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Here at Ask an Investor, we’ve covered the things that VCs don’t care about. But what’s more helpful to you as an entrepreneur is likely understanding what VCs do care about – specifically, what metrics matter. This is a question I’m asked almost every time I meet with a founder. As we’re building our relationship and establishing a trajectory of performance, it’s important to know which metrics to optimize for to set founders up for a successful funding round. So which metrics truly matter?
At the most basic level, financial KPIs are helpful in understanding optionality, valuation expectations, and relative performance. Optionality comes from burn and cash in the bank. How many months of runway does your company have left? More than six months leaves a good buffer for your fundraising process – less has me concerned you didn’t raise enough capital last time.
Across all these elements, the one true commonality is to layer retention. Within your ACV, drill into how much of that is recurring vs. services revenue.
Layered on top of that is run rate. This gives me two key insights – a ballpark indication of the valuation you’re expecting, and a sense of relative performance. The second is less obvious as it combines run rate with burn. Velocity is a key determinant of success in fundraising – the faster you’re able to grow to a specific revenue number and the less you have to burn to get there, the stronger your team and growth engine appear to an investor.
The final factor here is gross margin, which becomes increasingly important as you scale. Different types of businesses have different gross margins and trade at different multiples on the public markets. Applying those valuation multiples (with a premium for higher growth rates) to your current run rate can be a helpful starting point for determining valuation. Investors need to defend their investments to their partners, their investment committees, and their LPs, and comp analysis is a helpful way to do so.
At a higher level, every business has specific key metrics that are fueling growth and are the best indicator of performance. However, these north star metrics are necessarily unique across businesses – there might be some commonalities across business models (i.e. SaaS vs. hardware companies will focus on different metrics in general), but the true key metric that you track as a SaaS business may differ from another SaaS CEO’s. Equally important to that metric itself (especially for early stage companies) is your ability to identify the key metric. VCs want to see that you understand the difference between vanity metrics and your true north star metrics. A founder who focuses on the core growth driver rather than cumulative downloads or another vanity metric is likely to be a founder that’s thoughtful about the business and faces challenges head-on, rather than highlighting positive, but meaningless, aspects in the wake of a true challenge.
These north star metrics should truly capture the heart of your business. The best way to approach determining yours is to understand what truly drives your business. Is it sales? It’s related to your funnel size and conversion, fully-ramped sales reps, and ACV. Marketing? It’s related to market spend, our conversion rate, and ultimately culminates in your return on ad spend (ROAS). Licensing? It’s related to the units you produce and the units your partners sell.
Across all these elements, the one true commonality is to layer retention. Within your ACV, drill into how much of that is recurring vs. services revenue. Within ROAS, break that down further to understand if a sales dollar is profitable for a one-off user or if you need them to purchase again via SEO or direct acquisition. Above all else, VCs are looking for scalability, and understanding your retention is a key element to understanding your scalability.
The challenge with writing about metrics is that every company is different, and the same key performance indicator (KPI) mean different things to each company. However, at scale, there are only two financial metrics that truly matter: revenue and profit. You must think I just lost my marbles, a VC talking revenue and profits.
Unfortunately, startups in a rush to grow and drive vanity metrics up and to the right (and the best vanity metrics can ONLY go up and to the right: total downloads is my personal fave*), all too often entirely miss the point of why they as a startup exist: to build a repeatable business model at scale. In other words, a business with sizeable** total revenue that is profitable.
The metrics we care most about are the ones you should care the most about.
Now the challenging part: you very likely have very little to no revenue (from a Fortune 500 perspective) and are very unlikely profitable. But you need to start thinking now about how at scale how you will get to those significant numbers.
The easiest businesses to explain this with are SaaS businesses. At their root, a SaaS business has a customer acquisition cost (CAC) and a total lifetime value (LTV). Their CAC should be low and get smaller month over month, and their LTV should be high and growing month after month. Obviously, VCs have a strong preference for a CAC over LTV – so should you!
Leaving SaaS land things get much messier. In the typical B2C business understanding your LTV pre-monetization can be next to impossible. So folks tend to look at daily/monthly (DAU, MAU) active users in combination with churn rate as a proxy for understanding LTV. If DAU is high, churn is low then the assumption is LTV will be high.
In enterprise B2B startups a CAC number, which is an average, is mostly meaningless.
In enterprise B2B startups a CAC number, which is an average, is mostly meaningless. Consider a startup that sells per-seat licenses to enterprise clients. They could land a 40,000 license company in weeks and a 3,000 license company in two years. The average cost of those two sales is mostly meaningless when trying to understand what the price will be to acquire the next 43,000 licenses.
The picture I’m trying to paint here, and so is Sarah, is that the metrics we care most about are the ones you should care the most about. Ultimately, the metric you should care most about in the long run is how much revenue will you generate and how profitable can you be; importantly, when you choose to become profitable.
The mess of early-stage startup metrics is why I like to come back to understanding a company’s gross revenue and profitability at scale. These two metrics are the great equalizers. The better you can explain to me what you think your KPIs look like at scale, the more likely I’ll have confidence that measuring and optimizing for those metrics will get you to a sizable repeatable business model.
*Sarcasm warning. Best not to ever show me a graph of your total downloads.
**Sizable: In determining size, VCs like to understand your total addressable market (TAM), this isn’t a metric per say, hence not discussed. It’s worth mentioning that almost all metrics are best considering in conjunction with a defensible TAM calculation.
Photo via Unsplash.