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Funding without a monetization model? What? Really?

I just learned today that neither Instagram nor Snapchat had monetization models in place while receiving both seed and series A funding. I couldn't believe it. I had always assumed both of these apps had some means of making money from the outset. After all, nowadays we often hear that a monetization model (or at least an anticipated revenue trajectory) is integral to a business plan. Without one, no investor will give you the time of day. Ummmm...apparently they will? Can a high user-acquisition volume alone (assuming the team is strong too) still draw heavy funding in this day and age? I know traction can speak volumes, but still...really?


11 Replies

Michael Brill
1
1
Michael Brill Entrepreneur
Technology startup exec focused on AI-driven products
If you build a large user base - cheaply - investors always believe you can monetize it. But there's a huge difference between paying for users and having growth driven by relatively free network effects. Nobody likes the former; everyone likes the latter.
Daniel Drew Turner
0
1
Interaction Designer, Xerox PARC
There is a long history of this. Okay, back to the first dot-com boom isn't long, really, but people have short memories. Read the first few chapters of "The Four Epiphanies" and think about how Kozmo and furniture.com thought "we'll just grow, then figure out how to make money". And check how many years Amazon's been making a profit.
Thomas Jay
4
0
Thomas Jay Entrepreneur
iOS / Server Architect / IoT / BLE / iBeacon / Apple Pay
Dive deep into Instagram and you will find that they built the iOS app and back end themselves and they were not programmers, the founders learned to program! They did not have funding initially, they lost images, they lost users, they learned the hard way. Some how they continued and started to gather users. Then they got a small amount of funding, hired some better developers and moved forward.

They never got a huge check until the purchase.

Lots of startups are created part time for a couple of years until the product launches, even then it continues as it can until the founders can work full time, its hard when there is no check and you have a family to feed but you make it happen.

If you have 100,000 daily active users for an app, then you might be able to claim a value of $4 per user or $400,000, depending on the type of user and the value you might be able to get funding. So nothing says you need funding before you get users and nothing says users do not have value.

1,000 users mean you have something your friends might use.
10,000 users means you have something people will use.
100,000 users means you have something that people will use and tell others..

After 100,000 users is a good time to talk to investors. I think money is easier to get when you need it to grow (Marketing) vs you need it to build the product (Development).
Daniel Drew Turner
0
0
Interaction Designer, Xerox PARC
Slightly side question: @Thomas, at the end you mentioned "grow". Why is that so fetishized? It's good to have more paying customers, of course -- this is true for a dry cleaner, too (and having a dry cleaning store can raise a family out of poverty, as I know). But nobody tells a really profitable dry cleaner that she needs to suddenly go into debt to have 100 locations in a 10-mile radius, so why do people push that startups need to grow exponentially, and not just steadily? Is it just that VC money wants to give a little money, sell off the pieces of what it grew, and get out quickly?
Paul O'Brien
7
0
Paul O'Brien Entrepreneur • Advisor
Tech Economic Development and VC CMO
Lean Startup has really done a number on entrepreneurship. Worse, frankly as that's not really to blame, as tech has perpetuated the world and innovation and entrepreneurship have left Silicon Valley for your neighbor's garage, investors have naturally been unable to keep pace. Granted, that's not their fault. Both factors though are realities which have led to you, to too many people, hearing that you have to have customers.

Let me let you in on a secret....
MOST, dare I say 90% of innovation, is funded WITHOUT customers.
  • New movies (film)
  • Residential home building
  • Commercial construction
  • Medicine
  • R&D
  • Video game development
For some reason, tech related startups have been thrust into this mantra that you have to have customers.

Let me let you in on another little secret. Microsoft was built without customers, so was Google, as was Twitter, Facebook, and more. In their earliest days and in some cases for years, they went without any revenue of note. Many are famous for not giving a damn how they make money.

For some reason, many of our incubators, books, advisors, and angel investors are telling startups they need to have traction in the form of customers.

What gives?! Where's the disconnect??

First, think about the traditional experiences and expectations of investors:
  • Banks (yes investors), don't understand what you do nor really care, but you have to deliver an immediate return
  • Angel investors, SHOULD know intimately what you do and have the means and desire to pay it forward seeking a very long term return.
  • Venture Capital investors, SHOULD know your industry but not necessarily your niche and they're obligated (in a sense) to deliver returns for LPs so their time table is a little more risk averse than Angels but they know the industry and market so they can make greater investments for relatively lesser returns.
  • Private Equity investors find validation through partners, corporations, and the like. They know the space but not necessarily intimately in any way because they have the means to move companies to later stages putting multiple millions of dollars into companies to get modest but sizeable returns.
Are those the behaviors of the investors with which you deal? Increasingly typically not. Angels need to be taught what you're doing. Why?

As tech has perpetuated the world and innovation and entrepreneurship have left Silicon Valley for your neighbor's garage, investors have naturally been unable to keep pace.

What is traction?? Why are other industries so well funded without customers? Traction actually means a great many things as it is really nothing more than evidence of opportunity. Lean Startup did a number on us by trying to simplify the path to a degree of success by saying that Customer Validation was paramount. In some cases, it is, but when thrust into a world that hasn't spent the last 30 years working with tech, when thrust in to a world where the investors have no idea how the tech works, how it scales, how it makes money and so forth, EVERYONE took that too heart and heard Customer Validation = Having Customers and Having Customers means getting funded.

That may well be one of the biggest frauds unintentionally perpetuated and yet significantly consequential in innovation.

As a result, now incubators, investors, and advisors, ignorant of any other way, are constantly telling entrepreneurs they have to have revenue to get funding. But think back to the original role of those investor types... funding means you get capital from banks. Banks. And really, why would you go anywhere else for funding??? Banks have the lowest cost of capital as an entrepreneur when you consider that you need not give up any equity in your business to get a loan. Of course, that presumes you can get one but how can you not, you have revenue!!

So here we are chasing Angels and VCs and failing to find or communicate any other traction than customer (because that's what we're hearing they want) and they, generally not knowing how to see any other form of traction anyway, looking at the headway you have with customers and thinking eh.... I'll just wait on the sidelines since I don't understand it anyway and when they get MORE customers, I'll write a check.

And our venture capital economy collapses.

How do we break this?

First, entrepreneurs have to appreciate once again that Marketing is not advertising or lead gen. Founders have to stop believing that customers are all that matter and funding marketing only when there is an ROI to acquire a customer.

It may sound like a foreign idea to you. After all, for the better part of a decade Marketing has taken a beat down as while the investor community has tried to keep pace with tech, the marketing community has had to do the same and the hard truth is, most marketers are crap. Founders have a bad experience, investors hear a bad experience, everyone starts asking only for leads and customers and like any half way decent marketer, marketers start schlocking customers, growth hacking, and leads.

And companies continue to fail to meet investor expectations. Investors continue to hear that marketing isn't worth it. Everyone keeps pushing for more customers, and fewer and fewer things deliver real investor return. Causing this question to happen.... wait, I just heard about Unicorn that had no customers... how the hell did they do that!?!?

Careful, investors who don't know aren't going to admit that. They certainly aren't going to show their complete ignorance about everything you're doing, but they read a book that said Customers validate the business....

Famed economist Peter Drucker once put, decades ago, I'm paraphrasing, that "only Innovation and Marketing create value in business, everything else is a cost, and Marketing is the distinguishing of the two." I assure you, he wasn't talking about the marketers who get you customers and leads.

If innovation is the creation, marketing is the intelligence. I don't mean that to sound like I'm saying innovation (or innovators) is ignorant; I mean intelligence in the sense of data, information, and answers. MARKETing is the practice of the Market whereas innovation is the practice of the inno... (sorry, can't help but make a poor attempt at humor when I rant), let's call it engineering and invention which are the engines of inventions.

Engineered inventions without marketing are those things you see on As Seen on TV or the failed inventions that get sent to Provo, Utah for an Inventors Certificate and a free book and membership card to Inventors Club of America.

Movies, new real estate developments, medicines, and more get billions in funding because they have done the marketing to know in what to invest, why, when, where, how, and for whom. They know who is going to buy the product, at what price, and with what return before they even begin the R&D. Investment funds known opportunities.

Sure, not all investments find Deadpool and Viagra as at the end of the day it's still investment but the marketing is the FIRST investment so as to find traction in dozens of different ways such that opportunity is validated for investors WITHOUT customers.

Imagine what that entails, for example:
  • Does the media like your idea?
  • What have competitors tried and failed?
  • Do you know your conversion and cost per acquisition metrics?
  • Have you determined what you need to invest and when or are you supposing?
  • How can you outperform them in some way?
  • How big is the market? Wait wait wait... this is where most pitch decks highlight the $100 billion dollar market for the entire industry of things related to what they're doing. Fail. How big is YOUR market at this seed stage and at the investment you want to make? What will it take for you to get 5% of that tiny niche of market? No idea? Okay, we'll wait till you prove you can do it by getting customers.
  • What kind of traction do you have acquiring a team? Yes, traction is in your ACQUIRING your team as well.... do you have an incredible cofounder, advisor, and head of Sales? No?! You can't convince people to work with you on something yet you want others to just give you money?!
Alright, having written the longest post I've ever written to FounderDating, I'll cut myself off (Truth be told, this was good for me as I'm doing a talk on this in Austin on Tuesday so thanks!). Here are some other thoughts
TLDR; traction does NOT only refer to paying customers
David Austin
0
0
David Austin Entrepreneur
Entrepreneur
If you don't have customers or a fully fleshed out way to make money, this will suffice: justifiable and validated proof that people want your product now and that you have a pedigreed team that can deliver it. Getting that validation and team is the trick.
Thomas Jay
0
1
Thomas Jay Entrepreneur
iOS / Server Architect / IoT / BLE / iBeacon / Apple Pay
@Daniel
When I use the term "Grow" (Marketing) for a startup, I was talking about the VC funding view. I grew up with a family business that had a solid income of $900K, it provided very well for my family as I grew up and went to school. If we had gone to a VC and asked for $400K they would have expected a good return. If a VC gives you $1 they might expect $100 or $1000 back, in general very high returns for high risks.

So if you were to get funding of $1M then perhaps the VC would expect $10M to $100M return.

Returns can come from several means, maybe you get customers and have some great sales (No very often for a startup) and pays off VC's, or you got public (again not very often) but more likely you are sold or merged into another entity (watch out for long term stock options like 4 years and the company gets sold in 10 months, then your out the door).

Maybe even a write off if the company goes belly up.

You also have to remember the 80/20 rule where 80% of all investments fizzle out and there is no return, that means that the remaining 20% must make up the differences so huge profits have to be expected from the few successful companies for VC's to continue investing.

A VC is not investing to make the same money they could make from a bank account (at least in the old days) of maybe 3%, they want higher profits, maybe 25% or more. They are not in it for the good of technology, its all about money.

When you take money from an investor you might just find that you give up the company in whole and then wind up with a very small amount or even a contract that states you have to perform or your out completely, lots of different deals can be found for startups at different stages.

My recommendations is always have customers when you talk to a VC, everyone has an idea but once you can prove that you can execute on it to some extent the better and if your just asking for money to grow then the better and possibly less risk.

Anyway, a long winded explantion of what I was talking about.
Dimitry Rotstein
0
2
Dimitry Rotstein Entrepreneur
Head of R&D at SafeZone
>why do people push that startups need to grow exponentially?

Because that's the very definition of a startup (or at least one of the definitions) - something that can grow exponentially and make a huge exit (M&A or IPO) well beyond its current valuation. Otherwise, it's just a regular business, not a startup. Have you ever heard of a dry-cleaner being sold with a 1000% return on investment?
Neil Gordon
4
0
Neil Gordon Advisor
Board Member, Corporate Finance Advisor and Strategy Consultant
The conversation with investors will go something like this:
Investor: "Interesting idea, but what's your monetization model?"
You: "We don't have one; neither did Instagram or Snapchat."

Whatever you hear after that is unlikely to be the sound of someone writing you a check.
Michael Barnathan
0
1
Michael Barnathan Entrepreneur • Advisor
Co-Founder of The Mountaintop Program, Google Alum
There's a good article about this on AngelBlog:

http://www.angelblog.net/Venture_Capital_Funds_How_the_Math_Works.html

When you think of the VC firm as a fund manager for other people who wish to invest in emerging companies rather than an investor unto itself, the dynamics make more sense:

http://blogs.wsj.com/venturecapital/2013/10/31/venture-capital-returns-rebound-but-beating-public-markets-remains-a-challenge/
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