Any investor in a business is ultimately looking for a positive return on investment (ROI). But in the online space “positive ROI” can be achieved by a product that does not in fact make much, or any, money. In fact, it is very possible that angel round investors, or seed accelerators, make a fortune out of an initial investment in an online product that will never, on its own, make any money at all.

What a startup does need to do is prove, or at least strongly suggest, is at least one of these:

• that it will be able to generate sufficient revenue on its own
• that it will attract a wide enough audience, that can eventually then be monatised
• that it has technology that will be desirable to a bigger player, and will be acquired

All three of these can work hand-in-hand, and having more than one potential revenue source is obviously a good thing.

At the end of the day, just like in any other business, an online product needs to add enough value to those who will be paying for it to justify the money spent.

Unfortunately, it is very difficult to get money out of consumers, advertisers or the “bigger” players. Consumers are used to getting things for free online, and will most often only shell out money if doing so will save them time or money. Advertisers have a plethora of advertising options, and simply offering them a “just another” new platform to speak to consumers is usually not a strong enough proposition. And the Bigger Players often have their own development teams or at least access to unbelievable coding talent, so will only acquire companies if doing so will offer a shortcut to them developing a similar product themselves, or if that is the only way they can get their hands on a patented technology.

Reddit.com is a case in point.

One of Ycombinator’s earliest success story, Reddit.com, is very similar to digg.com: it creates a “front page” of the web, listing and linking to interesting stories as voted up by the users (readers). It appeals to a tech savvy crowd, and gets about 7 million page views per month.

It was initially funded by Ycombinator with $11,000 and went on to attract about $70,000 in angel funding, and rejected a buyout offer from Google five months after startup. (Interesting enough; when the two Reddit founders first approached Ycombinator for funding, it was with a completely different idea that YC didn’t particularly like. What they did like was the team, so together they developed an entirely new idea, which resulted in Reddit.)

When Reddit launched in 2005, it had no advertising on the site, and no revenue stream or model. What it did have was an extremely low burn rate (money needed to exist, over and above revenue generated) and a strong focus on growing traffic. About six months post launch, it started displaying advertising. It also sold merchandise. It allowed people to buy placement of headlines on the front page (which would have been most controversial, had it also not allowed the readers to vote those headlines up or down). But the key to success was licensing their technology to a bigger player – in this case Conde Nast. In the end, Conde Nast was so impressed with the product, and the team, that they acquired the company for an undisclosed sum (but rumored to be between $10 and $20 million).

Today, Reddit relies on advertising and licensing as revenue generators.

Lessons learnt:

• Keep the bigger picture in mind, over and above everything else. In Reddit’s case it was about providing value to the readers (at no cost) so that there was a strong, cohesive audience.
• Think outside the box. Reddit allowed its technology to be licensed by other companies, which made it a proveable concept and led to an acquisition.
• Stay cheap. Even at time of acquisition (18 months after startup) Reddit’s highest expense was rent.

(Just for the record, I consider Reddit a success story only from the founders and YC’s point of view. I do not think it was a particularly successful acquisition for Conde Nast. That, however, is no fault of the Reddit founders, and is a topic that deserves a blog post on its own.)