I received several questions in response to my post titled The Purpose of Numbers on a Y Axis and my followup post titled The Lack of Numbers of Y Axis Doesn’t Disqualify You. One of the questions prompted a rant in my brain that often spills out of my mouth when I’m on the receiving end of an early stage pitch.
The question is: “what kind of numbers would actually get your attention on a revenue chart for the first 12 months of business (or would income / cash flow be a better measure?)” Before I answer the question, I want to add an explicit qualifier – this answer applies to early stage software / Internet startups – think a few people, an idea, and maybe a prototype.
The answer is – none. I’ve seen around 4,387,215 financial models for startups. I’ve invested in over 100 companies. As far as I can remember, not a single revenue model was anywhere close to accurate in the first 24 months, other than the ones that said there would be $0 revenue.
Now – I invest in software / Internet companies – the vast majority of which don’t make any money in the first year or two. But – the principle scales beyond year 1. I can’t remember a company that I have been involved with that had an accurate view of its revenue dynamics until at least the third year. The vast majority of companies were well below their initial expectations (which isn’t necessarily bad); a few demolished their expectations (on the upside.) In either case, the conclusion is the same: Your Revenue Forecast Is Wrong.
I’m not suggesting that the right answer to the question posed above is “don’t bother with a financial model.” Rather, I’m suggesting that your financial model is going to be incorrect and a credible early stage investor is going to know that before you sit down with him. It’s actually a good test – if your potential investor immediately digs into your financial model before understanding how your actual business works it might be a good signal to you that he doesn’t understand how a startup software company evolves.
As a result of my assertion that your revenue forecast is wrong, I’m less concerned about the absolute numbers and more interested in understanding how you think about them. I’m also very interested in how you see the expense side of the equation growing over time since that is the piece you ultimately have control over. However, I don’t want to spend any time on this until I understand what you are trying to accomplish with the business and whether or not it is in an area that I believe I’d be interested in investing in. Especially because whatever you have forecast and are presenting to me will almost certainly be wrong, although not necessarily invalid.