino development and I am looking to expand my business. Could you possibly provide some advice on how to find venture capital?

For someone who lives in the startup world, this looks pretty silly.  But I’m sure I’d say a lot of silly things if I were getting in to the taxi business, too.  So I figured I’d point him to a simple explanation of why taxi companies (actually, services companies in general) aren’t appropriate for VC.  I did the Google thing for a bit to find a good article.  And no luck.

Well, you know what they say: When the Internet fails you, make more Internet.  Here, then, are a very good set of reasons not to take venture capital (or – why venture capital won’t take you).

1.  You want to build a profitable company

First day of Founder’s Institute I ask how many people want to raise venture capital.  Most of the hands go up.  I then ask who wants to build a profitable company.  Again, most hands go up.

The funny thing about this is – VCs don’t actually like their companies to be profitable.  Someday, sure, but not on their watch.  You see, profitability means that the company won’t grow any faster.

This seems odd, but think about this for a minute. At the early stages, a company may be making money, but it’s almost certainly investing every penny it makes back in to the business.  If it has access to outside capital (e.g. a VCs), it’s investing more than it makes.  And that’s exactly what VCs like: companies that can grow at amazing speed, and never slow down their burn rate to amass cash.

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They like this for two reasons.  First, VCs want to invest in companies that can grow explosively.  That means huge markets, executives who can scale up a business fast, and a willingness on the part of management to double down on a winning bet – over, and over, and over again.  Second, because it means the company keeps coming back to the VC for more money on positive terms.  That means the VC keeps getting to buy more and more of the growing concern.

Of course, this is something of an over-broad generalization.  I’m required to include one per post or I lose my startup blogging license.  In fact many venture backed companies are profitable, it’s very impressive to bootstrap your company to profitability in a few months before raising outside investment, etc.   But if you are excited about a profitable business that can cut you giant dividend checks (not that most VCs can even accept divided checks  – long story), realize that VCs will not be pleased with that approach to running the business.

They will want you to plow those earnings back in to the business.  And when the day comes that a VC-backed business generates cash faster than it can effectively spend it?  They sell the company, or IPO (which is technically also selling the company), or replace the CEO with someone who can spend faster.

A taxi business should be run for profits.  That’s not VC style.

2. Your business has reasonable margins

As a general rule, VCs don’t like reasonable margins.  They are exclusively interested in outrageous margins.  Ludicrous margins.  We’re talking about sneering at 50%, and hoping for 80%, 90%, crazy astronomy stuff.  Venture capital is all about investing a little bit of money to create a business with massive scale and huge multiples – investing tens of millions to build software that then can be duplicated or served up for virtually nothing extra per-person with a total market size of billions.

In particular, VCs don’t like businesses that are people-powered.  Software businesses are awesome, but their evil twin – software consultancies – are near-pariah to VCs.  If adding revenue means adding bodies, they don’t like it.  In fact, enterprise software companies, which can tread a fine line between software consulting & software development, sometimes get really creative to come down on the right side of the line.

So the rule of thumb is that VCs like product companies: software, drugs, cleantech, and so on.  And they don’t like the manufacturing, service industry, and consulting businesses that often are just a tiny shift of business model away.

Every new taxi requires a… well, a new taxi.  And a new taxi driver.  Not the right business for VC.

3. You are going to double your investors’ money

I’ve covered this before, but VCs really don’t want to double their money.  Strange though it sounds, their economics make that look like a failure.  They need to target a 10x return on their investment, and that means – depending on stage and fund size – that you company has to grow to somewhere in the hundreds-of-millions to billions range to be interesting.

That means taking your taxi business from $20 million in annual revenue to $40 million just doesn’t do it for them.  Particularly because the valuation multiples on the aforementioned lower-margin businesses are smaller.

4. VCs probably don’t want to invest in you

Here are the people VCs really love to invest in:

• Entrepreneurs who’ve already made them lots of money
• Their closest buddies