Revenue vs. margin optics trade-offs for investors

Michael Brill Technology startup exec focused on AI-driven products

July 24th, 2013

I'm trying to figure out how to pitch a revenue model to potential investors. The business model conceptually operates on an affiliate revenue basis (I get paid for referring traffic) but technically I take ownership of product for a short period.

So let's say that the model calls for $200 million in transactions at a 7% affiliate fee or $14 million in revenue at basically 100% gross margin. But I'm concerned about the optics of "only" a $14 million business to a tech investor. Alternatively, I can present $200 million with 93% COR or COGS - that shows a much more exciting top line and it's correct from an accounting perspective.

Also, since there is the potential to shunt some of the revenue to own-sourced products with much greater margins than affiliate products, I think it might be a more relevant number.

Thoughts?

Hoi Lam Senior Developer Advocate at Google

July 25th, 2013

I have worked as a technology analyst at two top ranked investment teams at Citigroup and Deutsche Bank. For me, I would regard $14m as the revenue and I would expect other professional investors too.

Some well-known companies such as Groupon has tried to account for the whole $200m and got into a lot of trouble for doing so. Accounting for the whole of the $200m is aggressive.

Also, pay attention to COGS, I know you said "basically" 100% gross margin, the reality is that you will need to account for the running cost / depreciating of your system as well as any traffic or content acquisition costs. Here's how Google define their COGS and they have a high 60s gross margin (excluding Motorola):

P.35 http://www.sec.gov/Archives/edgar/data/1288776/000119312513028362/d452134d10k.htm

"Cost of revenues consists primarily of traffic acquisition costs... Cost of revenues also includes the expenses associated with the operation of our data centers, including depreciation, labor, energy, and bandwidth costs, credit card and other transaction fees related to processing customer transactions, amortization of acquired intangible assets, as well as content acquisition costs."

Jeff Mills Global Vice President of Sales at iMerit Technology

July 24th, 2013

Hi Michael, Interesting... I've spent a bunch of time in VC meetings lately and they are ALL about margins. Ultimately the Gross Profit potential is all they are going to see anyway, so showing your GP is based on huge margins is a better story. That said, you can highlight other potential revenue models based on the "owned sourced" products piece... My 2 cents... Jeff

Jack Rose Founder at Colony

July 25th, 2013

My father drummed into me from an early age, "Revenue is vanity, profit is sanity."

My two cents would be to present your figures as transparently as possible, don't try to make it seem like a bigger opportunity than it is; it will only serve to undermine your credibility.

Jack Rose Founder at Colony

July 25th, 2013

It's a very interesting and challenging question. I understand you aren't trying to be misleading, otherwise you wouldn't have asked the question, but the conversation which has ensued evidently demonstrates there is scope for misunderstanding between yourself and investors which it would be preferable not to have to explain your way out of!

Anonymous

July 25th, 2013

Michael, I was being marginally facetious when I said it, but I actually have found the adage to hold a *little* weight. In the instance you outlined, I would just close with an indirect ask: "How closely do you think this is aligned to your own investment thesis?" (Note that it's an open-ended question) If the response is favorable, stop talking. Schedule another meeting right then and there, and bring whatever type of proof points they seemed interested in to that next meeting if at all humanly possible. That's what I'd do. But I really want to hear from the guys who have raised 7 and 8 figures, because while I'm a second time founder w/a happy exit in my past, I'm just raising my first-ever seed round now. (Bootstrapped last one to profitability, held it 6 years) C.

Michael Brill Technology startup exec focused on AI-driven products

July 25th, 2013

Thanks again everyone... I'd like to repurpose this thread to address Cynthia's money<>advice comment.

I'm trying to reconcile this with the other oft-spoken wisdom of making sure the ask is clear and possibly turning off investors by *not* being clear about what you want. I think someone just posted something on this topic in the past day or two with lots of +1s and huzzahs.

Let's say you have a warm intro to an experienced angel, you give a quick pitch, chat for awhile and feel like the conversation has gone reasonably well and this is conceptually in their investing universe. How do you end that meeting?

Anonymous

July 25th, 2013

I think it's very important to make a distinction here between angel investors and institutional investors. Yes, calling $200M your top line revenue is problematic when you're either publicly traded or taking money from institutional investors, because it's actually the SALES number and not the revenue number. But when you're talking to early stage investors, they want to fall in love with your dream and your vision. They know that the actual nuts and bolts of the business as it matures have very little relation to what you talked about or expected in the early days. And most importantly, if you're raising a convertible round, you're not actually issuing a security upon receiving the financing.

Bill Kelley

July 25th, 2013

Cynthia, I think you're on target.

Generally, VCs will tell you if they are investing in "your area" right up front. If they are, draw them out on where they think the opportunities are.

The 'stop talking' advice is in the to 5 hard but essential to learn parts of pitching.

The thread yesterday spoke of giving access to prospective customers to hear actual marketplace feedback. If VCs do not get guidance from you on who to talk with, they'll find their own, and the results may not be to your liking.

Momentum is important. Most VC firms are hearing a bunch of pitches a week and you want to hold on to whatever mindshare you've gained. Do not be afraid to respond to individuals who expressed specific interests in your presentation. You need advocates on the inside.

ABC -- if you don't know what that is, watch Glengarry Glen Ross at once.

John Wallace President at Apps Incorporated

July 25th, 2013

IMO the most important thing an entrepreneur can show investors is that they understand the financials of their business. I'd make sure the numbers reflect the real financial opportunity and gross margins, and account for competition. If you presented this to me as a $200M opportunity with 100% gross margins and no competition, I'd be pretty skeptical. If true, that's incredible! But is it true? Ultimately, if you do a deal you will be contractually bound to hit the numbers or you risk losing everything. (BTW, that doesn't mean that you shouldn't show that there is a vibrant $200M market, especially if there are market forces that will cause it to grow. Also, depending on competition there may be opportunities for greater margins, or other revenue streams. Also, as BIll pointed out, there may be many exciting arbitrage opportunities.)

Bill Kelley

July 25th, 2013

Michael, I think you have a clear understanding of the situation. In another thread on FD is a discussion of how to present to VCs/angels. It echos the underlying thoughts you have in structuring your presentation. Graph the revenue/cost projection. When you show the revenue flow and clearly highlight COGS, you'll have every brain in the room thinking about how to lower costs. When they are thinking like they are involved in your company, you're halfway there. I've helped raise 8 figures of VC and angel cash in the past several years and the initial presentation is 'placing the hook.' You should have addendum pages to your pitch that clarify everything so those (rare) VCs who want to dive deep can do it immediately. But everything will come out in DD in any case. Your initial presentation is a test of your marketing ability. And, as has been said 100X before, investors put money in the team, not the plan. So be accurate, be complete, have the backup at hand and do not be afraid to say that you're looking for ideas on improving the revenue/cost ratio. Bill Kelley techweenie@techie.com

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