Sunday, June 22, 2008

The Tyranny of Revenue Projections

What a senseless exercise we have all gotten ourselves into. I am talking about revenue projections for start-ups. These 'mandatory' projections that are supposed to be included in all powerpoint pitches to VCs. I know that I am part of the problem here, as I too expect to see a revenue projection from the management team when presenting its business to Clearstone. And yet, it does seem rather silly. I may be in the minority in saying this (but I do not think that I am): NONE of the 2 dozen start-ups I have funded over the years has ever hit its first or second year revenue target. Some have done much better, some have done much worse, but none have gotten to the desireable 95% accuracy rate I would like them to hit. The reasons for this terrible track record are quite obvious. Who the heck knows how a product will sell before it is even in the market? How long is the sales cycle? What ASP will the market accept? No one knows at the beginning. It is all assumption laden guesswork. So, why do we even bother with revenue projections until we have some bonafide sales data to build upon?I think I know the answer. It is about signaling. Signaling what? When an entrepreneur shows a revenue projection of what the business will do in year 3, she is sending a message about how big of an idea she is pursuing. The specific number is not so important as is the growth rate year over year and the order of magnitude. The problem comes up when we (the VCs, the board, future investors), start holding the management team accountible to a specific number. "Why did you only do $5M last year when your plan was to do $7M" is a common type of question asked of early stage companies. A proper, albeit politically incorrect answer, might be "who the hell knows why?. We pulled that original number out of a hat 2 years ago before we had even launched out product. The fact that we even got that close is a miracle". Of course, that would be considered an inappropriate response since it is not based on some analystical foundation. But it is more truthful than a lot of answers that I hear entrepreneurs give. In my next posting, I will provide some guidance on what I think a start up should do when presenting revenue forecasts.

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