A VC in Vacationland

I have had a number of requests to expand my shortest Blog ever–the one the said that the biggest mistake entrepreneurs make is a failure to monetize their business model.  So here goes…and thanks for asking.

Let’s say you have this really great idea like a search engine to compete with Google.  There are sure a lot of these getting funded at the moment.  The big question an investor will ask is how are you going to make a lot of money.  Advertising, you say! Great, says the investor, how will you attract the advertisers?  And how will you get people to use your site instead of Google so that the advertisers will pay for placement? Answering those questions will help monetize the first part of your business model, and, unfortunatley, there are additional monetization challenges you must be prepared to face over the life of your company.

Let’s take the monetization question in bite sized chunks.  I will assume that you already have the great idea that people cannot live without , that you have conducted appropriate market research and that you understand how to build the new search engine, software, game, applet or whatever. Take a deep breath.  The hard part is coming.

First, your key challenge is to be able to separate people from their money, both upfront and on an ongoing basis.  Many plans I see are predicated on single purchase business models.  Not good enough.  For example, assume you want to sell a new software product. The business model may involve license fees, services and maintenance purchases.  That’s fine for the first few years, but you must also think of how you can get existing customers to buy more over time as well as attract new customers. Why?  Selling to existing customers is a lot cheaper than finding new ones, so a business model that includes additional revenues from current clients is more attractive to investors.  That’s one way to monetize your business model.

Second, Your business model must generate sufficient margins to pay off investors and reward the entrepreneurs.  Again, I see a lot of proposed models that are focused on one pay off or the other, not both.  Business plans predicting hundreds of millions in revenue in a few years are rarely believe or happen.  You need to build a company that keeps expenses well under revenues for an extended period of time to generate sufficient cash to reward the various constituents.  Start with the end game in mind.  If you have angel investors, think of how they can realize decent returns in five years or so, perhaps via a recapitalization involving venture capital.  Similarly, you need clear plans on how you and your dedicated employees with monetize their sweat and other equity.  Don’t think that both groups are not worried about these questions.  Always have some good answers ready around this issue, as it comes up frequently.

Finally, monetization often will occur via an exit and you need to have a strategy (with options) to ensure maximum rewards. A recent post of mine, Planning for Exit, discussed how to develop an exit strategy.  A key part of that strategy is understanding how equity invested will be monetized in the process.  With preferences, warrants, options and numerous other factors affecting the final numbers–not to mention earn-outs and other methods of extending pay outs into the future, figuring out which is the best approach can be tricky.  The savvy entrepreneur carefully monitors how any and all of these factors may impact the ultimate monetization of his or her business.

The reality is that business model monetization comes in many different flavors during the life cycle of a company.  You have to get the initial monetization models right up front, then you have to ensure that operational execution actually can generate excellent margins against the model and finally, that you can have the right exit to maximize return to all relevant players.  This is a tough process to execute well, but a necessary one if you are going to "monetize your business model" correctly.