When asked about “traction,” entrepreneurs assume it’s in reference to revenue. Revenue seems to have eclipsed other metrics as an overall indicator of how well the business is doing.
I think the rise of revenue has something to do with blowback from the late 90s, when we suspended traditional financial indicators for our so-called new paradigm. It did not end well. We learned the hard way that financial indicators are important, so we returned to them with a vengeance. “Engagement, whatever…how much money are you making?”
In our back-to-basics approach, we’ve buried some metrics that are more important than revenue because of what happens to most startups; they either die, or are acquired by a bigger company. Revenue itself isn’t the main driver of those outcomes. Acquisitions are more likely to come from how your product can be applied to a much larger installed base of customers, or how your tech or market presence can accelerate an acquirer’s roadmap.
Your revenue might give an acquirer a sense of your viability as a standalone business, thus setting a lower bound on what they will offer. But it will not set their value on your company.
Here are 6 metrics that matter more than revenue:
#6 Gross margin
Gross margin doesn’t tell a story by itself. There are plenty of great low-margin, high-volume businesses. Gross margin is good for gauging how many options you have at your disposal. A high gross margin usually means you can adjust if things don’t go as planned. For example, you have room to drop price if competition stiffens, or you can make a move to profitability if financing gets tight.
#5 Liquidation preference
Liquidation preference is simply the “first dibs” preferred shareholders have on your proceeds from a sale. It’s the bar you have to get over before you can divvy proceeds to other shareholders like founders, employees, etc. It’s not debt, but it can sure feel like it when you are trying to make all classes of shareholders happy. Liquidation preference puts boundaries on your available strategic options. If liquidation preference is high, you can forget about being satisfied with dominating a small niche, or taking a modest acquisition offer (unless it’s that or fold-up entirely).
#4 Revenue concentration
There are various ways to measure revenue concentration; all of them gauge how much of your revenue is at risk from losing your top customers. High revenue concentration puts a serious pinch on valuation because a single instance of churn can send the company into disarray. A typical treacherous startup path: chase big customers to drive revenue growth, add overhead to cover problems with an immature product and keep those customers, end up in a more precarious spot than had you foregone the revenue altogether.
#3 Months to cash zero
Running out of cash is obviously very, very bad. Not much else to say except, if you are driving revenue at the expense of your cash runway, you should have a good plan for how that turns around.
Assessing whether your customer churn is high or low can be complex. There are markets with endemic churn, like weddings, infant care, Realtors, SMBs, as well as business models with endemic churn. It’s important to have your own internal benchmark. Like an EKG monitor flat-lining, when churn is high, you stop what you’re doing and address the root issue. The root issue can be hard to uncover. It can be pricing, support, missing features, bad tech, renewal timing, or competition. Whatever the case, as long as the problem goes unaddressed, all the resources you are spending on sales and product are potentially for naught.
#1 Cost of the problem you are solving for would-be acquirers
Ultimately, the value of your company will be measured by the problem you solve for an acquirer. That problem is either (a) product (capabilities, features, something new to sell to their customers), or (b) market (an entry point into a certain type of customer). Value is not simply a matter of what it costs BigCo to build your product, although that is part of the equation. It’s mostly a matter of how long it would take them to build it, and the opportunity they are passing up in the process. Projects can move slowly in a big company, and the ability to unlock value now can justify a high price.
Focusing on revenue for an outcome that won’t have much to do with revenue is like training for Sport A, then playing Sport B. A lot of the skills you learned will transfer, but you would have been better off practicing directly relevant skills all along