When I was a venture capitalist, I saw a recurring, common mistake made by startup founders who were trying to project their company’s revenue for the coming years. Of course, now that I am actually trying to help a startup create their financial projections from the other side of the table I almost made the same mistake! This issue is particularly important when the startup has a SaaS or viral revenue model.
How to NOT project SaaS revenues
Probably the number two or three mistake startup founders (and me, almost) make when estimating their revenues is to assume they acquire their customers in a linear fashion during the year. Many, many CEOs project revenue by the following formula:
(Number of expected customers at year end) X (monthly subscription revenue) X (12 months) X 50% = Anticipated Yearly Revenue
The 50% discount attempts to take into account that you haven’t acquired all of the customers on January 1*, but instead get some of them month 1, some month 2, some month 3, etc. However, this creates a major assumption - the assumption is that you get the same number of customers in month 1 as month 12. Usually this is not the case if you are a startup ramping up your marketing and sales programs. Typically you get more of your customers in the final months, and many, many fewer in the first couple. This effect is more pronounced the greater number of marketing programs you are layering on during the year.
To illustrate how this 50% discount will over-estimate your revenues, consider the following example. I am over-simplifying everything to make a point, so please don’t make too much fun of this. Although it is so simplified as to be comical.
Assume a startup has 12 different marketing programs that will run for at least 12 months each. The CEO anticipates that these will result in one new customer per month that they are running. The team will have bandwidth to launch one new program per month, so one new program will be launched each month. The company’s service is so amazing that no customers will churn; assume the service costs $100 per month. Customer acquisition will be as follows:
1st Month: 1 new marketing program. 1 new customer
2nd Month: 1 new program, one old program. 2 new customers, plus 1 existing customer = 3 total paying customers.
3rd Month: 1 new program, two old programs. 3 new customers, plus 3 existing customer = 6 total paying customers.
…
I think you get the picture. By the end of the year the company will have 78 paying customers.
Running the formula above for expected revenues, we get $46,800.
The problem is that the company won’t actually have that high of revenue. Revenues will really be only $36,400. 77.8% of the amount projected. So, even if the company hits their customer acquisition plan they will miss their revenue target. Obviously this could have serious implications to their cash flow, etc. The level of your revenue miss will be even greater if you have a viral product, since your growth will be even more exponential.
It’s a much better idea to identify the specific marketing programs that you will be implementing, the months that you’ll be rolling them out and the anticipated customer acquisition by month from them. I realize this takes a long time, and you are probably pretty busy trying to actually get your company going. But projecting your cash flow is such an important part of the success in the early life of your startup that I’d suggest you do it and don’t fall into the trap of making such simple revenue forecasts that you misjudge your cash needs.
*Or whatever your fiscal year day one is
