When venture capital investors look at the scalability of a company, they want to see three things: that the business was designed to grow large, that the owners want the business to grow large, and that the owners have the capability to make it happen.
Scalability refers to the act of growing larger while keeping intact the ease with which business is done and the business’s profitability. Said another way, scalability is how easily your company can increase sales.
Judging your business’s scalability
All businesses are scalable to a point, but some have to make significant changes to their models to grow any further.
If you have a successful consulting company, for example, you may make $1 million per year with five consultants. To grow to $2 million per year, you probably have to add another five consultants, and so on.
You can grow your company nicely, but it isn’t considered scalable because the incremental costs rise proportionally to revenue. You have to hire and train a lot of people to grow, and your profits will likely never exceed a certain per capita amount.
A venture company may spend a lot of money up front in designing a product, but the returns will rise exponentially as volumes rise. Some examples of this include medical device companies or SaaS (software as a service) software companies where the incremental costs to each sale are almost negligible, but there is a significant up-front cost. SaaS companies are popular with VCs because of the large profit potential if sales grow significantly.
Unlike the consulting company, which can only scale by adding more and more people, a venture company is designed to be scalable from the beginning, and the costs of incremental sales drop sharply as scale increases. Make sure you know the points of scale that will challenge your company’s model. VCs look for companies that are able to grow very large easily.
Looking at your desire to grow
Not all entrepreneurs have the desire and capability to scale up to a large organization. Many are satisfied when they make $250–500 thousand per year, and their companies may grow slowly after that.
As an entrepreneur, you need to ask yourself which type of business you’re running. Is it a lifestyle company that will yield a comfortable living for you and any other principals, or is it a high stress, high growth venture company that you want to grow to the tens and hundreds of millions?
Lifestyle companies can bring in great profits for the owner(s). The owners tend to control the majority share of the company and therefore have control over the large and small decisions that are made in the company.
Owners of lifestyle companies tend to stay involved with their companies for decades or even pass the company down through the family over generations. These companies tend to be low-risk, healthy companies that grow slowly and conservatively. Lifestyle companies are not interesting to VCs.
Venture companies are best for founders who want to grow a company fast, make a lot of money quickly, and then move on to the next thing in their lives. Lifestyle companies are best for founders who want to create jobs and wealth for themselves and their family members over many years.