Investing in startups that are yet to generate revenue can be like setting sail on a vast and uncharted ocean. It may be a thrilling journey filled with potential, but it also can  carry significant risks. For every success story, there are numerous failures. As an investor, understanding the metrics to look for in the absence of revenue generation can be crucial in making informed investment decisions.

Investing Pre-Revenue

The Pre-Revenue Challenge

Investing pre-revenue can be challenging. Unlike mature companies with established revenue streams, these startups operate in an environment where they are either building their products, conducting market research, or in the early stages of product development. The absence of revenue can make it difficult to assess the financial health of the company, making traditional financial metrics irrelevant.

However, pre-revenue startups often offer unique opportunities for investors to get in on the ground floor and realize growth if they succeed. To make informed investment decisions, it can be important to focus on alternative metrics that provide insights into the startup’s potential.

Metrics for Assessing Pre-Revenue Startups

Team

A strong and capable team can be considered the backbone of any startup. In the absence of revenue, investors may closely examine the qualifications, experience, and commitment of the founders and key team members. Key metrics to consider include:

• Founder’s track record: Have the founders previously built successful startups or worked in relevant industries? This can be a valuable indicator of their ability to navigate the challenges of a pre-revenue stage.
• Team composition: Does the team possess a diverse skill set that aligns with the startup’s needs? A well-rounded team with expertise in product development, marketing, and technology can impact a startup’s chances of success.
• Commitment: Assess the level of commitment demonstrated by the founders and team members. Are they dedicated to making the startup a success, and are they willing to persevere through challenges?

Market Validation

Before generating revenue, it can also be important for a startup to validate its target market and product-market fit. Investors can look for signs that the startup is addressing a real problem or need and gaining traction. Metrics to consider include:

• Customer engagement: Is the startup attracting interest and engagement from potential customers? This can be measured through metrics such as website traffic, sign-ups, or app downloads.
• User feedback: Gathering feedback from early users may provide valuable insights into product-market fit and the startup’s ability to meet customer needs.
• Beta testing success: If applicable, success in beta testing or pilot programs can be an indicator of market validation.

Intellectual Property and Competitive Advantage

Pre-revenue startups often rely on their intellectual property and competitive advantage to gain an edge in the market. Investors can assess whether the startup has developed proprietary technology or processes that can give them a competitive advantage. Some key metrics in this area include:

• Patents filed or pending: The presence of patents can indicate that the startup has developed unique intellectual property that may protect it from competitors.
• Barriers to entry: Evaluate the startup’s ability to maintain a competitive edge through technology, data, or other assets that are difficult for competitors to replicate.

Product Development Progress

Even without revenue, a startup’s progress in product development can be an indicator of its potential. Investors may consider metrics related to the development of the product, such as:

• Product milestones: Has the startup achieved product development milestones? This could include reaching a minimum viable product (MVP) stage, securing partnerships, or gaining regulatory approvals.
• Development speed: The pace at which the startup is progressing can be crucial, especially in fast-moving industries. A slow development process can hinder the ability to capture market share.

Market Size and Opportunity

Understanding the potential market size and the startup’s ability to capture a share is also a consideration. Investors could assess the total addressable market (TAM) and the startup’s serviceable addressable market (SAM). Key metrics to consider include:

• Target Market: The specific group of potential customers or consumers that a business aims to reach and serve with its products or services. It can be a well-defined segment of the larger market that aligns with the company’s offerings and marketing strategies.
• Serviceable Addressable Market (SAM): SAM represents the portion of the target market that a business can realistically and effectively serve with its products or services. It takes factors into account such as geographical limitations, distribution capabilities, and other operational constraints.
• Total Addressable Market (TAM): TAM refers to the entire potential market for a particular product or service, without any restrictions or limitations. It represents the total demand for a product or service within a specific industry or market, assuming there are no constraints on resources or market reach. TAM provides an upper bound estimation of market size.
• Go-to-market strategy: How does the startup plan to enter and capture its target market? Evaluate the viability and effectiveness of their go-to-market strategy.

Traction and User Growth

While revenue may be absent, traction and user growth can be indicators of a startup’s future growth. Investors can examine metrics such as:

• Monthly Active Users (MAUs) or Weekly Active Users (WAUs): Track user engagement and growth over time to understand the startup’s ability to attract and retain users.
• Conversion rates: Evaluate how effective the startup is at converting leads or sign-ups into active users.
• Retention rates: A high user retention rate could indicate that the startup is providing value to its customers.

Partnerships and Alliances

Strategic partnerships and alliances can impact a startup’s growth and market penetration. Investors may assess the startup’s ability to forge valuable partnerships with established companies or industry players. Some key metrics include:

• Partnership agreements: Look for signed contracts, letters of intent, or Memorandums of Understanding (MOUs) with reputable companies that validate the startup’s value proposition.
• Strategic alliances: Assess the startup’s ability to leverage partnerships for growth and distribution.

Funding and Runway

Since pre-revenue startups lack cash flow from operations, investors may consider their funding history and runway. Metrics to evaluate may include:

• Total funding raised: The amount of capital raised and the sources of funding (angel investors, venture capital, grants, etc.).
• Burn rate: The rate at which the startup is spending its capital and how long its current funding will last before needing additional investment.
• Upcoming funding rounds: Understanding the startup’s future fundraising plans can be crucial for assessing their runway.

Competitive Landscape

A competitive analysis can help investors understand where the startup stands in relation to existing and potential competitors. Metrics to consider may include:

• Competitor analysis: Evaluate the strengths and weaknesses of the startup’s competitors, their market share, and their customer base.
• Market differentiation: Assess how the startup distinguishes itself from competitors through unique features, pricing, or other strategies.

Exit Strategy

Even in the absence of revenue, investors can inquire about the startup’s exit strategy. Knowing how and when investors can expect a return on their investment can be important. Some metrics to consider include:

• Exit options: Understand the potential exit paths, such as acquisition opportunities or initial public offerings (IPOs).
• Historical exits in the industry: Examine past exits in the same industry to gauge the potential for the opportunity.

Final Thoughts

Investing pre-revenue can be both challenging and rewarding. While traditional financial metrics may not apply, alternative metrics can provide valuable insights into a startup’s potential. Assessing the team, market validation, intellectual property, product development progress, market size, traction, partnerships, funding, competitive landscape, and exit strategy can help investors make informed decisions in the absence of revenue.

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Want to learn more about investing in startup? Check out the following MicroVentures blogs to learn more:

• Demystifying Private Equity: A Beginner’s Guide
• Finding Your Sweet Spot: How Much Should You Invest?
• Beyond Stocks and Bonds: Exploring the World of Private Markets
• Benefits and Risks of Investing Pre-IPO

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.