According to Peter Thiel this will kill your Startup (and how to fix it)

"Poor distribution—not product—is the number one cause of failure. If you can get even a single distribution channel to work, you have great business. If you try for several but don’t nail one, you’re finished." - Peter Thiel

As a startup, when you raise a Seed and Series A rounds, your primary objective over the next months is to go back to your investors and show them that you have a figured out a distribution channel that is worth pouring money into (Bessemer calls is a Revenue Engine). This will get you a huge series A or a Series B. It doesn't matter if it is Google and Facebook ads, content marketing, field marketing, Craigslist hacks, conference sponsorships or cold calling. Just figure out one that is scalable. This single process might be the most challenging aspect of building a company in the early days.

The biggest problem, is also that many founders from startups in Silicon Valley have no financial acumen. If you have no idea how to measure CAC Payback periods, LTV, or understand any important financial ratios, as Peter Thiel says, "you're finished." In these occasions just remember Alice in Wonderland:

“Alice: Would you tell me, please, which way I ought to go from here?

The Cheshire Cat: That depends a good deal on where you want to get to.

Alice: I don't much care where.

The Cheshire Cat: Then it doesn't much matter which way you go."

So first step is to define your destination. If you are a B2B SaaS company, follow great minds like David Skok, Jason Lemkin, Tomasz Tungus, and get the answers. For example, this infographic shows us that the average CAC Payback period is 18 months. Bessemer says that if you sell to SMBs, your CAC Payback needs to be in the 6-18 months range (due to assumptions of higher churn and therefore lower LTV). On the other hand when selling to Enterprise, you can subsidize payback periods of 24-36 months.

How do you scientifically test your Revenue Engine?

There are two steps in trying out different sales methods and finally finding your revenue engine.

1. Test if the method is a viable strategy
2. Give yourself permission to iterate for 3-12 months as you measure CAC.

These two steps should help you make decisions that are neither too hurried, nor too slow. As an example, here is how I approached testing an outbound campaign recently.

Test if the method is viable

Late July the founder poured $12K to test a lead generation engine using phone + email. The hopes was that this strategy would generate enough leads over the next 4 weeks, to hint us towards a viable Revenue engine. We knew that it would take 3-12 months to really know if the strategy would eventually become viable at scale, so we were merely looking at pre-qualifiers. "Can we schedule 5 productive conversations that turn into Opportunities?"

After scheduling 7 meetings in two weeks and having 3 productive conversations with interested prospects, we decided to continue the experiment, focusing on iterating the strategy and measuring CAC.

Give yourself permission to iterate for 3-12 months as you measure CAC

Over the next month we scheduled 22 meetings with our approach and crunched the numbers. We are now still running this experiment with AltiSales, because here are the assumptions.

Meetings that actually show up 90% -> 22*.9 = 19.8

Meetings that want to evaluate the technology (becomes an Oppty) 70% -> 19.8*.7 = 13.86

Oppties that close 30% -> 13.86*.3 = 4.16

ACV at $10K -> 4.16*$10,000 = $41,600

Gross margins at 85% -> $41,600*.85 = $35,360

So, considering we used Jason Lemkins first sales hire compensation plan, and paid the AE 25% of Revenue, our cost of the AE was $10,400 for the month, or ~$125,000/yr.

The cost that we could spend to build this engine to get a 18 month CAC Payback period was as follows. Use the Gross margins and multiply by the number of months of payback target and divide by 12 to get months of ACV. For example.

$35,360 * 18 / 12 = $53,040.

Since we already paid the AE $10,400 and including 25% costs on taxes, benefits, etc. we have:

$53,040 - ($10,400*1.25) = $40,040.

Therefore if that campaign that brought the leads, including all costs, from the SDR, to the sales tools, marketing tools, office space, management, etc, costs your company less than $40,040 per month (the length of the campaign that produced these meetings), then you have an investable company. This is also assuming all the close rates, show rates and other numbers prove to be true.

How do you know if you have a rocketship?

If you hit the point where you have a 10 month CAC Payback, you have a rocketship. To find that, your yearly Gross Margins must be equal or less than 10 months of your costs. In our case.

$35,360 * 10/12 = $29,466 -> This is our rocketship budget

$29,466 - ($10,400 *1.25) = $16,466

If we are able to keep the costs of our "Meeting generating system" at under $16,466, we have a rocketship. Literally, we could call Bessemer, explain our Revenue Engine, and likely get them to invest.

Final details about our experiment

In this case, we had run that experiment that for 22 meetings for a tiny fraction of the $40,000, so we proved we could make this an investable business. Moreover we way under the $16,466! We have a rocketship! However, as I said above, we need to test this for 3 months at least, for us to collect enough data and get our next investors for the business.

Therefore, we decided to continue investing in this initiative and continue gathering data about our show rates, close rates and revenue produced. Very likely, this company now has a tremendous Revenue Engine, and I myself have offered to invest in the company.

** I am not disclosing the company, or the actual initial cost of the test yet, but I might in the future **

I hope this example has been helpful. For all the entrepreneurs out there that are trying to figure out their go to market strategy, feel free to ping me with additional questions via Inmail or just leave a comment below.

Also, let me know, what else you'd like me to talk about when it comes to building a Revenue engine for startups.