I got excited — very excited — when I found out that Substack’s equity crowdfunding effort would result in it releasing financial results.
Sadly, due to rules and the timing of the fundraise, Substack is not required to detail its financials for 2022, and so the startup released hard data for 2020 and 2021 along with certain user-specific metrics for last year. This provides an interesting, if incomplete, picture of the company’s health.
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I expected to spend some time this morning weighing in on the morality of Substack’s choice to not share its audited 2022 results, but Dan Primack nailed that argument this morning in Pro Rata. Since I can’t improve on his words, we can leave that point to Axios and instead focus our fire on parsing the data.
So to kill time while we nurse our post-Y Combinator Demo Day hangovers, let’s dig into Substack’s growth model (inclusive of its most recent nonfinancial data), ponder over the company’s current financial health, and then compare its upcoming capital raise to its potential cash needs.
This will be fun. Think of it like a quick look at a partial S-1 filing but for a Series B company. Sound good? To work!
There’s a lot of data, but not enough
You can read all of Substack’s released financial results here in case you want to play along.
To start, let’s note that the company raised lots of money through 2021 to invest in its platform and grow its user base. So while we consider its results through 2021, it’d be wise to remember that the company was growth-oriented at the time. How did that work out?
Substack’s growth model is expensive, if effective
Substack’s gross revenue scaled by over 400% to $11.9 million in 2021 from $2.4 million in 2020. That’s precisely the sort of top-line expansion that venture backers want to see from a startup in its investing cycle. The company had announced its massive $65 million Series B in early 2021, meaning that it had access to that cash in the year.
We expected Substack to lose money in 2021 given that it had just raised a bunch of capital and was busy investing in both its team and product. The company’s operating costs reflect that, rising to $16.3 million in 2021 from $3.4 million in 2020.
If you deduct the operating costs from its gross revenue, you get a loss of $4.3 million for 2021. So how did Substack wind up seeing its net loss rip to $22.9 million in 2021 from $2.3 million in 2020?
We have to get a little bit technical to understand what happened, so please be patient with me here. In the P&L table, we can see that in 2021, Substack deducted $447,664 worth of “returns, allowances and discounts” from its gross revenue of nearly $12 million. Fair enough.
But that’s not the number that matters. In 2020, the company recorded a contra-revenue charge of $889,299 for “partnership expenses,” a figure that exploded to $16.6 million in 2021. That particular item ballooning meant Substack had to report that “total revenues” were actually negative $5.2 million.
What is a partnership expense? Here’s how the company explains it:
The Company entered into agreements with the writers. Under the terms of the arrangement, the writer is paid a minimum guarantee in exchange for Gross Revenue – Partnership Subscriptions Fees. These fees are amortized over the term of the agreement which is generally a 12 month term.
For reference, revenue from partnership subscription fees grew to $5.5 million in 2021 from $1.6 million in 2020.
I am considering these partnership revenues and costs as kind of a marketing expense. Sure, the effort plays out as revenue and contra-revenue in its financials, but Substack was effectively investing in writers that it expected to come, build and help evangelize its platform. The work helped growth, as we can see from the growth in partner fee revenue. It just came at a high upfront cost.
Substack has a similar read. From its Wefunder page (emphasis added):
We have long believed that establishing a network can give Substack a competitive advantage and increase the value of the proposition for writers and subscribers who may be considering our products. This growth period was critical to building a leadership position in our category and attracting a critical mass of writers who could demonstrate the efficacy of the Substack model. We entered this period of spending knowing it would be an expensive but worthwhile—and limited-time—endeavor. (Indeed, since our Partnerships Expenses are categorized as contra revenue, we effectively incurred negative revenue.) These efforts have paid off.
There’s some merit to an expensive growth strategy if it ends up expanding your top line by more than 400%. The question is how the spend played out afterward.
It’s very hard to understand the company’s current financial health given the dearth of recent data
Substack may be occluding its 2022 numbers under some sort of false modesty, but the company did provide some hints that its last year was similar to its run in 2021. Here’s how the company discussed its partnership expenses through last year (emphasis added):
We expect this network, now growing under its own steam, to ensure that our revenues continue to grow and give Substack customer retention advantages in a competitive marketplace. As the platform’s network effects are driving organic growth for the business, we do not expect our Partnership Expenses to ever again be as proportionately significant as they were from 2020 to 2022.
In short, we should anticipate that Substack had a material contra-revenue item yet again in its 2022 results, but that should shrink 2023 onward. We can therefore presume that its gross revenue was far more attractive than its total revenue in 2022, as we saw in 2021.
The issue is that we know how much cash Substack closed 2021 with ($55.4 million) as well as its operating cash burn for that year ($24.7 million). What we do not know is how much of its gross revenue last year was consumed by partnership costs, nor its resulting net loss, nor how much it wound up burning in 2022.
Sure, Substack has said that it scaled to more than 2 million paid subscriptions. That’s great, but it’s pretty far from the numbers we really need. With what we have today, I cannot say anything concrete about the company’s cost structure, viability or cash health heading into 2023. That’s a pain in the backside.
That said, I think we can agree that:
$5 million ain’t much
Let’s be very generous and presume that Substack managed to halve its operating cash burn to about $12 million in 2022. That would put its cash balance at around $43 million at the end of last year. Compared to those figures, a $5 million community raise is small. It’s worth what, less than two quarters’ burn?
If the company kept its operating cash burn flat last year, it ended 2022 with a little more than $30 million in cash, which would mean its $5 million fundraise is worth less than a single quarter’s costs. Once again, the figure is minute.
Either Substack has managed to moderate its cash burn and has enough funds on hand that its crowdfund seems oddly modest, or its operating expenses are significant enough that the amount of money it is looking to raise doesn’t add that much room to its burn countdown.
Sure, Substack is stuck with the rules and can only raise $5 million here. But because we don’t have its most recent data, we’re simply unsure if the company is merely topping off its cash balance from a position of financial strength or is desperately working to extend its runway in hopes of raising venture capital later.
More data, Substack. Get on it.
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