The Paradox of Consulting Revenue
Tell me if you’ve heard this one before: a new founder talks to investors to get advice on what to focus on before raising early-stage capital. The VCs wax poetic on a variety of subjects, with many of them eventually landing on one: revenue. The eager founder then goes about building her business and, along the way, makes a point of generating revenue the only way she can: through consulting. Fast-forward to fundraising time and she gets an ice-cold response when proudly trumpeting her revenue numbers.
The founder has fallen into the paradox of consulting revenue. While well-meaning advisors will often tell founders that “all revenue is good,” the reality is that when it comes to fundraising not all revenue is created equally.
Predicting Future Business
The problem with consulting revenue, from a potential investor’s standpoint, is that it doesn’t necessarily tell us much about the business that the founder is trying to create, even if the consulting work is in the same space. Consider the following example:
A founder of a marketing automation startup generates early revenue by doing content marketing consulting for several companies. Her rationale, beyond just generating revenue, is that it would let her see first-hand the challenges that real companies face in the content marketing space and provide a funnel for early beta testers and (hopefully) customers. Perhaps she’s even generating $10K or $20K per month in revenue, yet when it comes time to fundraise, potential investors don’t seem to care. Why not?
Here’s what consulting revenue tells us:
- The founder is knowledgeable about the space
- The founder is able to sell (very important for potential investors!)
- There is a market for content marketing consulting
What it doesn’t tell us is whether or not there’s a market for the marketing automation software itself.
Worse yet, it may raise concerns about the founder’s focus:
- Is she spending enough time on the core business?
- Is she going to get “addicted” to the consulting revenue?
When all is said and done, one big question remains: can she actually turn the consulting revenue into product revenue?
How to Frame Consulting Revenue
This is not to say that our founder should hide her consulting revenue (or not pursue it in the first place), but within the context of a fundraising pitch it’s essential that the revenue be framed correctly. Specifically, consulting revenue should be presented as a means to an end and it should never be misrepresented as product revenue.
Consider the following two charts:
While both charts show the same revenue from October through March, the chart on the left omits any indication that the revenue is from consulting. By contrast, the chart on the right explicitly calls it out as consulting revenue. Better yet, it adds projected product revenue and an eventual decline in consulting revenue in order to preempt the obvious question of “when do you expect to transition from consulting revenue to product revenue?” and prompt a conversation on the topic.
It’s very tempting to “hide” the fact that early revenue is from consulting in order to make things look better, but any remotely experienced investor will figure out the truth with a few simple questions. Not only is there literally nothing to be gained from this charade, but taking this approach will negatively impact your fundraising efforts, as the first impression they will have is of a founder who intentionally misleads investors on revenue — not a good thing!
Be Proud But Honest
All other things equal, a startup that has any revenue (even consulting revenue) is in a stronger position to fundraise than one that does not, if only for the insights it provides about the founder’s knowledge of the space and their ability to sell. However, it’s essential that non-product revenue be presented to potential investors for what it is and you must be prepared to answer questions about how/when/if you will transition away from consulting revenue, when you expect to begin making product revenue, etc.
Remember that investors are trying to understand the business you’re pitching them, so unless your goal is to create a consulting company, then be sure you’re prepared to answer questions about your consulting revenue head-on.