What's infuriating is that over here in Europe, the focus on making money early on with a startup is considered the biggest drawback of the VC and investment community.
"VCs are so risk adverse here, they expect you to get some revenue in the FIRST COUPLE OF YEARS! Man, why can't we be more like the Valley?"
I've long said this is a feature, not a bug. It's refreshing to see this article. Maybe some over here will take note.
Try East Coast (US) VC's and angels. "Risk averse" doesn't even start to describe some of these folks. We have angel investors who want you to have paying customers and then still want to do 6 months of "due diligence" before making a seed investment.
Had this happen to us in Texas. We had paying customers, and customers who wanted to pay that couldn't afford us (needed to nail down pricing), but we weren't profitable quite yet. Angels wanted nothing to do with us until we were profitable, so that sucked.
It seems like the terminology has shifted a bit or something.
Exactly. There basically isn't anybody doing seed stage investment out here (where "here" is North Carolina for me)... the angels are basically doing what used to be an "A round" and the "early stage" VC's are either "A" round or later.
Now I understand the desire to minimize risk... we'd all like to minimize risk, surely? But for angel investors and venture capitalists to be this risk averse just seems counter-intuitive. Seed stage investing and venture investing are inherently risky, hence the term "high risk, high reward". But these folks seem to want all the reward and none of the risk.
About the best shot you have here at early funding out here is "friends, fools and family", or hope you get lucky and get into Triangle Startup Factory or get an NC IDEA grant. Otherwise, you just have to self-fund everything, or pursue some sort of "alternative" strategy (customer funding, crowd-funding, or whatever you can think of).
Of course, the flip side is that if you do self-fund and you can get some serious traction going, then you have much more leverage with investors at that stage. When you can honestly say "Hey, we don't really even need your money" then you don't have to accept absurdly unbalanced terms from would-be investors. shrug
Angel investing means that they buy equity but don't have input on decision-making. VCs buy equity but do have input on decision-making (usually sitting on the board). I meant it in that context. If that terminology is different between Texas and the Valley, then I'm not aware of it.
Perhaps you should lay out the obvious analysis : Once you're profitable you won't be in a position of needing their cash. Which means that they'll have to make themselves attractive to you, rather than the other way around - they'll understand quickly that much of their negotiating leverage will soon evaporate (assuming you can confidently predict when you'll get to profitability).
What I dislike about Euro VC is not so much this focus, it is their insistence on risk reduction in the above way coupled with low valuations not properly accounting for said derisking.
Amen. 100% agree. I've been in a few meetings were these VCs play the dumb-I-don't-know-corporate-finance card. These VCs do not create value, but solely profit by buying into a business which is already making serious money, without the "genuine startup risk", with the "genuine startup risk" priced in. This situation has been created thanks to the lack of competition at the investor level.
I can only say that other financing players in Europe are starting to wake up. I've already seen two European startups making serious money go on to raise considerable capital via debt financing, one via a bank syndicate and the other via an institutional investor. Terms are less strict on management, capital cost is a fraction of VC equity, no equity/board seats are given away, avoiding the abusive-VC free ride. On the other hand, debt-finance does require considerable financial discipline (which can be good and bad). As long as you have a clear idea of how that capital is going to be used and how much cash is going to come back to the business, startups with user traction and free cashflow should go the debt financing road.
That might be true on the continent, but not in the UK. We've been profitable since month one, grown out revenue and profits by >100% YoY, and VC cash just ain't worth it, as on this side of the pond the best earnings to value multiplier you'll get is about 1.5. Not 15, not 150, 1.5. We net about £.6m/yr, ergo our value is about £.9m, tops.
If you have no revenue - you'll get a 50x multiplier on your theoretical revenue, no problem.
VCs are NOT INTERESTED in profit-making businesses. They just want a white elephant to pump and dump.
Taking cash is hard and leads to an anxiety response.
Selling means you're out there. You're putting your idea on the market and hoping someone buys. If they buy, great. But if they don't, then it's back to the 9-5 grind and the 'change the world' party is over. That's hard to digest for many.
Like in 2000, startups are again becoming the middle income 'phd'. A way to avoid having to face reality, even for just a few years.
I am so glad Suster said this. Hell, I would have been glad if any of the most visible VCs said this.
I get the sense that people really do believe that tech startups are actually a different beast, that the basic rules do not apply, and that we really are not building businesses as the rules just don't apply to tech startups... they are different.
We should be calling bullshit on that. The core rule should be that revenue should be higher than costs.
It seems so dumb to say, as it is obvious. So how did we end up in a place where people will tell you with a straight face not to worry about revenue, far better to grow (increase costs) and increase valuation.
As soon as you are in that game it seems that the goal has shifted to the next funding round, the next inflated valuation, and not to have built a sustainable and possibly high-growth business.
The exit should not be the end and your goal. It is the goal of the VC, and your paths may be the same for a while, but before the VC you need to find the right ingredients for a new business, and after VCs have exited you need to have set your company on a path of sustainable growth.
Growth is important, but n times no revenue is still zero. Revenue should be our most important metric, and growth should be second to that.
"I get the sense that people really do believe that tech startups are actually a different beast, that the basic rules do not apply, and that we really are not building businesses as the rules just don't apply to tech startups... they are different."
I understand your point - revenues should be a concern from day one. If you have neither revenue nor a plan to obtain it in the very short term, you don't really have a plan for your business beyond "get big and hope".
However: Traditional brick and mortar businesses don't expect profitability in the first year, and sometimes for as many as the first three years.
This is not to say that they have no revenue - only that there isn't an expectation of revenue greater than costs in the short- to medium-term.
The notion that a business should be immediately profitable has always been a popular one, but seldom has it been an accurate one.
The record label I once worked at wasn't profitable until year 4, but they had revenue from 4 months in and built upon that at every opportunity.
My point is that you don't become profitable without revenue, and that an acquisition may work for literally a handful of startups, but it is not something anyone should bet on.
"So how did we end up in a place where people will tell you with a straight face not to worry about revenue, far better to grow (increase costs) and increase valuation."
Because once you start taking money, that is your valuation, more or less.
You've got 10,000 users using your service, growing at, say 30% annually. Once you start charging, say, $30/month, you've put hard numbers to things, and there's a financial framework to work within. Until then, you can keep projecting $x/year, because it could be anything.
Because once you start taking money, that is your valuation, more or less.
That's certainly the perception, but I'll argue that it's a short-sighted perception. There are lots of ways companies can push the gas pedal on growth, even once their financial model is known. Launch a new brand, do a line extension, do a brand extension, make an acquisition, goose the advertising budget, etc., etc.
To look at a company today, take their financial metrics, and assume they will always stay on the same trajectory, strikes me as silly.
I see how "playing the game" makes it seem that way, but projections are worth about the same in my hand as a fart.
If you have enough VC to keep going and you want to be the next twitter, I wont say you shouldn't, but it seems common sense that you would want to start making money so that you know, you start making money.
Yeah, and maybe I want to say something along the lines of "your valuation should be more closely tied to your actual ability to make money."
I will ponder it more, thanks for your comment.
There is a financial metric I frequently calculate for private equity firms called zero growth return which allows one to partially disentangle the steady-state business's working capital requirements from investment. The value in figuring it out is knowing, as a manager, how much capital you have to "play" with for capital investment purposes, whether that be servers or devs.
Just out of curiosity... would you think that the kind of material on valuations contained in this text (or similar ones) would be of value to startup founders, especially vis-a-vis negotiating with investors? Or is it all stuff that doesn't come into play until later, when you're dealing with private equity or trading on Wall Street exchanges?
I remember tearing that book out of the box from Amazon and cramming from it for an internship interview as a college freshman, hoping the interviewer would think me at least a junior (it worked). Recommend it for the interested.
That text is not for start-ups - it too precise to be tuned to no track record. I believe start-up founders should focus on understanding their waterfall, revenue models, and the intersection: cash burn projections. Less for negotiating with investors than for guiding decisions.
Thanks. It sounds interesting, I may pick up a copy sometime, just to help round out my knowledge of areas that I'm less than strong in. As a developer, I'm admittedly kinda weak on the financials / accounting / valuation stuff. I feel like I need to go take an accounting class or two. Guess I should look and see if there's anything good on Coursera...
It's bizarre that this type of essential advice is news to so many founders (including me). It's understandable from the VCs perspective though. Since they're mostly in it for huge exits it's rational for them to prefer companies with zero revenue, but good traction, over profitable (or close to profitable) companies with the same traction. Simply because the close to profitable company will have much more leverage than the zero-revenue one. In fact, a zero-revenue company who has been aiming at a VC Series A will often be forced to accept the term sheet at one or another VC whereas the profitable or close to profitable always can downsize, get a loan etc if they're not comfortable with the terms they can get at a VC. All this is because profitability isn't to the VC that much of a hint of long-term mega success as some growth metrics might be.
Related to this, it's a shame that the VC terms are often not well understood among first-time founders. If they were, I'm sure more people would try the revenue-route.
For a founder, it all boils down to how much this possible revenue will harm overall growth. In some cases (Instagram etc) it really does. In most other cases, it does not (or very little). But the zero-revenue route is easy to decide on since it's less work. "Yeah, let's take sales and all that later on" is easy to say especially when endorsed by the VC industry.
I might want to add this advise to coders also: You fix some bug in some free software, to help some other company. Write them a small invoice, don't be shy of asking for money. You win a customer. Coders like me are cursed by infinite ideas, vs limited time. My approach is to wait till more then one possible customer for the idea exists, and the first one offers enough money to pay the prototype. Its then just a question to ask the others to pay a similar price to get into production break even. And any future sale is nearly passive income from old software and maintenance contracts.
Ring the freaking cash register is even more important for lifestyle business, even if it feels as if every customer is your good old friend.
The thing that is killing me the most is all of these free companies have changed consumers expectations. While there used to be narry a complaint about paying $49.99 for software at CompUSA, people write me ANGRY emails that I had a nerve to charge anything for a premium version of my software (which costs $29.99 per year), and I still offer a free version! Try charging $.99 cents in the app store and wait for all the furious reviews.
If my reading of patio11's business of software stance is accurate, I believe he'd say these irate emails are actually helpful signals to you that these people are not a market you want to bother serving! Because they have so little invested in understanding your product and making the most of it, they need to compensate with volume and vitriol. It's better to focus on people who more strongly need and want what you are selling and are willing to signal that with $$.
There are different customers today than there were back then, though. The market of "people who buy software" has expanded massively as software has crept into all sorts of places it didn't used to be found. Lots of people are buying apps for their phone who would never ever have walked into a CompUSA, so they don't have the preset expectations of what software "should" cost that you and I do.
Is this still that big a problem? From my vantage point, everyone is ringing the cash register. B2B and B2D is huge right now (in SF at least), and all but the most naive of entrepreneurs (that I meet, but I do meet a lot of entrepreneurs) have a B2B focus, with enterprise on the mind.
How many people are still making go-big-or-go-home consumer/social/mobile startups?
YMMV, but I know a few companies, many in mobile-but-not-games, who have X00,000 or Y million MAUs/downloads/etc and are afraid of cursing that by monetizing. A couple are in your neck of the woods.
No points for predicting my advice to those of them who have asked for it.
"As an investor that’s a no brainer. Hmm. Let’s see. Should I write off my $2.5 million or put in 16% more ($400k) to see if we can get to break even and maybe find more money and/or find our magic growth curve?"
That's the "sunk cost fallacy" (http://en.wikipedia.org/wiki/Sunk_costs#Loss_aversion_and_th...). The $2.5M is already gone and so the ROI should be evaluated on whether the outcome is better worth putting in the $400K (while also looking at the opportunity cost).
In the context of that point in the article I think he was just framing that 16% as easily being in the range of the previous investors. He was noting how that $400k would have some legs when augmented with sales and another $2.5+ million round wouldn't be needed.
> if we monetize too early we will scare away our nascent marketplace and not grow as fast
What about slight, unobtrusive monetization? You don't have to put up a paywall, focus completely on revenue, and ruin your entire site. Add in a tiny premium feature that a small number of users will buy to pay the bills.
Personally I like this, but there might a problem for fundraising that when you start any kind of monetizing, you have metrics on that regard, and people can analyze them. So when you're kinda-monetizing your metrics might seem low and not attractive as a business.
Sometimes is "easier" raise funding when you don't have numbers but just a dream eg. pre-lauch / pre-monetization.
We've been focused from early on about figuring out a repeatable sales model and though it has been a grind, we are now at a point where we are closing sales consistently week to week. We have 25 customers, all acquired via this repeatable sales model.
In our meetings with seed stage investors, we're repeatedly compared to PORTFOLIO_COMPANY_X that may have 3-4x free users, often acquired after the funding.
The other disappointing thing is that most blog coverage regarding traction is often very misleading. You get the real story when you actually talk to the founders. For example, one of the companies that we really revere apparently over $20,000 in sales before they built a product according to the blogs. Then we found out that all of that $20,000 was commitments from the founder's existing rolodex, not via a repeatable sales model. In our eyes, that is an important detail to know; but for the blogs and the mainstream, not so much.
I've made this point before on a Suster post and I will say it again: entrepreneurs for the most part look at the market and adjust. If the VCs keep preferring 4 free users to one paid even in enterprise, they'll keep getting more of that.
That said, I really really dig Mark's example conversations in this post where he clearly admits that the VC and the entrepreneur's interest may not always align on this topic.
Are you managing a business or are you starting something? If you're managing a business, ring the cash register and we'll all thank you for getting a jump on the inevitable. If you think you're starting something, roll the dice. The manager will cash out shortly.
From another comment: "Growth is important, but n times no revenue is still zero. Revenue should be our most important metric, and growth should be second to that."
If your goal is revenue, and you have no revenue, you've done something wrong. But not everyone's goal is revenue. If it were, the open source community would be a graveyard of used-up ideas and remixes.
Revenue is great for companies, but useless for tools. Tools don't need revenue, and if you're building tools, don't try to get paid. People buy hammers, but the inventor of the hammer isn't getting rich. Doesn't mean people don't want hammers.
Revenue should be the most important metric for people who want to make money. That's inarguable. Are you one of those people? There's nothing wrong with it, but that doesn't make it a meaningless question. Answer truthfully, and your path (lower-case p) is illuminated.
> Revenue should be the most important metric for people who want to make money. That's inarguable.
Revenue is a good start but at some point you need to consider profit. And yes, I have been in a room where someone proposed making up the per-unit loss through greater volume (on physical goods).
I hope, for their sake, that they were banking on some sort of economy of scale where increasing volume would decrease per-unit costs and therefore negate the per-unit loss...
They may have been hoping that the economies of scale could work but they were arguing with people who knew they wouldn't. There may have been a language gap though I don't think that was all of the problem.
This is surprisingly less common than you think. Most people don't have a very good grasp of business, and many many businessman have a "sales mentality" that insists that selling as much as possible is the best way to grow a business (while completely ignoring margins, which are what is actually important).
Yep. (Although I think you mean "more common" or "less uncommon"). It is what can happen to sales people especially when bonuses/performance reviews are based on sales not profit.
If you're building an open-source tool that you never intend to make money off of, then you're not the target audience here - you're not building a business in which VCs are going to invest. This is for people who are giving up current revenue in the hopes of making lots of money in the future.
I can't find the link but wasn't there an article, either by Ycombinator or about Ycombinator, that directly contradicted this article. The gist of it was that a VC firm isn't really looking for already-profitable companies that can assure a nickle-and-dime cut of steadily-increasing revenue. The idea is to invest in 10 companies with a high-risk margin, and the one company that (statistically) takes off will earn such incredible revenue, magnitudes greater than any reliable and stable business could hope to earn, and that will pay for the investment lost on the other 9 which, being high risk, will not make a return. The underlying philosophy was that if it seems like a stable, reasonable business idea, then anybody and everybody could have, and would have, thought of it already, and the potential for fantastic growth is just simply not there. They'd rather pay for someone's quirky, crazy startup on the 1/10 or 1/20 chance that it will take off, as the return from that will be so great that it can pay for itself, pay for the other failed high-risk investments, and then keep on paying.
I don't see the contradition between the articles. It says why VC's do OK when startups go for the big time but that it isn't always in the companies interest.
I think it should also depend on whether you have genuine (low acquisition cost) exponential growth. If you can show that growth I think funding should be possible without revenue and riding the growth might be worthwhile but if not you really need to be about alternative approaches.
I'm all for "ringing the cash register" personally. I've said my bit on this before[1], but I'll just re-iterate my position... I'd rather build a business that's designed to actually make money, by selling a product to people for money. BUT... I don't see any conflict between that and a desire go "get big". I see no reason you can't "go big" the old fashioned way... steady, sustainable growth over a period of time. I mean, neither IBM nor Wal-Mart started out as huge megacorps, keep that in mind.
What people often don't see is the loads of money that flow around in a bubble. Yes, maybe Startup Community is a bubble right now. But still there is a lot of money. And still a lot of people get rich by playing these "unrealistic" rules. The bubble isn't bad until the last moment and for those guys who don't see it coming. In my eyes, the solution is not playing a completely different game, but playing better.
Key metric appears to be that 99.99% of startups will not be the former FB, Stanford Grads, Suster is talking about so, there's a higher probability that they will succeed if they actually make money. No? If someone isn't willing to pay for your startup, are they really a quality user?
We agree that's why we created Bellhopr, a new start up that will literally play a cash register bell sound for your team anytime you have a new customer or sale.
It only takes one line of JavaScript to make work, and for the price of a coffee you too can "Ring the Freaking Cash Register".
A+ for actually building something that shipped, but in my opinion that idea seems really stupid. Most companies have the developer capacity to build an idea like this quickly, even for the arguably little provided return it offers.
I hear "freaking" often enough in spoken English that I don't think anything of seeing it in written form. I can't say that I've heard "fscking" said aloud, which almost surprises me, but I bet some folks here have.
"VCs are so risk adverse here, they expect you to get some revenue in the FIRST COUPLE OF YEARS! Man, why can't we be more like the Valley?"
I've long said this is a feature, not a bug. It's refreshing to see this article. Maybe some over here will take note.