What are some of the most popular metrics that Venture Capital firms focus on when they consider investing in startups?
Answers
Id say the most common is the track record of the
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Agreed. What would you say are the metrics associated with that, Simon?
How soon can the business generate positive cash flow and how much ?
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I would say that is no 1. Just spent hours on cash flow/budget for PE company. Then question was when sales should ramp up, how fast would receivables be collected.
Bottom line, how much cash will be needed and when.
The problem with a focus on cash flow is that, rising sales can cover a multitude of sins. I've worked for three startups (not tech) in my life that were wildly successful out of the gate. One went from a garage operation and $5M in sales in the first year, to a 40,000 sq ft facility and $70M in sales by the fifth year.
But the cash flow generated from rapidly rising sales was covering up the fact that expenses were growing just as fast and, in all three cases, when sales plateaued, expenses continued growing because controls were not in place. This was due to the sadly mistaken core belief in infallability of the founders and that one must "spend money to make money". i.e. the founders, based on their previous successes, were willing to keep on spending despite revenues going flat in the belief that doing so would return sales growth to the previous astronomical rates. In all three cases, the companies went out of business eventually. But, they all died a slow lingering death and the founders cashed out well before so, it was of no financial consequence to them. And sadly, I always joined too late to be considered part of the original group and never benefited from the buy outs.
The original management team's resumes? In fact, looking at the resume's of the early management teams at these entities would lead an observer to believe that they were a bunch of successful, serial entrepreneurs. But, that's only because they hedged their bets by at cashing out early - selling to larger firms - but stayed on in some capacity. This is not apparent on their cvs at all as they also started other ventures at the same time so it looks like they sold profitably and moved on.
It is so easy to spend other people's money. ;-(
I am firmly entrenched in the "profit is king" camp. You can be the fastest growing, the biggest, the baddest in the industry, but at the end of the day if there is not net profit on the firm's activities those other measures are worthless.
I have always thought that as CFOs, part of our job was to remind the owners and executive team to keep their eye on the profit metric. The bottom line needs to be black more than it is red or failure will result.
Mr Anonymous -
Your answer is spot on, but not to the question posed. VC's want to see positive cash, and profits are nice. They are looking for the flip; you are looking for the longer term (and should be).
For early stage investments the most common metrics would be revenue rate and burn rate (i.e. cash related metrics).
For later stage projects the focus shifts to growth, market share, profitability, operating margins (growth&profit related metrics.
There is no reliable metrics on the team quality as far as I know, even though it is one of the most important success factors for any VC.
Track record of management team can be measured by their resumes. What successes and failures have they had in past endeavors. The details behind their failures could be most telling.
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I agree with Stephen. There are a lot of great ideas,
Initially a VC is mostly betting on the team. Then the financial model needs to pass the sniff test. Once the funding has come in, expect to be constantly dogged on execution (show me the money - being made). This initially comes back to your financial model, but then you need to layer in your sales pipeline, so those metrics are important. Putting out a financial forecast that is not tight will come back to haunt you, if numbers are subsequently missed. Thus, a constant laser focus on your sales prospects and backlog are paramount.
After those 2 primary areas, I see a focus on headcount and associated metrics (revenue per HC, average wage, etc.). Pretty typical - do more with less people... Hold your ground when pressed, otherwise staffing gets cut, first on paper, to meet bottom line expectations.
Beyond the comments above especially gross margin and growth rates, important metrics are customer acquisition costs, expected lifetime customer value (although perhaps is less relevant for some business models), and information about the sales cycle. It's critical to demonstrate that the management team gets this and knows the industry. Break-even and burn rates are important tactical measures.
Margins on everything, positive cash flow, relationships in the business cycle.
Bessemer Venture Partners, a respected VC firm, published a "Top 10 Laws of Cloud Computing and SaaS" that explains key metrics for this type of business, including recurring revenue, cash flow, customer acquisition cost payback period, customer lifetime value, and churn. This document is a good place to start understanding how a VC will value your business, especially a cloud business. http://www.bvp.com/cloud.
Not necessarily a metric but market size is critical-how big is the market you are going to be competing in.
Definitely for an early start up the focus is on revenue rate or who long until revenue begins, and as the next step come questions about burn rate. Showing a bar chart or sensitivity analysis chart that shows X amount of months of runaway given Y investment against Z burn rate is a great way to show VCs (or other investors) a menu of potential outcomes with varying investment levels.
For qualitative issues definitely the team and I would add what they are giving up for the venture in terms of economic and financial opportunity costs. For example, are they quitting school or a
Other important financial metrics tend to be the size of the market - is it something worth going after? Is the addressable market large enough with attractive demographics to support growth. On the costs side what is the monthly burn rate, how much time will the current capital give the company to reach their next milestone whether based on units shipped, sales, EBITDA, subscribers, etc. whatever.
Also, don't forget to have realistic options for an exit. The worst thing is to be invested and have your money trapped. IPO's are not realistic for most companies. So you need to make an assessment of what the most viable exits are - who is going to buy you out? the public, a competitor, a client, etc.
I agree that management track record is important, maybe most important. In terms of actual data, I find VC's., PE and sophisticated angels usually delve deep into base assumptions, i.e. cost and/or time to produce one unit, then your assumption for unit growth, then pricing in the market place. Same basics with personnel, capex and other costs. Point is: create your financial and execution plan from the bottom up not by saying "we are going to do $100M revs in year 3" and then fitting the model to prove that. Identify your assumptions and be prepared to defend- even if they disagree, they can't accuse you of not doing your work. Also, identify and know the competition. Nothing gets me to say no to a project, and nothing drives investors away quicker than an entrepreneur who says "we really have no competition". MSFT, GOOG, APPL, Facebook, WALmart, etc all have competitors. Thats fine, it means consumers want the product or service. Tell the story around why and how you can effectively compete and take market share.