An old management adage goes “You can’t manage what you can’t measure”. There are various ways for a startup to measure, and thus manage, its performance but what many founder do not understand is that the metrics on which the investors measure their venture may be completely different from their approach.
A startup owner is seldom provided any explanation from the investor about the basis on which his/her venture was approved or denied funds. What goes in the mind of the investor when assessing a potential investment remains a mystery to most entrepreneurs. We chanced upon an insightful article by Danny Circhton, who is a author and a researcher in TechCrunch and has focused his research on early stage investments on this particular subject.
The article categorizes the possible metrics that are analyzed by investors when judging an early-stage startup into five groups: financial, user, user acquisition and marketing, sales and market metrics. While some of the metrics mentioned in the article are specific to certain industry; for e.g. K-Value, a measure of virality is more appropriate for a social media venture and is not as important for a B2B service provider; we would be reviewing a few metrics which are more relevant in general in India.
As a financial service provider, we try to focus more on these metrics for our clients when we try to raise funds for them. As mentioned in the article it is crucial for any startup and a venture may get investments sometimes just because of the balance sheet and cash flow generated by it. The article goes on to brief on a few of them as below:
Monthly Revenue Growth:
Take the current month’s revenue, subtract last month’s revenue, and then divide by last month’s revenue.
It is quite an important metric to measure the near term performance of an emerging startup. Tracking it over a long time also shows the impact of seasonal variation on the performance. A sudden increase in Monthly Revenue Growth can be ascribed to various factors such as a festival season, greater discount or even a sudden surge in demand for a particular trend. Understandably investors tend to not read much in this metric. As the article goes on to mention, “While VCs don’t use this metric as heavily as the next one we will discuss, some guideposts are still helpful. A growth rate of 40 percent per month is very good. A growth rate below 40 percent can be considered good if you can convince an investor that additional capital placed in sales and marketing will drive the growth rate higher.”
Revenue Run Rate:
Take the revenues recognized in the most recent month and multiply by 12.
The VCs are more interested in the projected growth of the startup and this provides a sense of magnitude to the investors in a simple manner. This is what he/she probably calculates in their mind when looking at the figures to get a sense of where the company would be when it goes for further round of funding.
“Thus, great performance is a revenue run rate that allows the next fundraise to happen. To get that number, reach out to investors and other founders until you have a good handle on the trajectory needed for your company.”
Gross margin is calculated as total revenue minus the “cost of goods sold” divided by the revenue. Net margin is similar, except we also subtract the total expenses of the business as well (except for taxes and a handful of other accounting line items).
Margins are the core of any business and indicates the value that is created by it. Margins differ as per the industry and even the category it focuses on. An ecommerce venture focusing on electronics will tend to get lesser margin than a similar venture operating in fashion segment. Margin along with inventory turnover rate is the most important metric for a retail organization.
“One additional consideration is margin compression. Margins become tighter when competition is greater, so successful businesses must develop defenses against new entrants who might force a company’s margins lower.”
Burn rate and Runway:
This is the operating loss per month. To calculate runway, take the amount of available capital and divide by the monthly burn rate to get the number of months until your start-up runs out of cash.
This is the metric that is the focus of any discussion with our client. As a virtual CFO we live and breathe this metric and our focus is to ensure that our clients have a low burn rate and we have enough funding options to keep the business alive.
“These numbers show the efficiency of a business, the timeline for fundraising, and the need for capital. While startups are often run quite cheaply until their first fundraise, VCs will want to understand how you will increase your expenses to grow the business more quickly with any new infusion of capital”
The article describes various other metrics which fall under different categories. We would advice to read it to figure out what may be more useful for your venture. The complete article can be read here: http://techcrunch.com/2014/01/31/the-complete-quantitative-guide-to-judging-your-startup/?utm_campaign=fb&ncid=fb.