27. June 2012–
Darren Fell is Managing Director and co-founder of Crunch, an online accounting service. Here he argues why it might be best to avoid the Freemium model if you want to build a sustainable startup...
The great startup giveaway – "Growth now, revenue later"
It probably seems blindingly obvious, but the objective of any company operating in the private sector is to make money. Sure, many espouse social good, and many help out their fellow man along the way, but a business’ primary function is to generate profit. Without it, they will cease to exist.
With that in mind, it seems the tech startup landscape is becoming curiouser and curiouser. “Growth now, revenue later” companies offering free products are the norm, with pre-revenue exits of hundreds of millions - or even a billion - possible.
However, for the entrepreneur looking to build a sustainable company, not just achieve a bank-busting acquisition, the Freemium model might be best avoided. It certainly enables fast growth, but you’ll be sacrificing all-important revenue, valuable equity and financial security.
Scaling too quickly can lead you to sticky situations
What if you scale your startup quickly, only to realise later that it cannot be monetised to the degree you had hoped? You’re suddenly stuck with a large business (with equally large outgoings), and not enough revenue to cover your costs. In this situation your only choice is to seek additional investment, which means giving up yet more precious equity in the company you created.
When launching Crunch, an online accounting startup, we decided on a Premium-first approach. We launched as a paid subscription service with a single monthly package. This meant we have had a solid, predictable revenue stream as soon as our first customer came onboard.
Cashflow is king – stronger bargaining and more equity
When seeking out investment – which we eventually secured from Bebo’s Paul Birch and Skype’s Michael Van Swaaij – our existing revenue put us in a much stronger bargaining position. With a proven product and existing income there is less risk for a potential investor, and also less investment required. Our first round was only £400,000 – a trifling amount when you think of the cash companies like Twitter have burned through.
These two factors have meant that myself and my two co-founders have managed to keep much more equity than if we had pursued a Freemium model. If we ever did decide to go for a big exit, the returns would be many times more.
It’s all well and good having a few million in the bank – but when you’re operating a growing business with substantial development costs, steady cashflow is infinitely more valuable. You’d be surprised how quickly a big stack of cash will disappear if it’s not being replenished now and then.
It’s been well documented that credit is difficult to come by in the current economic climate, and banks will look at income as a key indicator of the health of your business. A steady income will help you fight your corner should you need help from your bank.
A free product on your own terms
Freemium is a powerful business model, and you should never discount it – many great tech businesses are built on a Freemium setup. The trick is to know when Freemium is the right path.
Let’s say you’ve built your business on a premium subscription model, and you’re now sitting on a pile of satisfied customers, steady income, and some happy investors. Now is the time to switch to Freemium; if it’s done right it can accelerate your growth exponentially. When we launched a free version of Crunch we already had a customer-base of around 2,500 clients. Our free product brought in 1,000 new users in just a few weeks.
By putting in a bit of legwork to build a startup with an income, you can make the “reverse switch” to Freemium when it’s strategically advantageous, rather than launching a premium product when it’s a financial necessity.
Your business will not only be more sustainable, but you'll be better-off financially, have much happier investors, and you as a founder will have retained more equity in your business.