Know the Difference: Revenue vs Venture Relevant Revenue
By Jaap Dekter
Founders are responsible for a great many things, including paying their team’s salaries on time. Given all these responsibilities, they often treat each euro that comes in with equal appreciation. Yet this may not be the wisest strategy for founders, especially those about to go into fundraising mode. It is important for founders to know that VC’s which focus on early stage investments have, and should have, a strong preference for certain kinds of revenue.
I want to differentiate this preferential revenue from any euro that comes in by using the term ‘Venture Relevant Revenue’, or VRR for short. While I’m aware of how foolish this may initially come across, I want to discuss why a euro in could be irrelevant and when a euro in does matter.
What’s NOT Venture Relevant Revenue
Let’s start with this scenario: The founder of a Software-as-a-Service (SaaS) company is excited by his or her revenue. He or she proudly boasts that the company’s monthly recurring revenues are €50,000, sometimes even a little more. In other words, each month the company has €50k coming in.
To the untrained ear, this all sounds fine, however, experienced investors know better. They know to dig deeper. The experienced investor will follow-up by asking a SaaS founder a question along the lines of: “What part of this €50k comes from subscription fees versus the proportion that comes from one-off consulting or set-up fees?”
Why this distinction? Well, because there’s a big difference between:
- Clients paying €50k each month for your software (€50k total VRR).
- Clients paying €10k each month for your software + each month the company succeeds in securing new clients to pay €40k in consulting fees (€10k total VRR).
Scenario one proves there is demand for your software. Scenario two shows your team is good at sales – not that you have a scalable product per se. So when it comes to VRR, aka the kind of revenue that matters most to (early stage) VCs, then one-offs and consulting fees are excluded.
Not only does the breakdown of the €50k say something about the company’s traction today, but it also matters down the road. Years from now, when the company goes public, it is the future earnings that will drive the price of shares.
I will now describe what I consider to be one of the worst offenses: When founders sell lifetime licenses to their software. If your business offers lifetime licenses, with each sale, you effectively kill part of your market. Furthermore, the case of lifetime licenses helps me demonstrate how founders and investors can interpret revenue differently.
Instead of nurturing a client who keeps coming back and paying for your services (e.g., monthly subscriptions, premium services, add-ons, and so on), lifetime licenses reduces this to a one-time transaction. Since lifetime licenses do not count towards a company’s VRR, a VC will effectively ignore any revenue earned from such sales.
Again, my apologies for singling out SaaS founders here, for they are far from the only ones unaware of the importance of VRR (versus any other revenue). It’s my sincere hope that all marketplace founders out there bragging about Gross Merchandise Volume (and not about their take) also read this article and take note.
Now that we’ve discussed what does not count as VRR, let’s turn our attention to what does.
What IS Venture Relevant Revenue?
For revenue to be of real interest to investors, a minimum of two criteria must be met:
- The revenue must be repeatable with that same client
>> Why? You can only charge setup fees once, and that’s likely at the beginning of that relationship. You won’t repeat these revenues later, and that’s why those fees don’t matter. Instead, subtract setup fees from your Customer Acquisition Costs.
- The revenue must be scalable
>> Why? As volumes go up, margins should not go down. When they do, something may be broken.
Two keywords to remember: Repeatable and scalable revenue count towards VRR. Here are three examples of revenues that do meet these criteria:
- For SaaS companies, what matters is your Monthly Recurring Revenue. This is the amount that you charge for your software. Netflix example: Monthly user fees.
- For founders who are running a marketplace, what counts is the amount of money hitting the company’s bank account, not the money that changes hands over your platform. Airbnb example: The total a user pays for the room is irrelevant, what really matters is the commission they make from each booking. 2
- For eCommerce, the top line revenue (or gross sales) is not of that much importance. What does matter is your margin, also known as the contribution margin.
Of course, as an entrepreneur, I understand that all revenue matters. Without revenue your company goes bankrupt and all these finer distinctions become irrelevant. That aside, I hope this post helps founders better understand why an investor might ask them to dig deeper into different numbers.
If you’re a founder or an investor, stay tuned for more blogs from Jaap Dekter – Founder of Amsterdam Venture Partners, StartupBanking.co and MD of the Angel Academy.
Want to know how your VRR compares to similar companies raising similar amounts? Take a look at our Benchmarking-as-a-Service product. Top performers are invited to one of our Seed & Series A events like the next one May 2, 2019 in Stockholm.