Category: Operating Plan
It’s a very informative, yet easy to read piece on strategies for cutting your company’s burn rate during these challenging times.
Most of her advice is with her employment law hat on, which is certainly a chief concern when contemplating cost reductions.
Take a read- it’s a good one.
Today’s guest blogger is Matt McCall of DFJ Portage. Matt was a co-investor with us in FeedBurner and sat on the board with me. He writes a great blog called VC Confidential. When the following question appeared, we did the super efficient thing and forwarded it to Matt to answer. Following is his response which is cross-posted on his blog at AsktheVC: Ad Revenue Models.
Question: (1) How do Web 2.0 companies like Feedburner make money? (2) What makes a blogger or content provider select one network or blog community over another (i.e., are the bloggers themselves being paid or are they essentially working for free)? (3) How is online media advertising different now than during the internet boom?
The most popular Web 2.0 revenue model is based on advertising. Publishers (blogs, media sites, etc) get paid by advertisers who advertise on their site. FeedBurner is an ad network and while it made some money off of licensing its platform to large publishers, most revenue came from the ads inserted into the feeds. This ad inventory comes from either the company’s own direct ad sales force or from ad networks. Some of the ads are CPM based (impressions viewed) while others are CPC ($ per click…a la Google). The publisher generally keeps 60-70% of the ad dollars and the ad network gets 30-40%. So, if Motorola runs an ad campaign through an ad network like FeedBurner, they might pay $5-10/CPM (cost per thousand impressions). The ad network then takes that ad and serves it up on the various websites it has deals with. If the ads are viewed 1,000,000 times, Motorola would pay the network $5-10,000. The network would keep $2-4,000 and the publishers would get the rest. In the case of bloggers, they first pick which ad networks to go with (usually based on which drive the most revenue for the space given) and then approve different ad campaigns. They get a cut of those ad dollars.
More advertisers understand the benefit of online advertising and so, there are more ad dollars flowing into this space than during the Bubble. More importantly, Google has created an entire ecosystem based upon its CPC model where advertisers only pay when ads are clicked on. They feel there is more accountability since they only pay when an action is taken. Also, there is very little cost associated with running many of these publisher sites, so it doesn’t take much to get to break even.
That said, the economy is likely sliding into recession and ad budgets will get slashed. CPC and CPA (cost per action) based revenue should hold up better than CPM based ones since there is a clearer ROI. In 2000, Yahoo saw its revenue plunge 40% in one year. When the cycle corrects, there will be quite a lot of carnage in the ad supported publisher world. Smart operators will get their costs inline and focus on driving the best possible results for advertisers.
Q: When performing diligence on a new investment I will dig through management’s projections. Even though I am a finance guy I try to understand the costs associated with the software development. Probably needless to say, I have been burned by cost overruns quite a few times. The Companies burn through our cash on development and don’t have enough left over to actually run the business. Do you have any suggestions (for both managements and investors) on how to better budget for these costs.
A: (Brad) I’m going to assume you are talking about an early stage company (pre-product, pre-revenue.) As someone who has been involved in creating a number of software products, they always take longer and cost more than budgeted. In addition, the revenue ramp almost always starts later than planned and isn’t as steep as expected.
I have come to simply not believe any early stage projections. Rather than worry about financial model, I use a zero-revenue based budgeting approach to figure out the appropriate staffing level / burn rate for a company at different phases of development. Early on, I encourage the entrepreneur to manage his spending so that he has enough time to get to the next “value point” in the business (whatever “value point” means – it’s different from company to company – but it usually means the next time at which you can logically raise more money.)
At some point revenue starts to happen. Or a bigger financing is raised. In either case, spending can be increased, but in a measured way to get to the next value point.
The biggest mistake I see is adhering to the entire budget assuming a revenue ramp. Early stage companies have complete control over their spending; they have very little control over their revenue. Most companies I’ve worked with have no trouble making their expense plan. These same companies almost never make their revenue plan in the early days of a company. So – manage the expense / cash side of the equation and lag your increase in spending behind the actual revenue generated.
Don’t forget to focus on gross margin. If you have a pure software product, $1 of revenue is almost $1 of incremental cash you have to spend. However, if your real gross margin is only 50% (because of services, cost of sales, equipment, installation, hosting), you only have an incremental $0.50 to spend for each $1m of revenue.
Q: What is the typical and expected burn rate of the funds raised from a seed round before proceeding with the Series A round? I know this time-frame will vary from case to case, obviously, but with a typical internet start-up, is there an average or expected burn rate of the seed round funds before achieving the milestones needed to raise VC financing? 6 months, 12 months, 18 months?
A: (Brad) 12 months is a typical target. You want to give yourself enough time to make real progress and still have time to pull together a financing. You should plan to have to spend six months to raise your Series A round, which gives you six months of heads down work and six months of work + fundraising.