Wednesday, May 28, 2008

Your Startup's Revenue Projections Are Wrong

People often ask me:
"Paul, what should our revenue projections look like to attract venture capital?"
I believe there is no good answer to that question. There’s no “right” projected number that makes us all want to throw money at a startup. Most VCs are savvy enough to ignore the number itself because frankly, most of the time, it's wrong. Not through any fault of the entrepreneur, but simply because if the future could be predicted, we would all be buying lottery tickets, and not starting (or investing in) companies.

What is important to understand and convey to a VC are the assumptions underlying the forecasts, because that’s what we go digging for when we look at those things. In other words, is the underlying assumption some formula about growth in page views (for example)? And if so, show me that those user growth projections tie directly back to the revenue projections. Then, take it one step further, and think about a basic sensitivity analysis. Show me three scenarios of user growth, and how that affects the revenue projections.
What the entrepreneur says: "Our revenue is projected at $25M for next year, because we think this is going to take off in a big way."

What the VC is thinking: "Looks like that number was just pulled out of thin air. This person didn't do their homework. I'm going to tune you out and get back to answering emails on my BlackBerry."

What the entrepreneur should have said: "Our revenue is projected at $15M for next year, because if we assume signed distribution deals with these 10 blogs, we should generate 100M pageviews, and with an assumed clickthrough rate of 3% etc..."
You get the point. The VC would rather see a smaller number built on a foundation of assumptions that you've verified, rather than a huge number which you pulled out of thin air. 

See where I’m going with this? It’s not about getting the right number, or even getting the number you think the VC wants to hear. It’s about identifying the assumptions, explaining them, testing them, and justifying them.


Sarah Prevette said...

Good advice Paul. Am interested to hear about how much data you think is necessary - VCs like Dave McClure have alluded to a preference for bare basics - focus on articulating the problem and engage the VC on potential solutions your company would be capable of providing. A common question entrepreneurs have when crafting their pitch is how MUCH data to share and WHERE to source it. Do they lose credibility if they cite other similar company's numbers (which in lots of cases are either guesstimates or in the case of new innovation direct comparables don't exist), find an average and use this as their own projection?

Paul Dawalibi said...

I agree with Dave. The focus should be on articulating the problem and solution. And hopefully just ONE problem with ONE solution.

When it comes to how much data, I always think less is more. Hit me with the big picture. Show me how revenues and usage scale over the next 3 years. Anything above and beyond that in terms of projections is too much for me, and I think it's all pulled out of your ass anyways.

More importantly, show me why you think those are reasonable numbers. That's the data you need to source and think about. It's not good enough to say "look, Twitter grew at 5000% per month, and we're Twitter for dog lovers, so we will grow at 5000% per month too". Comparables tend to be weak, because entrepreneurs invariably look at only the very successful companies in their space. For every Twitter, there were 100 companies who didn't grow at all. Did you factor those into your average?

My biggest preference is to see you build those assumptions (that formed the basis of your simple projections) from the ground up. Show me that you understand who might reasonably use your product, and how much they'll pay and how it scales from there. Therefore, the source of the data that I really care about, is your understanding of your market and customer. It's your understanding of how users will behave and react to your product.

As a VC, I won't spend any time trying to poke holes in your projections. I will however try to poke holes in the assumptions that were the basis for those projections. I will do my own research, and talk to your customers/users, and make sure that the assumptions you're selling me are reasonable.

Irene said...