Capital efficiency is a great point of view. The take that every dollar from a customer is worth 5 is a really good conversation to have with a CEO.
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.
Actually every VC I’ve spoken to freely admits this. It’s “grow big, fast, or try again later”
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.
I need to build my v2 and am avoiding accepting angel funding from an investor who wants 30% for $250k. Sales are not stopping at this point. I am using stripe for all sales. Do you have a suggestion for me to get a loan? I need $150k to build v2 AND keep the lights on for say 12-14 months. Thanks.
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
I agree. But I'm on WP and the sales are not slowing down.I need to build out offWP to a web app. Keep the WP version running while standing up the web app build. But the engineers want $12,500 for 100 hours/sprint for both. I get a designer + Engineer. I'm thinking just pay enough to get to a web app with maybe 2 sprints $12,500 X 2 = $25k. Start making sales and then use the sales to keep paying if needed to increase sales / expand add new features from customer feedback.
I applied to tiny seed i don't think they want me. I filled out the Lighter capital form today (no reply) i think i applied to earnest capital , kabbage no. MainVest never heard of them but i am gonna look and point9 same. looking for money is taking time away from making sales and improving the product. I think i "may" be able to swing it from sales!
Aren’t some of the frontier tech investments to also understand the space, where the tech is currently at, and what team members to back or grab when the space is ready? To me, it would make sense for Sequoia to allocate some capital to these situations in order to capitalize on when the tech is ready to move from frontier to viable?
> 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.
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.
In early-stage SaaS, a rule of thumb I've often heard is that it's great if you're maintaining a 1:1 ratio of cash burned to ARR generated.
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).
> Many people say growth is the only important metric, and that’s actually wrong. The reason is simple—only 5% or fewer of startups are growing so fast that efficiency doesn’t really matter.
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.
On the cost side, it’s difficult for me to understand how most startups can pay SV rates for talent and be considered efficient. The problem space usually is just not difficult from a technical aspect, you don’t need top talent. Maybe unpopular here due to the bias of SV talent in HN but from a capital efficiency standpoint startups need to be designed in SV/US and developed elsewhere.
We (OP here - Estimote) have a significant team in Europe doing just that. Working on sensor networks. Interestingly our customers are in the US and we went through YC and have mostly Silicon Valley investors.
In one his essays, Paul Graham, pointed out that the number one cost is hiring, so you're not wrong, because hiring bad people can be bad for business, hiring good people can be bad for business if growth stalls.
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 SV salaries are why you're seeing platform B2C companies lead the pack and build full engineering teams in the Bay Area. For many B2B, especially in non-platform markets, building hybrid teams (or building completely outside of SV) with Founders in the Bay and scaled operations often outside the US.
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.
Idk, that “only $1b” is an annual bump to the bottom line. Net income only crossed into the B’s for the first time in 2018. Was significantly less in prior years. The question is how much growth would it take to add another B and how long would it take. At this point, is the market even that big?
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.
it was hard to find a point here. it seems to boil down to "hey, don't forget about capital efficiency!", which is not so helpful.
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).
You wonder if somebody is being disingenuous when they tell you that an investor who is famed for investing in Uber uses capital efficiency as part of their decisionmaking process.
It's hard to say what their real capital efficiency is without detailed (and probably proprietary) breakdowns of their numbers.
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.
Why is every dollar from a customer worth $5 from an investor, as opposed to $2 or $10. I understand the idea behind revenue dollars being more valuable than investment dollars, but I question how the ratio is constant across startups rather than heavily dependent on other factors like industry, stage, round, etc.
Does capital efficiency really matter as much though in "winner take all" markets that seem to be more and more the norm in tech these days? The reason it feels like so many VCs are pushing for growth at all costs is that in many sectors now being 2nd is an order of magnitude worse that being 1st (and being 3rd is almost equivalent to being non-existant). Look at social networks: Facebook's market cap is around half a trillion dollars. Linked in was acquired for $26.2 billion, very similar to Twitter's current valuation, Snap is ~$16 billion.
And all of those companies had multi-billion dollar valuations before they barely had any customer revenue at all.
Many investors care more about growth than capital efficiency. The investors in the last round of your startup typically have a 1x liquidation preference as well as protection against down rounds. For a company that's generating revenue this provides with protection in case things go wrong. They also have a portfolio. End result is that many investors are more risk tolerant than founders and will push for growth at all cost.
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.
Totally agree. Investors are the worst at pushing this. And they do it with a lot of psychological tactics. We’ve been really fortunate to have great lead investors who are available to us and support us too. I think it’s very rare.
>for every dollar you take from an investor assume you need to turn it into 10
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
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.