Unlocking Pre-seed Capital: Why You Should Have Dollar Signs in Your Eyes to Win Investors

Founders love products, investors love money. That's because investors have “limited partners” to whom they need to pay back interest; if they don't, they'll quickly be out of business.?

To craft a convincing monetization strategy, you need to be clear on revenue, unit economics, and differentiation.?

• Revenue: What is your path to achieving USD 70-100 million in annual recurring revenue in 7-9 years without capturing more than 10% of your market?

As a very rough (and not always correct) guideline, annually recurring revenues in the range of USD 100 million will bring you into the realm of a unicorn valuation (more than USD 1 billion). You need to achieve this within the space of 7-10 years, as this is the typical cycle of a venture capital fund. Another thing to keep in mind: capturing more than 10% of a respective market is often seen as unrealistic.?

“The global e-commerce market accounts for USD 4 trillion, while in Europe we have USD 700 billion, so I only need to take 0.01% to reach USD 70 million in revenue.”

We see these kinds of top-down market estimates frequently and we tend to disregard them completely. Why? Because most startups only address a small subsegment of a larger market and the assumptions behind these estimates are often totally unclear or even arbitrary.?

To do this bottom-up is often better:

First, choose which types of revenue streams you are creating. In his blog , Dave Parker lists more than 20 different revenue streams a startup can create. Popular ones include: B2B subscription-based models (e.g. Salesforce), lead generation models (e.g. Groupon), transaction-based models (e.g. Airbnb), and usage-based models (e.g. AWS). Some startups utilize two to three revenue streams concurrently. Here is an overview of the key revenue streams according to Dave Parker:

After having selected your revenue streams, you need to estimate the number of customers, the price you can charge them, and your target market share.?

Here is how to conduct a bottom-up market estimate for a FinTech that is offering bank accounts and bookkeeping services for SMBs.

You start by calculating the total number of potential clients in a global market and multiplying this by the expected annual recurring revenue per customer. Globally, there are 10 million SMBs. You estimate that you can charge USD 5,000 per company per year (“annual recurring revenue”). This results in a total addressable market (TAM) of USD 50 billion.

You then estimate the number of potential customers in the region in which you will be active (e.g. Europe). There are four million SMBs in Europe. The annual revenue per customer is still USD 5,000, resulting in a serviceable addressable market (SAM) of USD 20 billion (40% of the TAM).

Finally, you apply a target share of the market that you believe you will be able to capture. Do not go above 10%, as anything higher than this will harm your credibility. Example: Let’s say your target share of the SAM is 1%. This would result in a serviceable obtainable market (SOM) of USD 200 million (1% of USD 20 billion). By calculating the market opportunity from the bottom up, you generally get a much more accurate estimate of the market compared to a top-down approach.

Here is a good way to show the results of a bottom-up market estimate - followed by the Techstars company Carwyze .

Unit economics: Can you build a highly profitable business?

While it is fantastic if you can build up revenue, you aren’t likely to attract many investors if you have a profit margin along the lines of a supermarket or an average restaurant.?

For investors, “unit economics” is especially relevant. This concept describes revenues and costs for an individual unit, i.e. either for one customer acquired or for one unit sold. If you grow rapidly, it is often okay to have negative earnings before interest and taxes (EBIT) - your “bottom line” - as long as you can show a path to profit on a per unit basis.

Here is a strong explanation of this concept.

If you want to attract venture capital you need to show a path to exceptionally high unit economics. This can be calculated in two ways.

First, it can be shown as the ratio between “customer lifetime value” and your customer acquisition costs. The customer lifetime value refers to the profit a business generates from a given customer before the customer “churns”, i.e. stops doing business with the company. If, say, a FinTech charges each customer USD 10 per month and these customers stay with the company for 20 months on average, the lifetime value of each customer is USD 200. If you can acquire a customer for USD 20, then you have a 10:1 ratio of lifetime value to customer acquisition costs (200:20). These ratios vary widely depending on the startup industry and stage. While in the pre-seed stage, we often see a ratio of 5:1 to 10:1, it will often drop to 4:1-2:1 once companies begin to scale.

The second way to calculate unit economics is to use the contribution margin, which is calculated by subtracting the costs that directly occur with the production of one unit from the revenue for one unit sold. If a rocket company sends one satellite transport into orbit for USD 10 million and has direct expenses per launch of USD 5 million, the contribution margin will be 50%.?

Venture capital investors look for very profitable businesses on a unit basis. While the exact benchmarks vary greatly depending on the industry, contribution margins that exceed 50% and LTV/CAC ratios of better than 5:1 in the early startup phases are often seen as attractive by investors.

Differentiation: Are you avoiding crowded markets?

Are you the only startup in your space and are facing no competition? For many investors, this is not a good sign. After all, no competition equals no market. Likewise, many investors stay away from crowded markets. In particular, if you have well-financed competitors operating in the same region, you need to very clearly show how you differentiate from them. The best way to do this is by grouping competitors into categories and showcasing the fact that only your startup offers a unique set of features. Many startups in the pre-seed phase fail to compare themselves to their competition on a feature level, so don’t fall into this trap. The Techstars company PatentPlus used the following way to show this.

Unicorn-level revenues meet strong unit economics and differentiation - this is the secret sauce for a successful monetization strategy for an early-stage startup.

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Dr Martin Schilling is the Managing Director of Techstars Berlin and co-author of “The Builder’s Guide to the Tech Galaxy”.

Brian Daly is a serial entrepreneur and Investment Principal at Techstars Berlin.

Thanks to the following friends and colleagues from our network for their relevant input to write this article: Andres Barreto (Managing Director Techstars Miami, Founder Socialatom Group, Founder & General Partner Firstrock Capital, Founder & Board Member Coderise), Gloria B?uerlein (B2B Angel Investor, former Index Venture Principle), Eamonn Carey (General Partner Tera Ventures), Isaac Kato (Former Managing Director Techstars Seattle), Matt Kozlov (Managing Director Techstars Los Angeles), Jens Lapinski (Founding Partner & CEO Angel Invest).

And special thanks to Ties van der Linden & Rozsa Simon from the Techstars Berlin team for their research, writing, and graphics efforts for this article.