Market gyrations and startup valuations have been the hot topics lately. With so much turmoil across the economy, it’s clear we’re still in for more pain as the world adjusts. On the startup front, a number of entrepreneurs are thinking through what to do and what needs to change in their current plan. While some startups are doing well, many that raised money in the last 18 months did so in a way that their valuation got too far ahead of their performance. What to do?
In the most recent episode of the All-In podcast, David Sacks shares that high growth startups with moderate burn will get funded while ones with moderate growth and high burn won’t. Continuing that thinking, he outlines four metrics startups need to optimize for if they want to raise money:
- Growth rate > 50%
Growth has been one of the biggest drivers of value creation for the last few years. Now, instead of growth at all costs, it’s one of several factors that must be evaluated. So, keep growing fast, but do so in way that’s more measured in relation to other metrics.
- Gross margins > 50%
Gross margins are what’s left over when you subtract the cost of goods sold from the sale price. Some startups have negative gross margins (lose money on every customer) or low gross margins because the business model is either sub-scale or challenged in other ways. The key is to have large, positive gross margins.
- Customer acquisition cost (CAC) payback < 1 year
Sales and marketing costs to acquire a customer can easily get disconnected from what makes for a good business when capital is cheap. Now that capital is more expensive, it’s important to be able to acquire customers at a cost that’s less than the revenue received from the customers in the first year.
- Burn multiple < 2
The old adage that you have to spend money to make money still rings true. Only now, for every $1 dollar of burn, the startup should add one net new dollar of annual recurring revenue. Many startups are burning an excessive amount of capital relative to a new dollar of recurring revenue and will have to adjust.
This isn’t RIP Good Times; it is a return to the basics: build something people want, acquire customers in a way that makes sense financially, and scale as fast as the metrics allow.
Entrepreneurs should focus on their growth rate, gross margins, CAC payback, and burn multiple in a way that’s thoughtful and optimized for their business and market opportunity.