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The financing environment for growth technology companies (both public and private) has clearly stumbled recently. For whatever reason (precipitous fall in Chinese market, fear of rate increases, etc.), the market has turned from a “maximize growth at any cost” market to a “optimize capital efficient growth” market. Your investors and board members who last year were asking “Why can’t you grow faster?” are now yelling, “Hit the brakes!” (Note: remember Sequoia Capital publishing “R.I.P. Good Times”! in 2008). What to do?
The answer in this case is — wait for it — it depends. Depends on what?, is the real question. Let’s try to create a simple framework as scaffolding, on which we can layer a bunch of critical questions:
The starting point is understanding the economics of the business. For many businesses, the critical number is the LTV:CAC ratio. A lot has been written on it, but the basic concept is that the lifetime value of a customer (sum of gross margin it generates over its lifetime before it stops paying you) should be significantly greater than the Customer Acquisition Cost. For details on the calculation, see SaaS Metrics 2.0 detailed definitions. Fundamentally, if this ratio is 3x or better, you’d ideally like to invest further in customer acquisition and can create value by raising and spending more capital.
If you’re not generating cash (and most venture-backed start ups aren’t), the question is whether you have enough money to break even. The one tangible thing I learned in business school is, “Cash is more important than your mother.” You can’t keep the doors open without it. Can you increase revenue fast enough to break even before you run out of money? It may come at the expense of some investments in product development or even pulling in your growth (marketing/sales), but it does allow you to “control your own destiny.”
The last critical question is whether you can raise more capital and, if so, at what price? This is the factor that has changed in the last several months. An economist would say that “the cost of capital has increased” but what you’ll feel is that it is harder to raise money and if you can, the value of your start up might not be what you thought it was earlier in the year. As a result, some of the investments in growth you wanted to make, now might not make the cut. If you need more capital, this is a time for a direct conversation with your investors about what they think it will take to raise another round (inside or outside), what milestones you’ll need to hit (revenue rate, growth rate, LTV:CAC ratio, etc.) in order to raise a round and what role they expect to play in helping you do so.
Investors are sometimes like (I can’t believe I’m about to paraphrase Sarah Palin) “members of your management team but without real responsibilities.” When the message changes quickly and the conversation gets a little shrill, the answer is to get your team in a room and pull up a spreadsheet. Netscape CEO Jim Barksdale (whom I’m much fonder of quoting) used to say, “Does anyone here have any data? Because if we’re just sharing opinions, then mine wins.” Your job as an entrepreneur is to lead the decision about whether to hit the brakes or accelerate — and to lead it with data.
Greg Sands is founder and managing partner of Costanoa Venture Capital.
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