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
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.