Revenue is King (again, but different)

Revenue is king now, and it’s even more extreme than before.

During a trip to NYC last month, I started thinking about two related and broad trends unfolding now. I talked with many founders but also with some friends and former colleagues who spend their careers thinking about the broader economy. Two themes emerged: first, the repricing of the capital markets represents a long-term secular shift in how founders need to build businesses; and second, the cost of building a company may, for the first time in decades, rise.

My biggest takeaway is that it really is different this time. That is not to say that things are worse; they’re not. For the economy as a whole, I’ll take what we’re dealing with now over something like the great financial crisis any day. For startups in particular, though, this environment presents a different set of challenges that require more fundamental changes than the “normal” recessions of the past.

“We didn’t realize at the time, but for a lot of us, 2001 through 2022 was an almost-unbroken bull run, fueled by free money”

In past recessions, investors exhorted startups to focus on revenue because a challenging fundraising environment meant that even strong companies could fail to raise and run out of money. If you could get close to breakeven, you could wait it out until things turned around. The assumption, however, was that, eventually, things would return to normal. You just needed to make it through the valley of sorrow.

This time, however, the value of a given company’s underlying business model is being affected by the cost of money. The best way to think about interest rates is that they represent the price, or the worth, of capital. When capital was very inexpensive, growth was always worth it. Maybe Uber was losing money on every ride today, but the expected return of adding an additional rider to the network just had to be greater than the expected return on the capital spent to finance that rider—which was darn close to zero. 

One of my friends put it to me this way: “we didn’t realize at the time, but for a lot of us, 2001 through 2022 was an almost-unbroken bull run, fueled by free money.” For many in the high-growth, high-tech sectors, the various recessions were almost background noise. Regardless of what was happening in the broader economy, capital was always flowing into those areas, because they alone held the promise of returns.

With the repricing of capital, high-growth startups are not the only ways to generate capital returns, and the potential profitability of growth will be measured against strong capital markets for the first time in decades. That reality, more than anything else, explains the critical importance of revenue today and is why I do not expect it to diminish in importance even as the economy improves, unlike in times past.

“Next year, I think, is the year that the slush fund for generative AI goes away”

For the first time in decades, the cost of building a startup is also rising. Almost every startup will be using LLMs to some degree or another, and these models are extremely expensive to run. Microsoft is charging $10/month for Copilot and still losing nearly $20 and sometimes as much as $80. That’s per month, per user. At my old startup, we used to laugh every time we got our cloud bills from Microsoft and Amazon (we split across AWS and Azure), because they were in such a desperate race to undercut each other. Even as we grew, the prices continued to go down. That has not happened with AI, and there appears to be no indication that it will soon.

So we have an environment in which a foundational new technology is increasing costs and in which capital is vastly more expensive. Of course both of these things could change, but I wouldn’t bet on it, certainly not within the time horizon of the average startup. Furthermore, the capital constraints discussed above mean that the AI companies themselves soon will have to focus on revenue. As one of the sources in the article linked to above said, “next year, I think, is the year that the slush fund for generative AI goes away.”

For founders, these trends mean that fundamentally sound business plans are an absolute must. Profitability on a unit level is crucial, and the ability to articulate how to generate revenue after just a single, early round of fundraising is essential. It is not enough simply to survive until the market changes; founders must reorient their businesses to deal with a reality that most of us have not experienced since the turn of the millennium: rising capital costs and rising business costs.