In venture capital, there is a very real phenomenon often referred to as the “magic of zero”.
The premise is that companies with zero revenue can many times be valued (much) more highly than companies with some revenue. The logic is based on the potential for growth and scalability.
When a company has no revenues, it’s often because it’s still not a company (but rather still a power point) or because it’s focused on building a user base, creating network effects, or over-polishing its product or service rather than monetizing. Investors can imagine boundless possibilities and huge potential markets, assuming that once monetization starts, the revenue growth will be exponential. There are no actual numbers to disappoint or contradict the investors’ assumptions or projections. Hence, the “magic of zero”.
And ohh boy, we’ve seen this phenomenon play out many times a week in 2020/2021…
Once a company starts earning some revenue, however, it can be easier to apply traditional valuation methods, which might result in lower valuations. A small amount of revenue can (many times wrongfully) indicate a limited market or slow growth, which could lead to a lower valuation.
That being said, it’s important to note that not having revenue is indeed a riskier proposition, and this strategy should not always result in higher valuations. The company still needs to eventually be built and then find a way to monetize effectively. And while some investors may be attracted to pre-revenue companies for their potential, at SaaSholic we prefer to see proof of a working business model and some track record of revenue.
The magic of having revenue
Showing some revenue, for us, means 3 things that de-risk any and all investments and helps us create conviction in an investment:
- Despite having a far-from-perfect product, the company has a found a pain that real customers (not IRL users) actually use and pay for it. Imagine if this company raises some money to polish and improve its product…
- The founders are indeed builders of an actual product. Not just power point designers or great story tellers.
- The founders are capable of selling. Yes, this a necessary skill that we don’t take for granted. After all, founders will still need to be involved in all sales in the early days and shall be involved in most high-profile sales for a long long time.