On Startup Capital Efficiency
stevecheney.com
stevecheney.com
It bucks the trend that showing revenue (and then, showing profit) are liquidation events, not just investment opportunities. So it's not saying much that if you show revenue, you get a chance to liquidate or raise an up round. People have known that forever.
The more valuable perspective here is that many startups deliver products that are copies of stuff that already exists. That's just what VCs fund. So capital efficiency is your special sauce.
It would be nice to have a conversation about where capital efficiencies lie generally in technology. My feeling is that it is still in some sort of user-generated content. This is totally opposite of the trend to fund AI companies, which seek to replace the human being. Seems so much more capital-efficient to get the human being into doing expensive labor for free.
This leads to the most interesting counterpoint to the POV advanced here: capital efficiency is super important, but it's also super boring. Maybe there are investors who want to line up outside your door to do your thing capital efficiently. But the people working for you, especially at the beginning, do not care.
People want to be thought leaders, not penny pinchers.
As far as winning out vs competitors, efficiency can be key. There is no question there.
One of the things about frontier tech (autonomous, AR, sensor networks, ML) is that many people are funded and do it too early. So they need to somehow last.
Most startups spend the money within two years or less. It’s programmed into the psychy. A Sequoia would never admit this but they want you to spend your money fast and move on to the next thing if you aren’t growing fast enough. Buying one more year can be crucial.
But they want tax returns and credit score. Thank you and i will look into Lighter Capita. SVB is silicon valley bank?
Tax returns and a credit score for your business? Or are they asking for a personal guarantee?
We decided not to take angel investment, took longer to build a small business, and gave equity to more founders.
We're very proud of our profitable centicorn (one hundredth the size of a unicorn).
I guess its not easy to qualify since they get a bazillion application.
Do you just apply on the web ?
Do u have good references ?
Is it "real revenue" or r u counting the nominal sale value ?
Also - if u r still on WP then 30% may not be too bad :/
I'd tell the investor they can do 5-10% at that, or better, a convertivle note w 20% discount and $3-5M cap and (A) pointing to YC and (B) pointing out no follow on investor would join if they did higher -- after seed/A/B, only 50-60% of co should be sold. If a real investor followed, you'd be stuck paying legal fees to wash out the angel investor.
This all assumes a scalable startup, not a consultancy etc
That’s why it’s a horrendous idea to take VC funding if you’re not looking to spend it fast, and take huge risks. If you want to be capital efficient, do that, then raise when you know you can spend the money and the ROI is “guaranteed” (meaning you have a successful sales and execution engine), because then you can do it on your terms.
Otherwise, you raise, lose control, and are beholden to VCs for your next dollar. Good luck with that negotiation; they have the leverage.
Profit and revenue gives startups leverage, in nearly every way.
If this is right then the recent EU directive with the link tax, upload filter and censorship machine provisions will kill consumer internet startups in the EU, permanently.
> Maybe there are investors who want to line up outside your door to do your thing capital efficiently.
Another way of putting this is that operational excellence is a good moat. Pg talks about this repeatedly with his insistence that most startups fail through poor execution than anything else, through avoidable mistakes. This boring focus on operational excellence, on putting best practices into practice reliably and repeatedly. That’s what software private equity portfolios like Constellation Software do. Make big boring profits.
So if you net burn $6M cash from Day 1 to now, and get to =>$6M ARR, you're doing great. Presumably that ARR has an LTV(lifetime value) that's some multiple of ARR.
But in early-stage, that "net burn of cash" figure includes both client acquisition costs, COGS, and initial R&D costs. So it's a pretty messy metric IMO beyond a back-of-the-napkin kind of thing.
Almost immediately you'd expect to focus on the king of the "classic" SaaS metrics - CAC:LTV, where LTV takes into account gross margin, and making sure you're above the 3x line.
Investing big $ in R&D for product expansion/improvement etc is almost a different question - it's its own ROI calculation.
Final point - in SaaS, the pay-back on the initial CAC cash outlay is also super important. If it's tight (good), you are "re-cycling" the initial CAC spend on add'l clients, and each is creating a stream of future cash flows.
In a perfect world, you're taking $100 of investor money, deploying it into CAC to produce x # new clients, which represents ARR streams, and who pay back the $100 CAC almost immediately. Then you re-deploy the $100 to get the next x # of new clients, etc.
This is the magic of compounding in SaaS.
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All this to say - capital efficiency should be understood in context (in my examples above, capital efficiency in go to market has it's own rules and dynamics, whereas other uses of capital may be different).
I'm confused. Isn't the whole point of VC to try and find that 5%? And to be comfortable writing off the remaining 95% as acceptable loss? Isn't that why VCs encourage startups to irresponsibly increase their burn?
I mean, it makes sense if the author wants to offer startups some weight in the battle against that pressure - after all, the VC has 30 other investments and the founders have all their eggs in one basket. But that's not the perspective of this article - it's very much written from an investment perspective. If I talk to my investors about capital efficiency, they tell me they think we should pour more money into everything to try and grow faster, runway be damned.
As an example for NFLX with $2.2M revenue per employee ($15.8B rev / 7,100 FTE) if they could save $150,000 per employee it's only $1B to the bottom-line. By hiring "the best" and keeping operations as simple as possible paying more per employee may actually be financially better for them too.
Also, Netflix is a great example of a product that could be engineered anywhere with US based design/management (if you’re of the opinion that innovative ideas start here). Especially since they’re on AWS for infra.
I guess the key is to hire in proportion to revenue and offer to pay more equity than dollars. This, Paul argues, has employees working harder for the startup, sticking around through tough times, and reducing the burn rate.
The second key thing is, either hire people who can code or can go out and get users.
the importance of captial efficiency is already highly scrutinized because startup success is most sensitive to growth rate (of profit, aka income minus expenses). the challenge is that many early stage startups can't be measured on profit, so proxy metrics (like user growth) are used to forecast future profit and growth instead.
even revenue-oriented startups try to be measured on proxy metrics because investors so easily misconstrue early capital efficiency metrics as characteristic of future performance (this happened to my startup, on very early unit economics).
Presumably they are accounting for promotional pricing as part of customer aquisition and then balancing that against the lifetime value of those customers.
There are likely lots of assumptions going into their numbers, but it's likely the numbers look really good or they wouldn't be able to raise as much capital as they have.
Although, it's also highly likely the VCs are keeping their own special set of books where return on capital is also taking into account the estimated future value of the shares in an overhyped IPO.
Maybe the true capital efficiency doesn't look that great until you factor in that VC/PR/Hype/Dumb Money multiplier.
And all of those companies had multi-billion dollar valuations before they barely had any customer revenue at all.
To be clear, here at Stream we have super supportive investors. But I've seen friends of mine struggling with their investors and the constant push for growth at all cost.
I don't think that's the right way to look at it. It's more accurate to say that for every dollar you take you need to generate $0.50 to $1 in ARR. Or for something like a social network acquire one customer per $10-15 you take. VCs are looking for an IPO or acquisition and that's how they're priced