Start-up Tip: What’s Your Revenue Model?

Mike and I stated working on crowdSPRING in the summer of 2006. We incorporated the company in May 2007 and launched the crowdSPRING marketplace in May 2008. We’ve learned many important lessons along the way. In some ways, our experience is typical of other start-ups. In other ways, it is not. I want to share some of our adventures (and mis-adventures) in the hope that it’ll help others looking to start a company or those who’ve already launched a start-up. So, once or twice every week for the next few months, I’ll post a new tip, based on our experience with crowdSPRING over the past two years (and my experience advising technology start-ups over my 13 year career as an attorney).

Start-up Tip 5: What’s Your Revenue Model?

Some people suggest that start-ups need not have a revenue generating model when they are founded. A few suggest that focusing on a revenue model too early can hurt a business. Many will point to Google’s lack of a clear revenue model when it was founded (and to other examples).

A number of companies (including Google) have achieved great success (whether measured by revenues or acquisition) even though they did not have a clearly articulated revenue model. For each of those examples, there are hundreds of thousands of companies that failed because they did not have a clearly articulated revenue model.

Let’s look at a few facts. In 2007, angels invested $26 billion in 57,120 businesses, according to Center for Venture Research. VC’s invested $29.4 billion in 3,813 businesses in 2007. That’s at total of 60,933 businesses.

According to the Ewing Marion Kauffman Foundation, about 495,000 businesses were started in the United States in 2007 – every month. That’s nearly 6 million new businesses in a year. The vast majority of those businesses will not receive any form of outside funding.

While those statistics include businesses like dry cleaners, retail stores, and others, they also include many technology start-ups. Although data isn’t yet available for 2008, there’s no reason to believe it will be vastly different.

It’s important for entrepreneurs to recognize that while they shouldn’t necessarily ignore an exit strategy, they should be looking to build a sustainable business, not a quick sale. The current economic market conditions make exit strategies extremely difficult. That means that companies must find a way to get people to pay them. Imagine that.

Some companies have a  simple revenue model: get acquired before they run out of money. An exit strategy is not a revenue model, except for a very tiny fraction of companies.

Other start-ups, when pressed on this issue, will suggest that their revenue model is advertising alone. Except for a very small group of companies, advertising alone is not a revenue model.

A revenue model has a number of components, but none more critical than a very simple fact: you must find a way to make more money than you spend.

If your goal is to make money (whether by operating your company or becoming acquired), you’ll need to find a compelling revenue generating model sufficiently early to be able to execute your plan. There’s a reason why potential investors drill entrepreneurs about the revenue model for the business – it’s because a business typically must earn revenues to succeed.

Our revenue model is simple: people pay us. When buyers post projects for logo design, web design, other types of custom graphic design, or are looking for a company name, product name or other writing services, we make a 15% commission on the awards offered by buyers in the crowdSPRING marketplace. We’re far from reaching profitability (we’ve been at it for only 4 months), but we assessed and developed our revenue model before we met with a single investor. We know that we must scale to succeed, but we also know that if we scale, our revenue model will allow us to operate our company profitably.

If the grim reality that most start-ups fail hasn’t caused you to sit down and think about your revenue model, the recent economic chaos should give you that incentive. Take the time and think about your business. What is your revenue model?

If you have your own tips or stories, please feel free to share in the comments. And if you enjoyed this post, please also take a look at other start-up tips we’ve written about:

Start-up Tip: Ten Suggestions For Raising Start-up Capital From Angels

Start-up Tip: When To Leave Your Full-Time Job

Start-up Tip: Lead by Example, Not By Title

Start-up Tip: Surround Yourself With Smart People