There are many ways for a startup to make money. A core strategic decision, the business model and revenue model a startup chooses to utilize can impact marketing, sales, scaling opportunities, and potential future growth. For investors, understanding the various revenue models a startup might choose can provide insight into the startup’s operations while conducting due diligence before making an investment. In this blog, learn more about startup revenue models, business models, and the various ways that a startup may make money.

Understanding Startup Revenue Models

Business Model vs Revenue Model vs Revenue Stream

Before understanding startup revenue models, it can be helpful to know the difference between a startup’s business model, revenue model, and revenue stream:

• Revenue Stream – represents a single source of income; a startup may have one or multiple revenue streams (ex: Amazon’s monthly subscription plus individual order cost)
• Revenue Model – dictates the strategy around how revenue is collected from customers (ex: retail purchase, recurring subscription)
• Business Model – the comprehensive framework of how a company operates; includes the revenue model, cost structure, value proposition, and customer acquisition strategy

With a startup’s revenue model acting as one key component of the startup’s overall business model, understanding some of the most common revenue models can be beneficial for investors.

Examples of Startup Revenue Models

The following are some of the common revenue models that startups may choose to employ.

Transactional Revenue Model

A transactional revenue model is one where a business earns revenue through one-time sales of a product or service. This model is common in e-commerce, retail, and some software sales, where a customer may be purchasing food, clothing, or a single-use software license.

Since a transactional revenue model is based off one-off purchases, revenue may be more irregular than other revenue models and is typically directly tied to sales volumes. In this model, there is no guarantee of recurring income, startups can face price pressure, and there is a threat of competitors earning a previous customer’s business for a future purchase.

Subscription Revenue Model

In a subscription revenue model, customers pay a recurring fee for ongoing access to a product or service. This model is mostly common is SaaS, media, and memberships, and may be used for gym memberships, subscription services, or software licenses. This model can create predictable recurring revenue, especially if there is a commitment.

Investors can measure the impact of a subscription revenue model through metrics like monthly recurring revenue (MRR) or annual recurring revenue (ARR). Additionally, investors may also want to consider metrics such as churn rate, lifetime value (LTV), and customer acquisition cost (CAC) when assessing startups using this model, as recurring revenue can be heavily dependent on customer retention.

Contractual or Project-Based Revenue Model

In a contractual or project-based revenue model, a company typically generates revenue through formal, long-term contracts. Most common in aerospace, defense, major construction, or government contracting, this revenue model involves companies bidding on contracts, and once the contract has been awarded, using the contract funds to fulfill the contract terms.

This revenue model can be beneficial if there are high upfront costs with producing a product, like a plane or spaceship. With revenue secured by legally binding agreements, often with defined deliverables, milestones, and payment schedules, this model can provide transparency into revenue over a longer period of time. However, a contractual revenue model also can come with high risks such as execution risk, the potential for material costs to increase mid contract, and long cash conversion cycles.

Licensing Revenue Model

For a licensing revenue model, a company grants rights for other companies to use its intellectual property, like software, technology, patents, or brand, in exchange for a monetary fee. In this model, companies have an opportunity to generate high-margin revenue with relatively low incremental costs after the product has been developed in the first place. Fees for using a product that utilizes a licensing revenue model can be one-time, recurring, or usage-based.

Other Common Revenue Models

In addition to the revenue models already mentioned, there are many other revenue models that an investor may come across when assessing startups:

• Advertising-Based Model – revenue is generated by selling ad space on a website or app to third parties
• Commission Marketplace Model – revenue is tied to referring customers to another business’s products or services
• Freemium Model – the product is offered for free upfront, with premium features available for a fee

Considerations for Investors

What are some key considerations for investors when assessing various startup revenue models?

Evaluating Alignment

Investors should consider if a startup’s revenue model is a logical fit for both the product and the target customers. Does the chosen model align with existing customer behavior in the market? For example, introducing a subscription fee in an industry that is used to one-time purchases can create friction and slow adoption. Consider asking the question, does the revenue model reduce or increase the friction for customers to the initial and ongoing purchase?

Assessing Scalability

A startup’s revenue model can directly impact its future scalability. Investors should consider how the revenue model and costs scale. Models like licensing and SaaS subscriptions can exhibit potentially stronger growth margins and lower incremental delivery costs. Conversely, service-based or contract models can be less scalable, as revenue growth may be directly tied to adding headcount or managing larger products.

Considering Predictability

Investors may also want to consider the potential predictability of a revenue model. For example, subscription and contractual models can provide a more consistent and visible revenue streams in comparison to transactional models and one-off purchases, as those are subject to fluctuating sales cycles and market demand.

Final Thoughts

A startup’s revenue model is a key component of its overall business model. It can be important for investors to be able to fully understand the benefits, limitations, and key considerations of a startup utilizing different revenue models for its product or service. Furthermore, investors should consider aspects like market alignment, future scalability, and predictability metrics in order to make an informed investment decision in a startup.

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

• Understanding and Assessing Term Sheets
• When is a Startup No Longer a Startup?
• Evaluating Go-To-Market Strategy
• Going Public: Direct Listing vs IPO vs SPAC

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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.