With cash now running rampant in the startup and venture world, cash efficiency is often overlooked for pure focus on revenue growth. Yes, revenue growth is critical in startup growth and proving product/market fit – Brad Feld had a great post recently tying revenue growth and levels to product/market fit milestones for startups – but what about the cost side?

It turns out that it matters whether it takes $10M or $4M to get to $250K in MRR. If it takes $8M, you might be headed for a flat or down round,. It probably also means an LTV/CAC ratio below the magic 3x and retention rate below 100%. Both are much talked about litmus tests of a healthy SaaS business. But they are also Murky Metrics. How do you estimate LTV on a one year old business? What do you include in CAC? Do you include pilots in retention? There are always ways to make these SaaS metrics look good… even when things aren’t.

I had this realization the other day when looking at a seed stage startup that launched 6 months prior and had $10K in MRR. I remembered they had raised $1M 18 months ago, and I thought “wow, they’ve really done something with that money.” Product development, launch, early growth. Then I found out they had raised *another* $1.5M six months ago and burned most of it. Ugh. Not cash efficient, and my heart sank. But they could point to great LTV, CAC and growth numbers… murky.

Basic cash efficiency matters – not only because it’ll help you raise less money and keep more ownership of more of your company – but because it is a critical sign of product/market fit. In a recent post on product/market fit, I mentioned PMF is when you can add and retain $20K/month in MRR at the same cost as the $5K/month you added 12 months ago. It’s a sign that you’ve hit a vein with your customer base. Of course this implies improved LTV and CAC, but the most transparent efficiency measure for a SaaS business is to see how much in **new net MRR you can add per monthly burn**. It’s hard to make that ratio lie.

So what is good and what is bad? Simple math:

Most series A SaaS companies we consider are doing $50 to 100K in MRR. A typical Series A we do is $3M in size (yup, Midwest). Success for a Series A SaaS startup is to grow fast enough *with the Series A they raise* to get to a Series B. These days it takes $250K in MRR at a trailing YoY growth rate of 200% to be *highly likely* to raise a nice Series B. That means wild success is growing from $50K MRR to $250K MRR in 18 months with a $3M investment. So…

**Net MRR Added / Net Monthly Burn** = (($250K-$50K)/18)/($3M/18)

= $11K Net MRR added per $167K burned per month

= 6.6%

This is an average metric over the 18 month Series A runway. If you assume the desired exponential growth (9.4% monthly revenue growth) instead of linear, you add $4.7K in month 1 and $21.4K in month 18! With constant burn, the ratio goes from 2.8% in month 1 to 13% in month 18. Sweet! When an investor sees that kind of performance, the check book comes out. Generally, at any point in the curve of a Series A or B stage startup, I’m excited when I see 10% but struggle below 5%, especially if the number isn’t rising quickly.

In the Valley, valuations and Series As are larger. So the right Series A size to metric for is $6M. That halves the ratios. Yup, Valley startups are simply less cash efficient. Geography and context matter.

I’d love to see someone do this math for e-commerce or marketplaces.

Hi Guy,

Great post! We actually have a similar situation to the comment above where our product spend is significant by comparison with other startups. So while LTV/CAC metrics are looking good with the cash efficiency ratio we need to look at the overall cost structure and explain why we are investing so much in the product.

Quick questions:

– when calculating the net monthly burn should you consider the MRR or the actual cash coming in each month (a mix of clients paying monthly and others paying annually)?

– is the answer different if we are 1) reporting past and current execution or 2) forecasting in our business plan?

We’ve been going fast for the last few months, average pricing for new clients is growing and annual upfront payments are increasing as well, so the difference between MRR and payments each month is starting to become significant.

Thanks,

João

Great post! One interesting tidbit is that the number of months between Series A and Series B does not appear to be a factor in the new-MRR/net-burn metric — it occurs in both numerator and denominator, and hence cancels out. As a VC, do you agree with this implication?

For example, consider two startups, both of whom have a new-MRR/net-burn of >10%. The first one took 30 months from their A round to get to that milestone (they spent frugally and chose to extend their runway); the second one took just 12 months (they spent aggressively and grew fast). Which one would you prefer to fund? Or are you indifferent?

Agree with you btw that I would love to see a similar analysis or metrics for marketplace and e-commerce models.

Abraham,

Great question! The short answer is speed matters. While the 18s cancel, 18 is actually also in the numerator of the numerator fraction (that sounds geeky). The definition of BIG success here is premised as 200% YoY growth over 18 months, which is about $50 to 250K MRR in that time period. So the calc of 50K-250K MRR has the 200% YoY growth built in and is an important assumption. Speed matters and is built into the ratio benchmarks.

That said, the comparison you describe is pretty nuanced because they are both super efficient. Likely we’d prefer the faster one, but with that level of efficiency on both, the other might be attractive as well depending on why they decided (or had to, due to capital limitations) go slower. The key question for the slower one would be “If we give them a lot of money, can they to deploy it efficiently and speedily like the fast startup already proved it can.” Some startups/teams struggle with this slow to fast transition, and efficiency struggles.

Great point! Both will be fundable. But having >10% efficiency with a high level of spend is a serious execution feat + leads to higher growth %, so they will raise more money at a higher valuation. Of course the faster one is higher risk until it is well funded because it has a higher burn and cost structure.

(Qualifier: I have a personal bias as a heavily product centric founder)

Guy – another great article! How do you think about the “semi-fixed” yet “front-end loaded” expenditures of a early-to-growth stage company impacting this calculation? More specifically, after raising a Series-A, I think many SaaS companies slam on two accelerators at the same time (1) Increase Sales & Marketing spend (with efficiency approximated by the “SaaS Magic Number”, LTV/CAC, etc) as the payback on this spend SHOULD be realized primarily in the near-term (measured in months and quarters).

(2) Rapidly ramp up product spend to expand near AND long-term revenue generation capabilities. The impact of this spend is much harder to measure on the monthly/quarterly basis.

I assume from an investor perspective, the game is always triangulating from multiple perspectives. If you’re willing to share any more thoughts, that would be amazing!

Hey Michael, awesome question. Thank you!

The Net New MRR:Net Burn ratio takes this into account. The denominator is Net Burn, not expense structure. So for a constant net burn of 3M/18 = 167K with exponential growth at ~9%, expense structure in Month 1 = 167K + MRR = 167K + 55K = 222K. But in Month 18 it is $250K + 167K = 417K! That’s plenty of money to invest in product. In fact in Month 1 it is hard to spend 222K because after just receiving cash, it takes 3 to 6 months to ramp a team from the pre Series A level of 5-10 to the 15-20 that can fit in a $222K expense structure. So then a lot of this spend and hiring gets back loaded. Of course all this is premised on success!

Point being that when the engine is purring, there is plenty of available cost structure to fit in the heads needed for both (1) sales and (2) product investment.

Thanks again!