Not all revenue is good (enough) revenue

I start today a series of articles trying to elaborate on concepts that are less understood in the local market. Examples of such concepts are “quality of revenue”, “venture returns”, “vested interests”. Hope this will help founders be better prepared to close their rounds and investors better assess their placements.

Many startups — and less sophisticated investors, as well — consider generating revenue early on as the ultimate proof of product-market fit. What can be a better proof of market fit than having paying customers, right?

Well, actually it depends on the quality of that revenue, especially as startups try to leverage their early income to command higher valuations.

So, what makes the “quality of revenue”? I’ll elaborate a bit on this taking as an example Mad Men Ltd, a hypothetical B2B company developing back-office technology for advertising agencies. Mad Men Ltd has launched just 9 months ago and they already signed three clients, generating close to €300,000 in annualized revenue. If everything goes according to plan, the company will be breaking even in just 6 months; they also plan to raise a Series A with some major VC funds in the US and Europe this summer. A very appealing company to invest in, wouldn’t you say?

Let’s take a better look at their “quality of revenue”.


That’s the consistency of revenue sources: Are you selling to the right customers for the right price? Are you at least selling to customers with similar profiles at a reasonably consistent price point?

Mad Men Ltd — our made-up startup — are making their first money by selling to one media buying agency in Nigeria, one full-service advertising network in Canada and one PR agency in Romania working only for the public sector. For the different clients on the different continents (the geographical spread proves a lack of focus in their marketing efforts, by the way), Mad Men Ltd are charging different prices, even using different business models: charging the media buying agency in Africa a fee for every transaction versus charging the advertising network in North America an annual licensing fee. Mad Men Ltdmay intend to raise their Series A this summer, but any sane investor would see a problem in the consistency of their revenue.


Is your revenue distributed among many accounts or concentrated with just a few? In other words, how much of your revenue is coming from just one client?

Once again, let’s look at Mad Men Ltd. They are making 97% of their revenue from the network in Canada, 2.9% from their media client in Nigeria and 0.1% from the PR company in Romania. This is just another red flag that will make their Series A difficult to raise this summer.


What’s the frequency of your revenue generation? Is it repeatable and predictable?

Remember that Mad Men Ltd is still exploring different business models with their clients (transaction fees in Nigeria versus licensing the technology in Canada). Which means that some of their revenue is being generated on a daily (or even hourly) basis while other is annual. Also, Mad Men Ltd does not have enough data points to calculate their customer lifetime value (CLV). They actually have no idea of how much money will be able to generate — neither from existing clients nor from new business — in the next cycle. This degree of uncertainty is never taken lightly by a later-stage investor.


That’s a tough one: How much revenue are you failing to re-capture?

Yes, Mad Men Ltd is generating revenue. Which means that they must be doing something right — creating value for their paying clients. But is this enough to command a high valuation for their Series A? The answer also depends on their ability to retain clients. But Mad Men Ltd is too young a company to prove this — they are still to close a first cycle, a first year of invoicing in order to confirm that the banks they work with are not a one-time kind of a client.

The actual profitability of revenue

This is quite basic: Are you making any profit on the revenue you generate? In other words, is the process of generating revenue more expensive than the revenue you generate? You should factor in the marketing costs (inbound vs outbound), the level of customer service required for generating revenue (light touch versus hands-on), the sales channels you use (direct, indirect, self-service, partners etc).

Mad Men Ltd estimates that they will reach break-even in just a few months, but for the moment they are still losing money. They over-service their existing clients trying to learn as much as possible about their needs, they still explore different channels looking to optimize the marketing and sales engine and, generally, spend too much to generate too little money. Which is exactly what they need to do at this stage of development but is also what will make their Series A round difficult to close at a high valuation.

On a closing note — if you are leading an early-stage company preparing to raise its Series A based on the revenue it already generates, ask yourself the questions above and try to assess what the quality of your revenue is. Going unprepared to a fundraising meeting with a VC, especially with the big boys, is something that only Mad Men (Ltd) would do.