If you have a startup that is free for all users and does not generate revenue, but the site/product is used by a lot of people so you have a lot of users, would a VC potentially give you funding even though you are not generating any revenue? I guess in a case like this what would be their exit strategy to fund a company like this with no revenue?
Take a step back.
Question #1 is: are you creating clear and distinctive value for your users?
If so, then go on and ask question #2, does the value for an additional user taper off grow incrementally, or grow more strongly?
Then here's the mapping:
Q1 = No clear and distinctive value: your best monetization is likely to be through a third party - advertising in some form.
Q1 = Clean and distinctive value created
Q2 = Tapering value growth You're probably not investable in the classic sense, but there will be multiple monetization routes, and possible exits. Sometimes, sites and products with this characteristic can become part of a growth business by using them as a template for further propositions taken to different audiences. This is a fairly common strategy - and it helps the learning process (for instance, if you have two sites, it's easier to take the risk of, say, charging for what's always been free, or introducing a freemium model.
Q2 = Incremental value growth This is where people often assume they are: my next user gets just as much out of the service as my last one. This is a strong base from which to grow. You need to be clear about how the value is created, and to ask the growth-shaped question of how can you acquire new users without over-spending. And then you have the basis for at least two things:
Q3 = Strong growth
This is the investor's ideal scenario. If the value function has a fixed component plus a component related to the size of the user community, then even if you have little or no income, you're growing value in a powerful way. Some investors will take the view in such a case that scaling comes before monetization. Or to put that another way, the learning achieved from monetizing isn't worth the risk of losing out on growth while absolute user numbers are a small fraction of the addressable market.
Yeah, it's kinda trendy right now (see Instagram).
Another thing is that VC's usually invest in people, not companies. If you have a strong team, I'd say you have a good chance.
You seem to be a great candidate for VC funding! If you have a product built and that's scaling, you should pitch.
The exit strategy would be an acquisition. You can say that you're not generating revenue at the moment because your priority has been to figure out how to grow and that there may be a self-sustain revenue stream that could emerge in the future.
Traction is one of the most important factor in deciding if your startup gets funded. However during the pitch to the VCs, you might want to propose a few ways you can monetize the startup in the future.
Agreed that having some ideas about what premium value proposition one could use would be helpful during funding discussions. Combining this with lessons learned from customer testing / research that helped you secure your traction and userbase is also important.
Here are a few recent posts to add some additional info to the mix - Gigaom on freemium has run its course, Mashable on freemium model doesn't work and the anatomy of a profitable freemium by M Wensing.
I tend to like Wensings approach towards Freemium that it ".. requires a business to maintain two value propositions with a well-designed interaction between the two."
He uses a free car analogy that describes the different value propositions which is both entertaining and insightful (Cargo Freemium, Airbag Freemium, Bomb Freemium, Cruise Control Freemium, and Bells & Whistles Freemium). Worth a read.
Best of luck with your fundraising efforts.