Financial Metrics for Startups
Take, for example, revenue growth. At a large company, you’re likely focused on yearly revenue growth. At a startup, you measure sequential growth over a monthly or weekly time period. And for good reason – given the power of compounding, hitting 10% monthly growth targets will create a 3x larger business within 12 months!
How Finance Professionals Create Value
The start of our careers are marked with executing tactical tasks such as weekly or monthly management reporting. Over time, finance professionals set themselves apart by becoming leaders and informing business and product strategy. To do this you’ll need to understand the right financial metrics for your business. There are clear differences between how large companies measure financial metrics vs. the tools you need to grow a startup.
Large Co. vs. Startup Financial Metrics
The Two Metrics That Matter: CAC / LTV Ratio and Cash Burn
1) The Fundamental Law of Growth
Most tech B2B or B2C startups (with some notable exceptions) must eventually obey the Fundamental Law of Growth which has generally been accepted as LTV/CAC > 3. The LTV/CAC ratio speaks to a startup’s revenue trajectory, capital needs, and in turn, how much “irrational exuberance” is demanded of its investors. The lower the LTV/CAC ratio, the less efficient a company is at deploying capital and the more capital it needs to sustain itself and its growth objectives; conversely, the higher the LTV/CAC ratio, the more value it creates for the same amount of capital. Empirically, there are reasons that 3x is roughly the minimum threshold needed to build big, sustainable businesses.
2) Cash Is King
“In some sense, the negative free cash flow will be an indicator of enormous success.”; Reed Hastings
Reed Hastings believes that Netflix’s negative free cash flow (-$2.5 billion expected for 2017), a result of investing in a tremendous library of content, will lead to the company’s success over the long-term. Most startups operate with the same philosophy but fail to realize that they are unlikely to duplicate Netflix’s track record for 20+ years (100 million subscribers!) and access to the debt and equity markets (for now). So what does that mean for a startup that’s currently burning through cash every month? Essentially, when you are in a cash burn (FCF negative) position, a company has to rely on investors (or in rare cases, banks) to fund the next few years of its life.
Both of these concepts are extremely important and over my next couple of posts, I’ll talk about how as a finance professional, you can tactically identify these two metrics as ways to improve your company’s value.