For many entrepreneurs the biggest point of confusion when starting a new enterprise is identifying what is necessary to start a business and what is necessary to obtain venture capital.  In boom times, this differentiation is often not necessary.  Often you hear about start ups that obtain financing, and then “find a business model.”  It is certainly true that many venture capital backed early stage businesses seem to meander a bit, as the founders take advantage of a multi million dollar financing round to find the right formula for success.  And, these success stories (if success is getting money and then figuring things out) reinforces for many founders the idea that the most important thing for any start up that has aspirations of growth is to get capital first.

Unfortunately, for many entrepreneurs and others in the emerging company ecosystem the concept of obtaining capital, and then growing a business seems the natural way of progression.  While, this might be OK when times are good, when VCs are not financing start ups (and Angel investors are worrying about their stock portfolios), this formula appears to break down.  And, many seem to conclude, without venture capital there is no way to start a business. 

Putting aside those that worry about the lack of venture capital, others observe that a recession is the best time to start a business.  There are many reasons for this: people who are “out of work” are more willing to take risks, labor costs are lower, real estate and other physical assets are less expensive and those that are willing to take the risk of starting a new venture (or continuing an existing one) differentiate themselves from those that don’t.  Those things are all true. However, I think that the biggest reason why enterprises started in down times are more likely to be successful is because they are started as businesses and not as a way to raise capital.  They are formed to pursue a commercial activity – serving customers or making products.  And, they are formed in a way that is capital efficient. 

So, what is a business?  A business has a number of key attributes:

• A repeatable business model to generate income for the owners.
• At least one committed individual to execute the business model.
• A near term ability to provide positive financial benefit for the participants.
• Capital requirements that are sized to the amount of capital that is immediately available to the business.

This definition of a business is often described as a “lifestyle business” by participants in the early stage ecosystem.  This term, which could be interpreted as having a negative connotation, is short hand for saying that a business is not a high growth opportunity.  This comment is often accompanied by a Seinfeldian “not that there is anything wrong with that” shrug.  What VCs want are high growth potential businesses, which generally have the following key attributes:

• A protectable technology or market advantage.
• A large addressable market.
• The ability to deploy an amount of equity capital and leverage it into a large business in a short period of time.
• A committed team assembled to execute the business model, which may or may not ultimately include the founder.
• Likely buyers for the business within a 3 to 7 year period at a significantly higher value than when the VC invests.

VCs are right to look for these types of characteristics, because that is what their investors are looking for.  The VC model is predicated upon generating returns from establishing and selling new businesses.  The overall economy has been served well by these investment criterion – a substantial portion of jobs in the US are currently provided by venture backed companies. However, substantial jobs are also created by lifestyle businesses. Both are important and meaningful to our economy.

What is obscured in good times, however, is that the successful venture backed companies all ultimately came to the common characteristics that describe a lifestyle business.  The lifestyle business really is a sustainable business model – one that can endure and grow through good times and bad.  There really is less differentiation between the two types of business than you would think.

Perhaps it would be better if instead of calling a business that isn’t a high growth business a lifestyle business we called it a “real business.”  That would give it the credibility that it deserves.  In fact, the best entrepreneurs that I have worked with, and the ones that I am working with now, all share that view.  Before obtaining outside capital they focused on running a real business, and even after obtaining outside capital they continued to focus on that as part of their overall plan.  Moreover, if you look at the early stage businesses that are being financed today (either by existing investors or new investors) they are all real businesses.  When times were good and now that times are bad they look at their enterprise the same way – as a real business.

When capital is hard to get it is often said that entrepreneurs “get back to basics.”  If back to basics means focusing on establishing real businesses, I am not sure that good entrepreneurs ever really got away from the basics.  A good entrepreneur runs a real business where obtaining capital is a means, and not an end.

I have said a number of times over the last year that the economy will improve this year and next.  However, the easy availability of outside equity capital is likely to be slower to return for many reasons.  A smart entrepreneur starting a business today should focus on starting a real business.  That’s what is most likely to succeed, and ironically enough, what is most likely to attract outside capital. 

Jonathan’s note: Amplifier is working on a new initiative to find and help grow some real businesses in the Mid Atlantic. Look for an announcement from us soon.