How Startup Valuation is Impacted by the Quality of Revenue?

The Startup world revolves around talent, ideas, capital, and entrepreneurship. Once an entrepreneur embarks on this journey, they become fixated on revenue generation to maximise the valuation of their venture for potential investors.

Money has no colour But Revenue has! 

But revenue is not just a number. It's a reflection of the business model, the customer base, and the market dynamics. The revenue streams of a Startup are critical to its success, and they need to be carefully thought out and executed.

Money, on the other hand, has no colour. It doesn't matter where it comes from or what form it takes, as long as it's legal and ethical. But revenue is different. Revenue has a colour, and it reflects the sources of income for the Startup.

There are different revenue streams that a Startup can explore. Some of the common ones include subscription-based models, transaction-based models, and advertising-based models. Each of these models has its strengths and weaknesses, and Startups need to choose the one that aligns with their business goals and customer needs.

Subscription-based models are popular among Startups that offer a recurring service. This could be a software-as-a-service (SaaS) product, a content platform, or a membership-based service. In this model, customers pay a regular fee to access the service. The revenue stream is predictable, and it helps Startups with cash flow management.

Also, Read - The Different ‘Corns’ in the Startup World

How Does Quality Of Revenue Affects Startup Valuation? 

In a recent post on LinkedIn, Vani Kola, the Managing Director of Kalaari Capital and a prominent investor and speaker on startups, venture capital, innovation, and entrepreneurship, highlighted this valuable aspect of Business Revenue.

Investors are willing to pay higher multiples for Startups with better quality revenue. Therefore, it is crucial for Startups to prioritize the quality of revenue as a core component of their strategy and positioning when presenting themselves to potential investors.

Disclosures made by companies, such as Alphabet, in their filings play a significant role in demonstrating the quality of revenue and potential risks to investors. For instance, Alphabet's disclosure stating that no single customer or group of affiliated customers accounted for more than 10% of their revenue in 2019, 2020, or 2021, is a crucial indicator of revenue quality

                                            From Vani Kola's LinkedIn Post: Pic Source: Peter Yang

Ms. Kola Said “At Kalaari Capital, I found that while start-ups offer metrics around GMV, it takes deeper analysis by us to evaluate the actual nuances of the revenue & its quality. Apart from the absolute revenue, customer diversification, collectability, working capital, & many other factors are important indicators of the growth & stability of a company.”

Startups that prioritise quality revenue as a core moat in their strategy are more likely to attract potential investors who are willing to pay higher multiples. It is imperative for Startups to prioritise the diversity and stability of their revenue streams to ensure sustainable growth and mitigate risks. By emphasising the quality of revenue in their presentations and disclosures, Startups can demonstrate their potential to generate steady, diversified revenue streams, making them more attractive to investors.

She makes her point by giving examples of Startups collaborating with Telecom as opposed to those working in E-commerce.

Also Raed - Facing Performance Issues: Low Vitality Among Unicorns

Risks Involved With Source Of Revenue 

If a Startup's revenue is heavily reliant on a single industry like telecom, it may face high working capital requirements due to the industry's lengthy Days of Sales Outstanding (DSO) period, which can lead to collection risks. Conversely, e-commerce companies often have low working capital requirements due to negative working capital cycles.

Companies that fail to diversify their revenue streams risk serious financial trouble in the event of a downturn in their primary industry, as seen in the telecom industry crash. Such companies also have a higher risk profile during diligence evaluations.

Diversifying revenue streams can not only mitigate risks but also serve as a growth driver, as demonstrated by Amazon's success with its Amazon Web Services vertical. Similarly, Apple's services vertical provides a predictable and stable source of repeat revenue.

Startup founders should prioritise achieving a healthy customer mix and diversified revenue streams to make their business more attractive to potential investors.

Readers can see Vani Kola's full LinkedIn Post here