Last week I wrote a blog post that answered the question, “What is a Scalable Business Model?”
Now that you have read that, I want to explain why I believe a scalable business model is so important. I am going to split this into 2 different sections:
- Why a scalable business model is important for your business goals
- Why a scalable business model is important for your personal goals
Business Importance of a Scalable Business Model
I think there are at least 2 reasons why building a business with a scalable business model is important for the future of your business success.
1. Ability to Raise Capital – Businesses that have a small “scalable range” (See: What is a Scalable Range? to understand scalable range) are unlikely to ever raise capital from investors. If the best case scenario for your business is that you become a $10 million dollar a year business, most angel investors and venture capitalists won’t be interested in investing. I know $10 million sounds great to you right? In order for me to explain, why it isn’t great for an investor, I need to steal from a previous blog post that I wrote titled, “How to Create Financial Projections for a Banker vs. an Investor”
“Investors are looking for companies with financial projections that have the potential to multiply their investment 10 times. You don’t need to project 10x returns in your financial forecast, but you need to demonstrate that it is within the realm of possibility. Why do angel investors and venture capitalists require 10x return potential?
Again, let’s look at the math. A good rule of thumb for angel investors is as follows:
- ⅓ of investments the investor loses everything
- ⅓ of investments the investors breaks even
- ⅓ of investments the investor makes money
Let’s look at 9, $50,000 angel investments. Right off the bat you can assume that your $450,000 investment is now worth $300,000 because ⅓ of the investments will fail. You will hope to break even on another ⅓. Now let’s assume the investors sell their share in the last 3 companies for $100,000 (that is double their $50,000 investment).
It might sound good to double your initial investment for 3 companies, but when you do the math that just brings the total $450,000 investment back to breakeven. Another problem is that it probably took 5 years for all 9 investments to cash out, and after 5 years their $450,000 did not earn anything!
In order to earn a respectable return on a portfolio of 9 investments, at least one of the investments needs to provide a 10x type return. If the best your company could offer investors is a 2 or 3x return, then you just are not worth the risk. Investors are willing to take risks where banks are not, but you have to demonstrate that a huge return is possible.”
If your business is not scalable into a large business, you simply won’t be able to raise capital.
2. Ability to Sell Your Business
If your business is not scalable, if it can’t grow past a certain point (relatively small), you may never be able to sell the business. Most business owners don’t get rich from operating their business, rather they make their money during a liquidity event, when they sell all or a portion of their business. A prime example of a business that is hard to sell because it lacks scalability is a consulting business.
It is extremely difficult to sell a consulting business because typically the consulting business is built around the expertise of YOU the owner, or a couple of the top employees in the firm. This is difficult to sell because as soon as you sell the business, you will probably want to retire on the beach, but the business will be worth less or worthless without you. You will end up selling a consulting business at a huge discount simply because it is risky. Will customers stay with the new company even though they originally became a customer because of you? Consulting businesses are also difficult to grow quickly. Consulting businesses can grow very large, consider the big 4 accounting firms who have grown through mergers and acquisitions, but it is hard to grow a consulting business organically and quickly at the same time. These are just a couple of the reasons I closed my consulting business. (See: Why I Closed My Consulting Business and Why You Should Too)
Personal Importance of a Scalable Business Model
I also believe that there are at least 2 personal reasons that you should start a business or transition your current business into a more scalable business model.
1. Scalable Businesses Allow You to Have an Impact - For me, this is the single most important reason to develop a business with a scalable business model. I am only 24, so I still have the optimistic, bright eyed, hope that I can change the world. In my opinion the best way for me to change the world is to create a business that can either generate significant profits, or be sold for a large sum so that I can then take that money and use it to support causes that I am passionate about.
I just wanted to give you a couple example of people who are now doing great things to impact the world, that would not have been able to have the same impact if they had not founded SCALABLE businesses:
- Bill Gates – This is the most obvious example of an entrepreneur who created a scalable business, grew it to tens of billions of dollars, and then devoted the rest of their life to changing the world. Bill and Melinda Gates started the Gates foundation, and are changing the world every day.
- Elon Musk - Elon Musk was a Co-Founder of PayPal. PayPal was an incredibly scalable business model. After selling PayPal to eBay, Elon has launched 2 new companies that are tackling HUGE problems. Elon would never have been able to start SpaceX and Tesla Motors if it wasn’t for his work, and sale of PayPal.
- Ryan Allis - Ryan founded iContact, an email service that sold for $169 million. In this Mixergy Interview Ryan talked about how he intends to spend the next 20 years of his life working to end poverty in Africa. Because of his business success he is now able to spend his time on a cause that he is passionate about.
2. Scalable Businesses Allow You to Have A Nice Lifestyle - Many people start their own business because they want the entrepreneur’s lifestyle. They are surprised to find out that entrepreneurs work harder than anyone until they sell their business. The fatal flaw of many business models is that they are impossible to sell. I wrote a couple blog posts on this topic:
If you can’t sell your business, you MAY never enjoy the lifestyle that you were hoping to enjoy as an entrepreneur. As I mentioned before, if your business can’t scale, it will be difficult to sell. It is hard to sell a business that has no prospects of growth.
So before you jump into entrepreneurship, consider your business model. Is it scalable? Will you be able to have the impact and the lifestyle that you hope to have?