Tuesday, May 4, 2010
The "Take Notice" effect on revenue modeling for start-ups
After completing more than 400 valuation reports including 409A valuations, we have obtained certain heuristic knowledge that we can share for the benefit of the start-up community. In this blog, I want to analyze something called the "Take Notice" effect. We have reviewed business models of so many companies that have almost similar hockey stick type projection of revenues. When we review these models, one question we ask the CFOs and the founders is have you ever considered the effect of companies taking notice of you when you have just become the right size that existing companies get threatened by your business model. After Google greatly disrupted the Madison Avenue business model, most existing companies are on their toes to look out for potential business threats. And they try to mitigate this threat using a variety of tools at their disposal such as lowering prices, lobbying for biased laws, cartelization, hostile acquisitions, hiring away key employees, and increasing the cost of acquiring capital. After analyzing so many companies, we believe the take notice effect is somewhere when your company reaches the $20 million revenue stage for hi-tech companies (Biotechnology companies are different and we'll reserve that discussion for a later blog post). This is the point at which most investors want to commit to further mezzanine rounds and take the companies to a ripe 100 million+ revenues level, a level considered prudent for financial exit. So, when you reach $20 million in revenues, expect competition and a slow down in growth. We call this growth model the hockey stick dip or the heart pulse model. No doubt you will take off in a hockey stick manner but there is bound to be a dip after the stick's peak is reached and then levels out to more acceptable growth rate levels. If you look at your heart rate monitor, you can see that the wave pattern matches what I am talking about. It is important for founders to acknowledge this dip as competition intensifies and to forecast a small dip in revenues or at least a zero growth period with increased spending for some time. This is also a period of transition. Some founders are good at starting up and enjoying the hockey stick growth but not so good at managing a dip caused by the "take notice" effect. This is the time for the founders to assess if they are the right people to be leading the company at this stage.