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Small profitable companies versus VC-backed startups

I recently had an interesting conversation with a friend centered around a key question that’s come up a couple times before:

How transferable are the skills you learn from building a small, profitable company versus doing a VC-backable startup?

This question came up because part of his life plan was that he wanted to do a “real” shoot-the-moon type startup at some point in his career, but before doing that, he wanted to work on a small profitable company so that he could learn more about the process. We had a discussion around the key assumptions around a plan like that, which centered around the question above.

In general, it’s my belief that most of the knowledge isn’t that transferable, and you are better off just trying to do the VC-backable startup from scratch, rather than deferring that experience. In the worst case, if you fail, you still learn a lot about VC-backable startups and what it takes to succeed. Compare this to building a small, profitable company, where even if you succeed or fail, you may not learn what you wanted to learn.

And of course, it’s a perfectly healthy thing to NOT to want to build a VC-backable company, ever. That is a great idea too :-) But for those who want to have that experience but are deferring it, I would encourage you to try sooner, not later.

VC-backable startups have weird constraints
Ultimately, the core of my beliefs stem from the fact that VC-backable startups have to deal with a number of weird constraints:

• they should grow really fast – people sometimes say ideally hitting $50M in revenue in <5 years
• they should be defensible – ideally having real technology that isn’t easily duplicated
• obviously, you want a great, experienced team – ideally experienced operators or cutting edge technologists
• it’s very centered on SF Bay area and less so on a few other areas (Boston/Seattle/NY/SoCal/Austin)
• early stage is focused on proving things out to get each new round of funding, not on profitability (which is a nice to have)
• etc.

Again, most of the above are nice to haves and they are always on some investor checklist somewhere, and are followed loosely/casually in most cases. Similarly, to get in the game, there are significant “community” effects that kick in too – it’s good to have the right angel investors, because they can help connect you with the right VCs. But angel investors are just random people (albeit random successful people), and they sometimes don’t like to give money to strange people from other cities. So they like to invest locally, and only through people they already know.

So the point on all of the above is, VC-backable companies have all sorts of weird constraints on what you have to be able to do.

Understanding these constraints, and working with them, requires a different mindset than if you are just targeting for profitability.

There’s different constraints on Lifestyle companies, aka Small/profitable companies, aka Passive income companies, aka whatever you want to call them
I think most of the constraints above are pretty silly if the only goal is to build a self-sustaining company that can get profitable and kick off passive income. In those cases, you really don’t need all the constraints above, which really take you down a different path.

In those cases, you could really execute your company anywhere – you don’t have to be in the Bay Area. Rapid growth is both unnecessary, and possibly not desired if new users are creating costs! Instead, you might prefer to charge users upfront, so that you can be sure that you can stay cashflow positive. Similarly, it’s fine to just work with your buddies, or family, or whatever you want – there’s less of a need for them to scale the business quickly, nor will their experience level play a role in whether investors fund the company.

What both the two styles of company do share, however, is that you still need to be able to build a product, and build a business for cheap, even if you are going after different goals.

But even with product development, when you are going for a smaller, self-sustaining company, it’s more OK to target niche markets or build high-quality products for slow-growth businesses. You probably don’t want to build for a new market, since that can take a lot of time and capital to get right.

How much do you really learn?
To net this discussion out, my point is that the two styles of companies are different in as many ways as they are similar. Instead of “walk before you run” it’s more like “learn to sail versus learn to bike.” Learning to sail does not increase your chances of success at cycling, and vice versa, as well.

So for all the engineers out there who are thinking about doing small web projects before trying to take over the world – go for the latter :-)

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