While venture capitalists pass on companies for many reasons, one of the most common reasons is that they don't think the opportunity is "big enough".
What does this mean? It means that even if the company executes as planned, the VC doesn't think the exit will be large enough to generate the VC-sized returns. This determination is based on the venture capitalist's "fund math" and their expected returns model. It means that VC doesn't think he will make a big enough return by investing here.
What doesn't this mean? This doesn't mean that the business is not going to succeed. It doesn't mean that the entrepreneur will fail. It just means that the VC doesn't think that the return profile of an investment in the business is a fit for a venture capital investment.
Like all VC's, I pass on many companies that I think will be successful and teams that I really like. I do so because I think that the economic returns won't move my needle. (And as one smallest venture funds around, my needle is smaller than most other funds. And yes, I say this because I am self confident enough to handle the "small needle" jokes).
However when I do pass for this reason, I try to make sure that I communicate the reason for my decision. Specifically, I state that while I think the entrepreneur will make money here -- I just don't think I will generate the risk-adjusted returns I need.
I think the industry places too much of a premium on raising venture capital -- and it has become the default operating assumption for every entrepreneur. Entrepreneurs can create great businesses -- and have great outcomes -- without raising meaningful outside capital. Just ask James Hong at HotOrNot, Eric Marcoullier at MyBlogLog, and David Clouse of VRBO.
Part of the problem, I think, is that the technology startup ecosystem seems to be structured so that the goal of every entrepreneur is to raise venture financing. There is a pretty strong gravitational force that pulls entrepreneurs towards raising VC dollars -- and it's often hard for an entrepreneur to overcome the inertia.
However, I also think that a big part of the problem is that there is no good word/phrase to describe these type of companies. The only phrase I've heard used is "lifestyle business" -- but I think that is inaccurate and pretty demeaning. It falsely implies that these entrepreneurs aren't working as hard as those of VC-backed companies. It falsely implies that these entrepreneurs are choosing a better lifestyle than they would have if they were operating a VC-backed company. And, as 37signals has written, it condescendingly implies that "A lifestyle business is for the hacks and amateurs while a real business is for the big guns and grown-ups."
I think we need a new word. Something that isn't demeaning. Something that doesn't imply laziness or lack of effort.
And maybe the best way to generate that word is by crowdsourcing it. Fred Wilson posted a similar challenge in 2006 and it sparked the word "freemium". And Brad Feld just posted a naming challenge yesterday.
So here's my challenge -- help me find a new name for "lifestyle business". Post your suggestions in the comments. I've also created a public challenge for this on ChallengePost. Thanks!