You’re thinking of fundraising for your startup. No doubt you’ve heard from others that you’ll need to “know your numbers” when you begin this process. The metrics behind a startup are indeed a major factor in whether or not an investor will invest. But what numbers do you need to know?
The financial metrics that will best showcase your company’s likelihood of success will depend on the type of company you’re building and what stage it’s in.
What round are you raising?
Andrew Chen of Andreessen Horowitz recently distilled the early-stage investment thesis into a Twitter post:
“2019 state of tech investing:
Pre-seed – Bet on the entrepreneur
Seed – Bet on the team
Series A – Bet on the traction
Series B – Bet on the revenue
Series C – Bet on the unit economics”
While this may seem like an overly simplified view of early-stage investing, it does emphasize one key point: As you progress through your fundraising rounds, your numbers become more and more critical to the story.
While an investor may make a seed-stage investment purely because of the pedigree of the founder and their vision, later-stage investments (with larger checks) will focus increasingly on heavy financial due diligence and the story being told by the numbers.
In short, the numbers become more important as you progress from one round to the next. So, what numbers should you be showing in your pitch deck? Below is a guide to understanding the financial metrics that compel investors to invest in startups.
Total addressable market (TAM)
This is a critical aspect of your story. The structure of venture capital funds means that in order to achieve the scale of returns required for their partners, VCs need to target companies with major market opportunities and large TAMs. The TAM quantifies the market opportunity that your company is targeting and will be a component of your financial model and your projections.
Be mindful of how you calculate this. A bottom-up approach is far more defensible than a top-down approach. For a bottom-up approach, consider breaking down your potential customers by demographic, geography, customer acquisition channels, competitors, customer switching costs (for existing markets) and potential revenue per user.
Make sure that there is enough supporting data to justify the TAM you present and be ready to respond to questions that come up. If you are too conservative, you undersell your company’s potential upside. If you are too aggressive, the investor may lose faith in the accuracy of your data and reasoning. In many cases, the growth rate of the TAM will also be important for your narrative.
You should be able to demonstrate to investors that you have done some market testing and have not only found product-market fit but have had this validated through early traction with your product.
The metrics that demonstrate early traction include number of customers, customer growth, revenues, revenue growth, churn percent, engagement, and other related values.
Knowing who your customers are and the metrics surrounding your customer acquisition is important. Here are some questions that typically come up:
How many customers do you have?
What is your customer growth looking like?
What is the value of each customer (lifetime value of your customers)?
For enterprise customers, what is the average contract value?
What is the breakdown of recurring revenue vs. one-time revenue?
What is the breakdown of return customers?
Do you understand your customer acquisition cost (CAC)?
What is the CAC by channel?
Is your CAC scalable?
Are you currently securing customers via word of mouth?
Do you understand the true cost of onboarding new customers at scale?
What is your LTV:CAC? (This demonstrates the return on investment from your customers.)
What are your churn rates?
Demonstrate a growth story. A forecast financial model is essential to quantify how the growth story is expected to play out. And while you don’t need a detailed, long-range forecast (as startup growth is by nature unpredictable), you need to be able to demonstrate a pattern for growth and expected future revenue with projected operating costs. The capital that you are seeking to raise should also be included as part of your financial forecast. In many cases, you may need to create a few potential scenarios for your forecasts.
Here are a few questions that may come up during the due diligence:
Are the growth rate assumptions sustainable?
What does your P&L look like?
Revenues: is it really a true representation of recurring revenue? Or is it one-off revenue?
What do you have to spend in order to grow your revenue?
How much capital will you need?
What is the expected return on the capital?
What are your projected gross margins?
Have you modeled the relationship between marketing/sales spend to customers to revenues?
There has been plenty in the press regarding tech companies that are unprofitable and have sought to grow at all costs. So, depending on the company and industry, there may be more or less of a focus on unit economics. But, showing that your unit economics are improving will generally be an important part of the march toward profitability and matter to your overall narrative.
Use of funds
As part of your narrative, you should have an ask. This section highlights what you are hoping to raise, and how you envision spending that money. For this conversation, you should revisit your growth strategy, and ensure your ask aligns to your strategy. Provide clarity about where the funding will be used. Some important questions to consider:
Are you planning to enter new markets?
Are you launching new products/services?
Are you investing in research and development?
What is your plan for increasing headcount?
How does your increased expenditure impact growth?
Your model should demonstrate a relationship between sales staff, sales funnel conversion, marketing spend, and increased revenue. That way you can demonstrate that investment in headcount on your sales team will lead to increased revenue.
This may sound intuitive but run through the exercise to quantify these elements, so you know how much money to ask for, where to spend it, and be confident that with that investment you can reach the milestones you are projecting.
Investors will also be interested in understanding what you did with previous funds raised (if any). Did you invest it where you said you were going to, and were you able to achieve the milestones you set out to achieve with the money?
Understanding your company’s cash use is paramount for survival. Many startup founders initiate their fundraising process around the time when their cash reserves run low. Some decide to fundraise only because cash is running out. Don’t do that.
You should be initiating the fundraising process when your metrics have reached compelling levels for investors. The best way to ensure that you can do this is to closely monitor your cash reserves. Make sure that you are not in a situation where your cash reserves are low because there is always the chance that your round does not close in the timeline you set aside. Go out for funding before you really need it and make sure that you have enough cash in your bank account to weather unexpected delays.
There are a couple things that you will want to closely monitor related to cash:
Cash burn: How much are you spending on a monthly basis? And, where is that cash being spent? Analyzing this will help you identify areas for potential savings if things get tight.
Runway: This is calculated as cash in the bank / monthly burn. Your runway is the best window into how long you can continue to operate before you run out of money. We typically suggest that you have at least 6 months of runway left when you start the fundraising process.
Know your numbers
The narrative you present to investors is crucial to your fundraising efforts. The financial metrics that succinctly and clearly illustrate your company’s traction and business model will underpin this narrative, providing the backbone to hold your company up against the scrutiny of the fundraising process. Know your numbers and showcase the most relevant metrics to compel investors to invest.
Runway from LTSE is a free, visual tool to help understand, manage and extend your cash runway. Learn more at startuprunway.io.