Companies start out as hopes and dreams and stay there for at least a little while. Even after the product has been launched and users are jumping aboard, the company is still in hopes and dreams mode.
But eventually one of three things happens to a company; it goes out of business, it gets sold, or it becomes a real business.
And one of the most interesting things to watch and learn from, as an entrepreneur or investor in entrepreneurs, is what happens when you go from hopes and dreams to the real thing.
There is a big chasm between hopes and dreams and the real thing. Companies need to grow up and go through the ugly adolescent phase. They start to doubt themselves, they start to churn employees, they may even go through a management change or two. Getting across this chasm is hard, it takes tenacity, both from the entrepreneur and team and from the investors. Everyone has to stay the course, buy into the plan, and execute it.
Crossing the chasm to the real thing is not nearly as fun as the hopes and dreams phase. It is hard work and it happens after the gushing media has left your company for the shiny new thing. Your company will take a morale hit and you will have to lead it through this phase.
But getting to the other side is worth all of it. There is nothing as satisfying in entrepreneur land than having a profitable growing sustainable business that doesn’t need another dime of anyone else’s capital. I have watched entrepreneurs stand up in front of their teams and tell them that they’ve reached that point. I get chills every time I see it.
Many entrepreneurs choose to sell their companies during the hopes and dreams phase. I can understand why. When someone is paying you in advance for all the hard work you are going to have to do in the future, it is tempting to take it. And there is always the chance that you won’t cross the chasm and you’ll end up in the deal pool at the bottom.
I don’t like to stand in the way of those decisions. But I also like to remind entrepreneurs that with the right amount of capital, the right team, and the right plan, they will get across the chasm and I like to point out what waits for them on the other side.
I also like to advise entrepreneurs to take advantage of the financing environment that is available to them during the hopes and dreams phase. It is a strange situation. Your company will be worth more to investors during the hopes and dreams phase than it will be worth while you are crossing the chasm. So you should raise enough capital at hopes and dreams valuations to get across. If you don’t, a down round is waiting for you as yet another challenge while you are crossing the chasm.
Companies with no revenues but big potential are worth whatever the market will bear. But once you have revenues and are heading towards earnings, the market will be able to better assess what you are worth. Revenues and earnings multiples will enter the valuation discussions. And most of the time, revenues and earnings multiples will result in a lower number than hopes and dreams, at least for a while.
Facebook is a great example of this. Microsoft paid a “hopes and dreams” valuation of $15bn a few years ago while Facebook was growing fast but just starting to generate revenue. That round didn’t get Facebook all the way across the chasm and there was that difficult financing in which Facebook got offers from private equity firms in the $3bn to $5bn range. Facebook eventually concluded a “down round” at $10bn with DST. And that round got them all the way across the chasm and now Facebook is profitable and its shares are trading at $25bn in the secondary markets.
Many companies go through this valuation roller coaster ride as they cross the chasm. Don’t fret too much about it. Once you decide to go for it, you need to be focused on the end game and interim valuations don’t matter too much as long as you hold on to enough of the business for yourself and your team. The right investors matter a lot in that scenario.
Anyway, this post is getting a bit too long for my taste so I’ll wrap it up. The best companies I’ve been involved with in my 25 years in the VC business are not always the big exits. I enjoy watching an entrepreneur and a team spend a decade or more building a real business that creates sustainable value for everyone. And that process is never pretty from start to finish. Don’t worry about that. Embrace it. It is just another challenge to be met. You can cross the chasm from hopes and dreams to the real thing if you have the tenacity, the team, the plan, and the right capital partners. And when you do, it is the greatest feeling.
Read more posts at A VC »
NOW WATCH: Ideas videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.