Subscription model: Strengths & weaknesses

Half the battle in growing a subscription product is figuring out the business model’s strengths and weaknesses.

Like the coach of a new team, if you want to win the championship, you need to figure out your strengths and weaknesses before you commit to any plans.

Start with these three key areas:

1. The product sells itself — The good: You, as the operator of the business, don’t need to find, hire, and train teams of salespeople before you can start selling your product. With this reduction, you can support lower price tiers. The bad: You also don’t have a sales team that can bring customer feedback back to the product team and adjust messaging on the fly to see what works with different customers. You may end up overhiring in other areas to compensate. 

2. Recurring cash flows — The good: Makes the business easier to manage and predict, putting less pressure on acquisition every month to acquire more revenue and keep the lights on. The bad: the sub-model comes with LTV unpredictability, churn and ceilings. But, these changes can’t be “known” until that group of users reaches the end of their lifecycle. It’s hard​ to forecast revenue and budget how much to spend on acquisition costs.

3. Durable revenue base — The good: Subscription businesses can weather bad economies relatively well. Their revenue base is diversified across potentially millions of small transactions. The bad: Subscription products take longer to scale up revenue than other business models because the average contract value is much, much lower than that of B2B products, and it’s harder to use paid acquisition to grow revenue. It’s not impossible, but it’s harder.

99% of the great subscription products were created by systematically improving the core product and acquisition channels. You live in the land of compounding small wins.

Lean into your strengths and try to mitigate some of the weaknesses of the subscription model.

👉️ For more, head here: The Strengths & Weaknesses of The Subscription Business Model

How to understand ‘Venture Math’

When investors look at your deck, they’re not looking for a good, profitable business. They’re looking for that needle in the haystack that will be the one investment in their portfolio that will return 100x or more and make their fund a success.

This is venture math. To understand your venture math and whether VCs will give your startup a look, angel investor DC Palter shares a simple way to calculate your venture requirements. 

• Simple return — To generate a return of 20% per year over 7 years requires an exit at a multiple of 3.6x what was originally paid. If the valuation was $10M when he invested, he needs an exit at $36M to be a good investment. That wouldn't be too bad, but…

• Portfolio return — If only 1 of his 10 investments succeed, for a portfolio return of 20%, he needs his 1 success to return 36x what he paid. If the valuation was $10m when he made the investment, he needs his one success to exit at $360M or more. Within 7 years. Gulp.

• Dilution — If the startup needs additional funding rounds, and almost all startups will, each round will dilute his ownership percentage, requiring a higher exit price to meet his 20% IRR requirement. If you need to raise 2 more rounds between investment and an expanded options pool, dilute him by 1/3 each time; his investment as a percentage of the total company valuation is 45% of what he started with. He'd need an exit that's 80x what he paid.

• Exit — With a profits-based exit of only 4x EBITDA, there is no way to get to the required return. Exits to private equity or based on company profits aren't quite failures but aren't successes either. If the exit takes over 7 years or requires more than 2 additional rounds of investment, that 80x multiple goes up even further.

As founders, you have 2 choices. You can either accept that your startup is doesn’t fit the venture capital business model and find another way to fund the business. 

Or you can rework the pitch deck to highlight how you’ll reach $100M in revenue in 5 years, and have a line of big companies desperate to acquire the business at a high multiple. 

👉️ Head here for a deeper dive into Understanding Venture Math

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