Un-Fundable: Lifestyle Business
If you want to set off an entrepreneur, tell them that their business isn't an Angel deal. We receive more complaints from entrepreneurs when an investor says that, than anything else.
There are a lot of reasons that a deal may not be right for investment, and over the next few weeks we will be covering a number of them. The important thing to remember is that just because a business isn't right for early stage investors, doesn't make it a bad business. However, it does mean that if you want to go ahead, you will need to find another way to finance your startup.
Lifestyle Business
A lifestyle business could generate enough money for the entrepreneur to live comfortably, but lacks the potential for scalability that would make it attractive for acquisition. It may also mean that even if the company could scale, it appears that the entrepreneur has no real ambition to do so past providing a comfortable income.
Example 1: The entrepreneur has a plan for a high-end concierge service for wealthy New Yorkers. The entrepreneur projects $2 Million in revenues every year.
It would be very difficult to scale this company. There are few places in the world where this service would be needed, and the potential market is relatively static. It may provide a nice salary for the entrepreneur, but there is little potential to grow this company to the point of acquisition.
Example 2: A famous designer decides he wants to break off and start his own company. He wants to work at home so he can spend more time with his children.
This is not the hallmark of someone who is interested in building a company. While he may be able to trade on his name to turn the new company into an international brand, it doesn’t appear that he has the ambition to do so. He is looking to create a lifestyle that is comfortable for him.
In either case, there is no exit for the company, and therefore no way for an investor to see a return. If the investor can’t get a return, there is no reason to invest.
So how do you start a lifestyle business without investors? If you’re going to start one, make sure you can bootstrap your way to revenue. Use income from another job, raise money from friends and family, or take out a business loan. If you can’t, then you may want to reconsider your business.
Jason Schwartz :: Jul.22.2008 :: Entrepreneur, Startup ::
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If the author has decided to overlook home-based entrepreneurs for investment than that is his prerogative. He is missing out on some remarkably talented, hard working and driven business owners. But what he shouldn't do is insult them while declining to invest with them. Unfortunately he's managed to do just that in this posting.
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"Lifestyle business" is NOT a pejorative term. Rather, it is a well-known and generally accepted expression (see <http://en.wikipedia.org/wiki/Lifestyle_business> and <http://www.powerhomebiz.com/vol100/lifestyle.htm>.
It describes the perfectly valid goal of creating a business that is fulfilling economically and spiritually for the entrepreneur and his/her family. I know dozens, if not hundreds of lifestyle entrepreneurs who would not change their jobs if you offered them ten million bucks: the homebuilder who loves being out on the job and creating a hand-crafted, perfect house; the picture framer who works six hours a day at a relaxed pace and knows every one of his customers by name; the personal shopping consultant who delights in finding just the right outfit for the perfect occasion...even the top VC who quit his job at Accel partners to move to Maine and start a mail order business specializing in a cappella music.
All of these businesses comfortably support the entrepreneur, each of the entrepreneurs receives great personal satisfaction from his or her business, and each is contributing to society...but not a single one of those enterprises is "venture (or angel) fundable". The point that Jason and the others are making is NOT that there is anything 'wrong' or 'tacky' or 'less desirable' about a lifestyle business, simply that the economics of it mean that it needs to be financed in some way other than risk equity. That can mean bootstrapping (usually the best option), personal savings, friends & family loans, or personal debt.
The fact is, because early stage, high-growth businesses are so incredibly risky (to expand on Evan's point, only 1 out of 100 businesses looking for venture/angel funding actually gets it, and five out of ten of those go bankrupt), seed and early stage investors need to maximize the potential return. I recently led a seminary discussing the somewhat complicated math involved (see <http://www.centernetworks.com/angel-investing-s...> for a look at the key slide), but what it boils down to is that EVERY deal into which a smart angel invests money needs to have the POTENTIAL to deliver a 20:1 or 30:1 return on the invested capital.
To run through a bit more of the math (and to make clear just how unbelievably tough that is), take an entrepreneur who comes to New York Angels seeing a $1 million investment and valuing his or her company at $4 million (this is a pretty typical profile for the kinds of businesses we see.) In order for the angel investor who contributes, say, $25,000 to the round to end up with an annual return of about 25% (which is about twice what you would hope to get from a hedge fund, and is commensurate with the risk being taken; remember the odds are 1000:1 that this will be "the one"!) that little startup company needs to be sold within six years for [I hope you're sitting down] ONE HUNDRED FIFTY MILLION DOLLARS.
And since there simply is no way from now to the end of the universe that this is going to happen to a sole proprietor home builder, or a local picture framer, or a personal shopper or even a mail-order a cappella music label, THAT is why those perfectly valid, great businesses, run by wonderful, smart, entrepreneurs (all of whom happen to be friends of mine, by the way) are "lifestyle" businesses and not appropriate for angel or VC financing.
So that is why it is really, really important to figure out at the beginning exactly what one;s personal goals are in starting a business, and what kind of financing (from bootstrapping to venture capital) is appropriate to support that goal.
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We are in no way slamming those entrepreneurs that decide to build what is referred to in the industry as a "lifestyle business." In fact, MANY successful companies are indeed that - and those hardworking entrepreneurs should be commended.
However, angels invest in companies to make a return on their own money, and are not doing it to help the entrepreneur build a business that does not have tremendous growth opportunity. So, while a hardworking woman might start a very successful clothing store and make a very nice living for herself, it wont generate a return for an angel that makes it worth their time and money. However, if she were to start a company which has explosive growth because of some amazing new idea that hasn't been tried before - that's something that is potentially of interest to angel investors and VCs.
The question is not whether entrepreneurs should or should not create a lifestyle business - the title was "unfundable" and VCs and Angels will NOT invest in lifestyle businesses. These type of business should seek loans and other means of funding their business.
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The point Jason is trying to make, is that this is not the type of company an angel typically wants to invest in (or can afford to invest in) because the potential returns are often not high enough to justify the risk.
If you look at some of the average stats on Angel investing you'll see that typically 1 in 10 companies is a success, and this one success has to bring in enough return to cover the loss on the other 9 companies. Thats a huge responsibility, many times we’re talking 30x or 40x your original investment!
To cover the responsibility Angel investors focus all of their efforts trying to find companies that can even come close to attaining that astronomical growth. Lifestyle companies typically don’t fall into this category.
That’s why you see many Angels investing in scalable technologies (software, bio tech, cleantech, etc). When they have a successful technology on their hands (google, ebay, a new computer chip, etc) the sky is the limit on the returns, and it can happen very quickly.
On the other hand retail stores, clothings lines, concierge services, or a variety of other businesses that could be a lifestyle business, typically can't grow this fast this quickly.
Its not a matter of putting those companies down or thinking bad of them (heck, the angel investor may have made their money doing a lifestyle business), its just a financial reality that the potential for massive returns needs to be there right from the start to justify the risk.
That being said, given the diversity of angels out there, you might always be able to find one willing to invest in your lifestyle business, but you might just have to spend more time searching for the right match...
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