Revenue Doesn’t Matter

I found myself in the middle of a debate on Twitter earlier this week about a topic that doesn’t really mean that much to me, but I thought I’d elaborate on my points.

It all started when Hunter Walk posted a link to a post by Jason Calacanis titled “There Is No Series A Crunch.”

Now let me be clear about one thing at the outset. I’m an entrepreneur that’s focused on building my own business. I try to drown out all the noise that’s going on in the industry by mostly ignoring everything that’s written. If I tried to read or keep up with everything, I would drive myself crazy with all the differing opinions about things that, quite frankly, probably have little to no effect on my actual business. However, I have to balance this with the fact that I am a start-up CEO that has to have some clue about what’s happening around me. Spending five minutes per day quickly scanning Techmeme headlines and my Twitter feed for anything relevant to my business is enough.

I say all of this because the audience for this meme about the “Series A Crunch”, namely start-up entrepreneurs, are precisely the people that shouldn’t be spending a moment of time reading it. Entrepreneurs should have razor sharp focus on their business to the exclusion of everything else.

The post from Jason Calacanis was pretty benign until I got to the following sentence:

VCs will fund any company with a Series A if they are making $2,750 a day.

This is far from the truth. Any novice or inexperienced entrepreneur reading it might be led astray and potentially waste a lot of time, so I felt compelled to say something. [Note: By “making $2,750 a day” the post was referring to revenue, not profit. That distinction is clear in the context of the sentence within the post.]

And with that, it was on.

I won’t rehash the whole thread, but I want to focus on this sentence in particular, why it’s not true, and what is true.

Revenue Doesn’t Live in a Vacuum

There are lots of companies making at least $2,750 a day in lots of different ways.

A well-run convenience store at a popular spot in Manhattan probably consistently makes $2,750 a day. That convenience store certainly isn’t going to get Series A funding.

There are hundreds, if not thousands, of niche websites that make $2,750 a day with just AdSense — it only takes 5.5M impressions at $0.50 eCPM or 2.75M impressions at $1 eCPM to do so. Those websites aren’t going to get Series A funding either.

Or maybe you’re one of those lucky start-ups that gets to $5M in revenue per year, which is $13,698.63 per day, but you’ve capped out. Maybe you’ve got a product that provides great value to a small number of players. You’re not getting Series A funding either.

Random revenue targets like these are just numbers in a vacuum with no context. An entrepreneur setting a goal for an arbitrary revenue number without the right context is setting themselves up for failure. This doesn’t mean you shouldn’t care about revenue. You should instead think about revenue through three difference perspectives.

Three Factors that Encapsulate Revenue

In the middle of the debate, one Steve Bennet piped in with a very thoughtful tweet:

He hit the nail right on the head. VCs care about market, growth rate, and margins. If you’ve got those three, then strong revenue metrics will follow. But you can have good revenue (perhaps $2,750 per day by a small team or single proprietor), and not have one (or any!) of these three important attributes. If you’re missing one of these, then a VC is not going to be interested.

Why do these metrics matter? Let’s look at each one.

Market. Venture capitalists are looking for monster returns. They need that 10x+ return to make their fund, so they’re only interested in companies that have the potential to achieve a 10x return. If you’re making $2,750 a day, that doesn’t necessarily mean you have the potential to achieve that great return. It might be a nice return for yourself and your team, and there is absolutely nothing wrong with it, it’s just not interesting to a venture investor.

Another way to look at this is by looking at employment data provided by the U.S. Census Bureau. According to the Bureau, in 2008 there were 5,930,132 firms with employees on payroll in the United States. Of those firms, only 18,469 firms had 500 or more employees. And only 108,855 had 100 or more employees. To achieve venture scale, you’re probably going to need at least 100 employees. Only 1.8% of all firms have reached that level in the U.S., and VCs are looking for new companies that could fall into that particular bucket. Just because you’re making $2,750 a day doesn’t mean you will be in that bucket. That doesn’t mean you can’t be, or that you shouldn’t try. It’s just that an arbitrary revenue level is not a sufficient condition to make that determination.

If you’re trying to grow a business to venture scale, then you’ve got to be operating in a big market. If you’ve gotten to sustainable revenue levels in a small market then congratulations, you’re like the 98.2% of other small business owners in the United States who are able to make a great living and support their families.

Growth Rate. If market describes the potential of revenue, growth rate describes the ability of you and your team to execute on that potential of revenue. In order for VCs to achieve that 10x+ return within a 5-7 year time horizon, you need a lightening fast rate of growth. If you’re in a big market but you’ve got a slow or no growth rate, then you’re either not executing properly or you’re too early. Whatever the case, that’s not interesting to a VC. Maybe you’re making $2,750 a day, but you’ve been making that consistently for the last 365 days. And the next 365 days look the same, no matter how much you invest in it. That’s not interesting to a VC. You better have a plan to go from $2,750 a day to $27,500 a day within a couple of years, or you’re not going to achieve the return that VCs are looking for.

Note that if you have tremendous growth rate that’s sustainable, then of course your revenue is going to achieve high levels. What level it achieves is important but it got there because of a growth rate. And it’s going to go higher because of a sustained growth rate. And it’s that growth rate that VCs love. Not just $2,750 a day.

Margin. Margin is the life blood of all businesses, and without it you don’t really have a business.

Margin measures how much cash your business generates and how much you can invest back into the business. The higher the margin, the less need for outside sources of cash, the less dilution for existing shareholders.

If you’re one of those companies out there that has to spend $1,000 on AdWords campaigns in order to generate $100 of revenue, then you don’t have a strong business. (Some might say you don’t even have a business, just a project or an experiment.) Or maybe you generate $2,750 a day in revenue, but you spend $5,000 a day to get that $2,750. That’s not a strong business either, and certainly not venture fundable. However, if you’ve got a path to $27,500 a day by still spending $5,000 a day, then maybe that’s fundable. It all depends on market and growth rate, and whether or not you have a believable story.

What Matters

Market, growth rate, and margin. As an entrepreneur, you should know status of all three of these attributes as it relates to your business. If your goal is to build a venture scale business, then you better be playing in a market that’s potentially huge. You better find a way to show a strong growth rate. And you better show that you can do it with healthy margins.

What doesn’t matter is how much revenue you generated yesterday as a standalone metric. There is no revenue number that matters. That’s why there are companies with no revenue that get purchased for a billion dollars and other companies with millions of dollars in revenue whose enterprise value is only slightly higher than their annual revenue. Market, growth rate, and margin encapsulate the health of your business and the value that others will put on it.