Back in 2009, shortly after the 2008 crash, I wrote The Importance of Revenue at Early Stage, Now More Than Ever. Up to that time, we had been on a roll – startup investing was growing well and we had bought into building traffic which allowed us to get to our next funding event. Then, the crash killed all that. Money was hard to come by, and investing in “momentum” or traffic only startups without much revenue was nearly dead. Only revenue generating startups were attractive to investors and a boatload of non-revenue startups died simply because they had none.
Then the startup funding environment came roaring back, we had our Instagram moment, and investing on momentum was in vogue again.
But times have shifted again. What has changed?
1. Tracking M&A values, they hang slightly above $20M [source: Berkery Noyes 2012 3rd Qtr Trends Report Online & Mobile Industry]. This is pretty low in general, and pretty unattractive from an investors’ standpoint when…
2. …Valuations for startups still hang around $6-10M cap or pre-money at early stage for the hotter deals, sometimes even higher. Remember that if you are to exit at the median, you must be doing pretty darn good and be above average. If you are not gaining traction, acquihires are happening at much, much lower values, definitely well below $10M.
Now to be perfectly clear, there are those out there investing on strategies that take into account 2-5X return on money. But our economics don’t allow us to do that – we need much more return.
3. Customers, whether consumers or B2B, are deluged by the exponential growth of startups and growth is harder to come by. In the near past, we used to tell startups that they needed 12-18 months to get to decent traction metrics; that quickly moved to 18-24 months, and now we think it’s 24-30 months. Wow! 24-30 months – this is a direct result of our observations on how startups are growing in the competitive marketplace, the battle for customers’ attention. When we saw them funded with runways of ~18 months or so, many needed more runway and so went to look for bridges, if they could not get series A – so we’re now at 24-30 months!
However, practically NO startup I know raises for 24-30 months at the seed stage – well, practically none. If you go to Techcrunch and other online publications that follow startups, you’ll see a ton of early stage raises at $1.5M-2.0M – what happened? This is smart. These founders, and their investors, have realized that they need more runway and have funded them for that. Startups who raise less than 24 months runway have a higher probabiility, now more than ever, that they will need additional runway to extend them to 24-30 months within a year.
But if you aren’t one of the startup darlings to get $1.5-2.0M at seed, what then?
4. Last, we’ve been in contact with some prominent financial guys who follow the economy like hawks. They process every bit of information that is out there, stuff we all can get and a ton of stuff that we can’t. (If there is anything I’ve learned about the financial industry, it’s this – there are those with the information and those without – those without basically include everybody else including you and me – and yes, the world will continue to have unfair information advantage no matter what we do with regulations). They are fearful that another 2008 is coming. We’ve been digging into this and have found evidence in a potential earnings cliff, and we are concerned as well.
All this means that we think the importance of revenue at early stage is back – one could argue that it never left, but what I mean is that it has risen to the top of the stack.
The world isn’t looking optimal for internet startup investing. That doesn’t mean there aren’t opportunities out there that can fit within the world we see right now – generating revenue is one of those key characteristics that can ensure some longevity even when the world is so uncertain. Once again, we look for that to bolster a startup’s chance for survival and give them maximal runway to achieve their next funding event.