At SAIF, during the course of any month, I meet ~100 seed stage companies which range from an idea, prototype or proof of concept stage. More often than not, they are pre-revenue and come with a belief that “VCs ask for revenue traction too soon”.
It is not unfair for an investor to seek revenue or a path to it. While it is great for a startup to have the cash registers ringing, I believe the filter of revenue generation cannot be applied to all types of businesses, especially those at the seed stage.
If I look back at companies I have liked in the recent past, certain trends emerge on what could make a company exciting, even if it is pre-revenue. About two-thirds of these companies had zero revenue or some small revenue generated in recent months (revenue here is a mere proxy for the product being useful for customers) and a third had achieved reasonable revenue over the last 12-18 months.
Zero / Early Revenue Companies
I have come across couple of business models where a zero / early revenue company has been exciting.
- Consumer facing businesses on mobile, including non-transaction oriented ones, can be exciting even before company has started making revenue. This is because the mobile platform can allow for explosive growth and multiple monetization models other than advertising are available (e.g., in-app purchases). Thus one can be inclined to possibly take a bet on adoption followed by monetization for a mobile product with great engagement. Some of the key metrics that define engagement are (these may vary somewhat by category)
- 30, 60, 90 day retention rates (active installs) in excess of 60, 50 and 40%
- Frequency of use per week of 4+.
- DAU/MAU increasing over time consistently
Additionally, it is imperative companies worry incessantly about quality of traffic. High customer acquisition costs are not sustainable, and traffic should largely be unpaid driven either by strong SEO/ASO and more desirably high social/referral and direct traffic.
- Disruptive / new B2B products – This is another category where current revenues are immaterial. Instead, what would be interesting to see is whether the product has few large businesses or many smaller businesses (even if free) using it regularly. Any early revenue would be a bonus but it would not be an absolute measure of assessing the business quality.
Strong Revenue Companies
Couple of business models that need to generate substantial revenues to demonstrate quality are:
- Consumer facing web businesses, especially transaction oriented ones, need revenue to prove multiple things – products / services sold are liked by users, the technology is working and the operations are delivering. If the business is a two-sided network, it is important to ramp up on growth on both sides as this makes the platform more valuable to both sides and also more defensible. Margins can be lower initially but will typically improve if the network quality is good. Most obvious examples here are Travel (bookings or lead selling) and E-commerce.
- A well-understood B2B product – Enterprise selling, especially for products in a competitive market, involves a longish sales lead-time. So if a company were operating in a competitive environment, sizeable revenues would serve as a proof of differentiation of the product among the crowd.
At SAIF, our key focus while evaluating businesses is user adoption. In few business models like E-commerce, revenue is the proxy of user adoption. While in other business models, user adoption metrics are different from revenue.
A startup should use its judgment to define what measures of adoption are best for their business (in the absence of revenue) and work towards improving those. It is definitely a riskier bet, but then isn’t that what makes both entrepreneurship and venture investing the exciting rides that they are.