Continuing from last week’s post on the Rule of 50, I received several comments and questions. The biggest and most important question concerns whether a Rule of 50 score equates to viability for funding. From a funding perspective for seed-stage and early-stage companies, founders looking to raise venture capital need to understand that a score of 50 in the Rule of 50 is typically not enough to raise money.
Let’s look at three examples:
Example 1: The startup is growing super fast with a 100% year-over-year growth rate and has -50% free cash flow margins. If you take the 100% growth rate and multiply it by 2, you get 200. Add the -50% margin for a score of 150. A score of 150 will often be sufficient to raise venture capital, assuming other expected elements like margins, market size, team, etc.
Example 2: The startup has a 30% year-over-year growth rate and is breakeven. At a 30% year-over-year growth rate times two, you get 60. Subtract 0 because there is no burn, resulting in a score of 60. A 30% growth rate with no burn is enough to raise funding but likely not enough for a typical venture round. In this case, funding could come from growth equity, a family office, or venture debt.
Example 3: The startup has a 10% growth rate and a 10% free cash flow margin. In this example, the 10% growth rate times two equals 20, plus your 10% free cash margin gets you to 30. So, in the Rule of 50, your score is 30. In this case, the business likely isn’t fundable and won’t be able to raise another round.
In the context of raising money, it’s important to know that a score of 50 on the Rule of 50 is good, but you often need to be exceptional to raise venture capital. The big idea of the Rule of 50 score is that there are many startups still finding their way and need a target to achieve a healthy baseline of general viability for the business—not necessarily to raise a nice up round.
The Rule of 50 score of 50 is a solid target representing a variety of businesses like high growth with lots of losses, medium growth with modest profitability, or something with low growth and tremendous profitability. Most of the 2020 and 2021 heavily funded startups should aim for medium growth plus limited burn in the near term to achieve a level of viability. From there, the belief is that as spending on software and investment in tools increases, they will be in a good position to accelerate their growth rate.
The Rule of 50 and a score at or better than that number is a good target for entrepreneurs who want a sustainable, healthy business. However, a score of 50 is not high enough to raise venture capital. Entrepreneurs should think through their goals and aspirations and target their Rule of 50 score accordingly.
David Cummings on Startups 