When considering a startup as a potential investment opportunity, investors should evaluate many metrics and performance indicators. From the founding team and traction to market potential and intellectual property portfolio. As a smart investor, it’s also handy to be able to quickly identify a startup’s business model (how it intends to create revenue) and measure accordingly. This week, we will be diving into assessing different startup business models and key metrics for each.
Common Startup Business Models
Under an advertising model, a startup will offer a free service. Revenue is generated by selling ad placements within the service. Examples of this business model would include social media sites like Facebook, Instagram, Twitter, LinkedIn, and Reddit, as well as online publications like Forbes, Entrepreneur, and Buzzfeed.
In the early stages of a startup utilizing this business model, key metrics to track include daily and monthly active users. These figures will determine how valuable ad space is on the given application or site. As it matures, ad revenue will be included.
- Daily active users (DAU) is the number of unique active users on the site or app within a day, averaged over a period of time.
- Monthly active users (MAU) is the number of unique active users on the site or app within a month.
eCommerce startups sell physical goods online, often making or sourcing the goods themselves. Outdoor Voices, Warby Parker, and Allbirds all utilize this business model to sell directly to consumers. Critical metrics for eCommerce brands include monthly revenue, revenue compounded monthly growth rate (revenue CMGR), gross margin, and customer acquisition cost (CAC):
- Monthly revenue is simply the revenue made per month.
- Revenue CMGR is the average month-over-month revenue growth rate. It gives you a picture of growth over time.
- Gross margin is revenue less any expenses for cost of goods sold (COGS). Gross margin tells you to what extent the company profits per transaction.
- CAC is the money spent to acquire a single customer. CAC is calculated by dividing the total amount spent on marketing in a given period by the number of new customers acquired in that period. CAC offers insight into sales and marketing efforts’ efficacy.
Enterprise and SaaS are two business models that have significant overlap. Enterprise-based companies sell services or software to small, medium, or large enterprise companies. Microsoft, IBM, Oracle, and Cisco all fall into this category. The SaaS business model is a very popular subset of the enterprise model. SaaS startups sell customers subscription-based licenses for cloud-based software. Popular SaaS tools include Dropbox, Hubspot, AWS, Zendesk, and Slack.
Important metrics for enterprise companies include revenue, bookings, and total customers:
- Revenue is calculated after the contract with the enterprise customer has been fulfilled and payment secured.
- Total bookings are the number of commitments the company has from customers to pay for a service. (Bookings do not count as revenue until they’re completed and paid for).
- Total customers are the total number of companies the company has completed bookings with.
For SaaS businesses, monthly recurring revenue (MRR), annual recurring revenue (ARR), churn rate, and CAC are all crucial metrics.
- MRR is the revenue a company can anticipate on a monthly basis from subscription-based customers.
- ARR, like MRR, measures the predictable revenue stream of subscription-based customers, but on an annual basis.
- Gross MRR churn rate is the percentage of revenue lost from subscription cancellations or downgrades. A high gross MRR churn rate can indicate issues with the product.
- CAC (see eCommerce above).
Under a marketplace business model, the company acts as an intermediary between buyers and sellers of goods or services. Etsy, eBay, Amazon, Poshmark, and Airbnb are all built on this model.
Key metrics to consider under this model include gross merchandise value (GMV), net revenue, and net revenue compound monthly growth rate (net revenue CMGR).
- GMV is the total value of merchandise sold over a period of time. GMV can show growth over time.
- Net revenue is the total proceeds from the sale of merchandise.
- Net revenue CMGR is the average month-over-month net revenue growth rate; an indicator of growth over time.
Subscription-based companies sell consumers products or services on a recurring basis; bi-weekly, monthly, quarterly, etc. Hello Fresh, Winc, and Harry’s all utilize this business model. Essential metrics for subscription-based companies are similar to those of a SaaS company. The major difference is that SaaS companies provide software and intangible tools, while subscription-based companies offer physical goods. In addition to MRR and CAC, notable metrics include monthly recurring revenue compound monthly growth rate (MRR CMGR), and gross user churn.
- MRR CMGR measures the month-over-month average growth rate of MRR.
- Gross user churn measures the number of customers lost per month due to subscription cancellations.
Understanding how a startup plans to charge its customers is one of the most important things to know when evaluating a potential startup investment. While this list certainty isn’t exhaustive, it should help you quickly identify and assess some of the most common business models you’ll encounter in the startup space.