Is it better to sell “Profit” or “Potential”?
I hear the saying over and over again that technology start up’s in Los Angeles are “focused on making money”, while the startups in San Francisco are “focused on getting users”.
It is often said like it’s a badge of honor.
Not that I’m against making money and staying focused on it, however is there something to be said for selling the potential?
Look at some really big recent exits or financings;
Facebook- Focused for years on users and not revenue
Twitter-Raised over $100 Million before they were making money.
Instagram- No revenue model- $1 Billion exit
Tumblr- $1 Billion exit. They sold into the hype. Claimed they had 300 million users, when the actual number was much less. Claimed $100 Million in revenue potential, when actually closer to $15 Million. http://bit.ly/TumblrNumbers
SnapChat- $800 Million valuation- no revenue (it’s said they don’t even have a revenue model or idea yet).
I agree that making money is a good thing. However, this has been a recent focus of conversation with a new start up we are launching.
It’s a photo sharing social network. We’ve actually built in an extremely unique revenue model that could start generating income within the first 30 days of launch.
In a normal sense you would consider that a good thing- correct?
Well, the conversation’s we’ve been having with potential investors in different geographies are interesting.
Here’s a brief sample-
Los Angeles- You have to have a product built, plus some users, and small revenue
San Fran- Anything that might take on Facebook we’re interested in.
New York- Don’t show a revenue model! Focus on users and sell the potential.
It’s this last one I find most interesting. The theory with the NY finance guys is the minute you put in revenue projections, or actually start generating money, you are penalized!
Here’s what I mean.
#1- If you show projections (which for a startup are a wild guess anyway), then you have provided a basis to discussion valuation (this is the amount of money an investor thinks you are worth before they give you any money). So if you have projections, you have provided a discussion point for negotiation of value.
#2- If you actually “start” making money, then you are subject to the “multiple” (this is the amount your company can be worth based on how much money you are making multiplied by a certain factor). So, if you are making $1 Million and the “multiple” for your industry is 8, then your company has a valuation of $8 Million. Sounds good, right?
Here is the issue, especially with #2. If you only have 1 million users you could sell the potential of what those users could be worth. Wild imaginations, valuations, multiples, etc.
The minute you hit revenue, you are now in the real world. Until that time, you are in fantasy land.
However, many, many of the VC’s outside of LA seem to prefer fantasy land.
For a few entrepreneurs, with their big exits, fantasy land didn’t turn out so bad.
What’s the moral of the story, especially if you’re trying to raise money in Los Angeles?
Try to find a balance between being focused on making money and revenue, and still being able to sell into the potential.
I’m not saying it’s an easy exercise. We’re trying to live it every day.