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August 05, 2008

In Praise of Revenue

The most noted Web success stories are of companies which began without a revenue model, grew like topsy, and eventually made very good. ICQ at the beginning of the first Web bubble; Google at the beginning of the latest one; and – on a smaller scale – del.icio.us, flickr, and YouTube in the Web 2.0 boomlet. I've advised some young web companies to grow first and worry about revenue later; this post qualifies that advice. Revenue is probably a good strategy for most – but not all – startups.

The no revenue approach is a long shot, a swing for the fences strategy. If growth isn't funded by revenue, it has to be funded by investment capital. If expenses escalate commensurate with growth, then growth itself can be a problem if there is no more capital available. If growth doesn't come as fast as planned, then time becomes a problem as capital is eroded. In an exuberant time, growth itself can attract capital. But we entrepreneurs don't control the swings the of the economy; when times are sour, money hides.

It's a lot easier to raise money with a demonstrated revenue stream; even easier if you are already cash flow positive and can show in simple terms how more capital will produce more cash flow from a "proven" model. The number of investors willing to invest in pure growth is much smaller than those who will invest in a revenue stream. A company with a revenue stream can use debt as well as or in addition to equity. Moreover, if more customers automatically mean more revenue, growth can be self-funding – assuming you have some way to pay for attracting those customers.

A company with revenue can survive a downturn in the investment climate and be well-positioned when investors swing back from funk to frenzy.

This may all seem pretty basic if you've never been part of the Web economy; but it's a reeducation for those of us who've lived on the leading, growing-edge of bubbles. Maybe it's a sign of how mainstream the Web has become that most (but not all) of the opportunity is available to companies which start with a revenue model and use revenue to either fund growth or attract the funding for growth.

Next: when a no revenue strategy IS (and isn't) appropriate.

I blogged about ICQ and creating network value here.

Yahoo.licio.us is about the success of del.icio.us.

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