Is Your Revenue Real? — Chris Neumann

Is Your Revenue Real? — Chris Neumann

The best investors, particularly at Seed and Series A, focus on growth and growth potential when making investment decisions. They’re looking for early evidence of product-market fit and indications that the founders understand the needs of their customers.

Many first-time founders (and, sadly, more than a few investors) believe that reaching a certain level of revenue will instantly unlock the next round of funding. They expect to succeed at fundraising the same way they did at school: get the “correct” answers on the test and you pass.

In theory, having the entire company focus on revenue is a great idea, but in practice, it’s easy to get caught up in growth practices that are unsustainable. Paradoxically, the important part isn’t the revenue number itself — it’s the number of customers it represents.

At each stage, investors are looking at how many people/businesses need your product badly enough that they’re willing to pay for it. Investors first and foremost want to see evidence of product-market fit. The next thing investors want to understand is how fast your revenue is growing.

Revenue = objective evidence that you’re solving a problem that matters to someone
Revenue Growth Rate = objective evidence that you’re solving a problem that matters to many people

Churn rate is a proxy for the quality of a product and its ability to solve customers’ problems. A decreasing churn rate demonstrates that you understand why customers are churning and are able to address those issues.

Customer Churn Rate = the percentage of customers who realize that your product doesn’t actually solve their problem
Net Revenue Retention = how leaky is your revenue bucket?

I find it helpful to think about three distinct cohorts:

1. New customers who fail to onboard or quickly realize that the product isn’t for them
2. Customers who stay for more than one renewal period and then churn
3. Customers who haven’t yet churned

Average Revenue Per User/Customer = how much will customers pay you each month to solve their problem?

Is there enough water to continue filling the bucket (is the market big enough)?
Can you make the bucket better (by improving the product and achieving product-market fit)?
Can you repeatedly fill the bucket in a sustainable way (is the business model long-term profitable)?

An LTV/CAC ratio of 3 is considered good.

Bootstrapping Web3 Networks: The Limitations of Token Incentives

NFX has proposed a similar idea called network bonding theory.

Passive Participation: When Token Incentives Work

The first is Helium, a decentralized network that provides cheap, easy internet access to IoT devices “in the wild” — like e-scooters and sensors. The second example is Arweave, which is described as a decentralized, censorship-resistant storage network. Another example is Compound, a lending network. Lenders deposit their crypto assets into a lending pool for borrowers to access. They all require passive participation from users, particularly from the supply-side of their network (not very different from the concept of passive crowdsourcing in data networks). That gives them financial upside and increases the utility of the network at the same time. The supply-side does not need to actively engage with the network to benefit from this financial upside.

However, networks with passive participation also tend to be rare.

Active Participation: The Limits of Token Incentives

One of the most important principles of bootstrapping a network is to start with the most underserved users. You also need the right type of users, i.e. those who feel the problem most deeply and would put up with any amount of friction to engage with your network.

Tokens can be a blunt instrument to target this underserved niche because they can attract the wrong type of users — those drawn to financial incentives and not the near-term utility of the network. When this happens, it becomes very difficult to reach the required density of the right kind of users. This shows what happens when there is a disconnect between financial incentives and network utility — instant growth out of the gates, followed by a painful decline.

To overcome these network effects, Looksrare executed a “vampire attack” on Opensea, i.e. it distributed (or “airdropped”) LOOKS tokens for free to high volume Opensea users. This go-to-market (GTM) approach should have been enough for Looksrare to beat the cold start problem and scale its network. Unfortunately, financial incentives led to user behaviors that weren’t aligned with network utility. Interestingly, genuine trade volumes began to collapse as token payouts normalized.

Sushiswap, a decentralized exchange, executed a vampire attack on Uniswap in August 2020. The results, again, followed a similar trajectory although perhaps less stark (and also plagued by governance issues).

It clearly can, but it will require active participation and engagement from its user base — with scaling tactics that are more likely to resemble active web2 networks like Roblox, rather than passive web3 networks like Helium.

At a high level, the only way to address this problem is to link token incentives to network utility, i.e. ensure that users can only receive token incentives if they add value to the network. In other words, rewards need to be restricted to specific, desirable actions, not just adoption.

Pay attention to the kind of network you’re building and how token incentives interact with network utility before relying on them as a bootstrapping solution.

In conclusion, when it comes to building a successful business and attracting investors, revenue is a crucial factor. However, it's not just about the revenue number itself, but rather the number of customers it represents and the evidence of product-market fit. Investors want to see growth potential and a deep understanding of customer needs. Additionally, the quality of the product and its ability to solve customers' problems, as indicated by churn rate and revenue retention, is important.

On the other hand, when it comes to bootstrapping web3 networks through token incentives, there are limitations to consider. Passive participation can work well in certain cases, where users can benefit financially without actively engaging with the network. However, active participation is often necessary to attract the right type of users and ensure network utility. Token incentives should be linked to specific actions that add value to the network, rather than just adoption for the sake of financial gain.

To apply these insights, here are three actionable pieces of advice:

1. Focus on building a customer base that truly needs your product and is willing to pay for it. This evidence of product-market fit will attract investors and pave the way for sustainable revenue growth.

2. When implementing token incentives in a web3 network, carefully consider how they align with network utility. Ensure that users can only receive tokens if they actively contribute value to the network, rather than just being drawn to financial incentives.

3. Continuously monitor churn rate and revenue retention to gauge the quality of your product and its ability to solve customers' problems. Address any issues that arise and strive for long-term profitability in your business model.

By keeping these principles in mind, founders can navigate the complexities of revenue generation and token incentives to build successful and sustainable businesses.