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Why Do Investors Insist on Revenue for Early Stage Startups?

It's a common problem for early stage founders:  How do I raise money to generate revenue when so many investors insist on seeing revenue-generating “traction” first? Why Do Investors Insist on Revenue for Early Stage Startups

Here's a useful explanation from Phil Nadel of Forefront Ventures.  In this guest post he explains the perspective of venture investors who avoid investing in pre-revenue startups:

Stop Swinging for the Fences

Conventional thinking in venture capital is that success requires aiming for the fences. Home runs (or even grand slams) are necessary to generate a reasonable rate of return in light of the large majority of portfolio companies that go out of business. But is this the most sensible approach?

Identifying unicorns at the nascent stage is nearly impossible. Especially because early-stage investors are forced to put greater emphasis on subjective or qualitative factors like the founders’ personalities and team dynamics rather than more analytical or quantitative factors like a company’s KPIs. How many of us can honestly say that had they heard a pitch in 2004 from Mark Zuckerberg, a college dropout with no startup experience, for a pre-revenue company targeting college students called Thefacebook (its original name), that they would have written him a check? I certainly wouldn’t have. If you speak to those who did invest early in Facebook, and you get them at a candid moment, they will largely credit luck as the reason for their fortunate investment.

I am uncomfortable relying on luck. Although I am fully aware of the high level of risk and speculation involved in early-stage venture capital investing, I prefer to increase my odds of success and greater IRR. How? By investing in companies only after they have some initial indication of product-market fit and some traction. For example, at Forefront Venture Partners, we do not invest in pre-revenue companies. This criterion alone helps to reduce the number of zeroes in our portfolio.

Is Anyone Willing to Pay For It?

Early revenue can only occur after a company has done a lot of hard work, including building and marketing a product. Many startups never make it to this stage. There is a quantum difference between a pre- and post-revenue company, and this huge leap is often not fully captured in the increase in valuation from the former to the latter stage. Getting a customer to actually pay for something is a major milestone — an indication that the company is building a product that a customer in its target market finds valuable. Before that first sale is made, it’s all just speculation.

Yeah, But Can You Get Lots of People to Pay For It?

Another key indicator we look for is a company having identified at least one efficient, scalable marketing channel. We want to know that our investment can be used to pour fuel on the fire powering the company’s growth. Knowing that the company has already identified scalable marketing channels that enable it to acquire customers at a reasonable cost (relative to projected lifetime value) eliminates another layer of risk.

Read the rest of this article at TechDayHQ.com

 

About the Author:  Phil Nadel is the Co-Founder and Managing Director of Forefront Venture Partners. You can follow him on Twitter or on Medium.

Thanks to Phil Nadel and Forefront Venture Partners for this informative post and the graphic.

Want to share your advice for startup entrepreneurs?  Submit a Guest Post here. 

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