Reach vs Revenue
Lately there has been a ton of talk about overambitious startups raising too much money to get to unicorn status. It goes like this: the startup is growing, but in order to grow into its crazy valuation, it needs to pour money into paid acquisition channels and meanwhile its unit economics suck.
One reality of Silicon Valley that will always be the basis for how VCs and entrepreneurs build crazy ideas, is nearly every startup needs to grow initially via leverage from venture capital. There are occasionally stories of incredible companies built with a low dollar-in investment figure ((Tellapart is a recent example, which Josh McFarland grew into a wildly profitable business before selling to Twitter for $500M, despite raising ‘only’ $17M.)) and it’s certainly eye-opening that Google’s initial investment round was sub $1M, but nothing has systemically changed around today’s company-building fundamentals.
One lens to evaluate startup growth and capital allocation is ‘reach vs revenue’. That is, what’s more important today for your business: attain scale in customers / users, or attain revenues and profit. Of course the answer varies depending on the type of business – e.g. consumer apps need scale and shouldn’t even consider monetizing through things like ads until the product has tens or even hundreds of millions of users. But not everyone is the next Snapchat.
Going after reach vs revenue (or vice versa) can be a dual-edged sword as investors never value an early business off of revenue, they always look at growth. Sure revenue (especially revenue with high profit margin) can greatly augment your story and absolutely is something you should be aiming for, but growth is the imperative early on.
But not all growth is comparable, and more importantly no one, including outside investors, understands the nuances of your business or whether it will grow in the future besides you. As startups mature, so needs the story you are telling around how growth relates to reach or revenue.
As an example, there is a lot of talk about the difficulty Twitter is having around native ads. It’s pretty clear the company is having a very hard time monetizing despite its scale, and the recent downturn in its stock is probably justified. Twitter’s PE is still overvalued compared to peers, never mind its PE/G. So what would solve Twitter’s problem, more reach i.e. faster user growth, or better monetization of those users? An argument can be made both ways… The fact is, even though Twitter is a ‘mature’ business with 300M+ users and valued above $20B, both of these levers greatly impact how the business is viewed by Wall Street.
And these affects are an order of magnitude more pronounced for early startups than for a mature business like Twitter. If you are a Series A backed company and are pitching your revenue story, it is likely the wrong angle. If an investor is really listening to you, there are other fundamentals to your business that could paint a growth picture before profits or revenue matter. People want to hear why and how there is a chance you could become massive.
The flipside is that profit is your best friend when growing a business because it reduces your burn and gives you more control of when you take outside investment, which is ultimately dilutive to the company. And this is super important today in light of the ridiculous burn rate some startups have. When or if the music stops, many will be left empty-handed, which will be the ultimate down-round.
The other funny thing about revenue is that, depending of course on the business, once you have revenue, the business is easier to model. There are many examples of businesses that become ‘VC living dead’ because they’ve monetized but don’t have a clear path to becoming huge at scale. One reason could be market size, but another could be pricing-based – e.g. if you price your product in such a way that it’s not clear how you become a real business, you could be in an entrepreneur’s worst scenario.
Follow this as an example: you’ve taken VC funding and have ‘proven’ people want your product because your startup has successfully penetrated SMBs. But the price point is low or your unit economics suck so your overall business is unsustainable. You wanted to go up-channel to enterprise but have run out of money before proving that market will pay more for your product. Your business is not ‘real enough’. This is a reality of how companies are judged, since each investment round requires a step function increase in performance.
Of course you always need to combine metrics while selling the dream: what’s going on in the world, what pain are people running into, what’s the major problem your startup is uniquely positioned to take advantage of and solve. Maybe your go-to-market evolves from X to Y and your metrics help explain why. Or maybe you have a good wedge story.
The more audacious what you are saying is, the better the frame needs to be around what you’re doing today vs where you will get to with capital and what milestones exist in the future. Often startups are counterintuitive. You need to be able to describe how your company is uniquely positioned to get to that place. It’s rarely a one-step moonshot, it’s a process. How do you transition from the hop to the skip?
The reality is startups are so delicate – nearly every company has traversed near-death experiences and any company can go up or fall flat. The smartest investments were often contrarian. So you need to be able to tell people ‘you can’t see it yet but this is what’s over the iceberg’. Here is what any one individual data point shows, but when you look above the iceberg here is the tidal wave that is coming…
For example, at Estimote we focus a lot on our distribution of customers. We know to a good degree what the long tail is doing and we know what the middle and head are doing. Today we stand on two legs of the stool so to speak – we have a thriving developer community that exercises our stack and serves as a sort of a 50,000 person distributed engineering and QA team that even pays us. But more important than the revenue is they break our product and tell us what to build next.
This has allowed is us to go up-channel from the developer market to enterprise. How so? The same way a company like Slack does. Usually, by the time a CIO or marketer has a fundable project for us, we already have engineers within the company familiar with our stack. This is classic bottoms up sales, where we develop advocates within the company. And once we’re selling, there are already engineers within the company that trust us and know how our products work.
The more of this pattern we see, the more we expect X percent of our long tail customers to go up to the head because of our bottoms up approach. Do we think every sandbox developer will turn into a massive paying customer? No. But we know that some percentage of these will grow and will become more than just distributed labor / QA and we will make money off them.
Back to the reach vs revenue question. Any growth story should always be clear as to how outside capital will help you grow, scale and develop in a way so that you can change the plan again… and then raise more and ratchet up growth sooner. That’s the best way to control your own destiny while staying agile.
But there isn’t always a perfect equation to follow around producing future cash flows. Deciding how to optimize for reach and revenue deeply impacts product and growth decisions, which is why startups by their nature can rocket into billion dollar companies or go under seemingly overnight. But rest assured many of today’s unicorns will eventually figure it out and become thriving, cash-flow positive public companies.