Your startup may have a high rate of growth, but is it financially healthy?
Even if you have great revenue, these top-line numbers can be superficial and don’t tell the whole story.
Investors, potential buyers, and lenders often look deeper. Especially investors, who are looking for the right opportunity which involves specific criteria. Primarily things like:
- Growth potential (market penetration and product expansion)
- Exit strategy (possible sale)
- Return on investment (of course)
That said, one ticking issue is either going to allow them to move on to the rest of your pitch deck or unfortunately on to the next potential investment. And that’s the financial health of your company.
Four key metrics paint a picture of financial health, for you and anyone who needs to know. Here, all four are covered, along with tips and resources to improve each.
1. Cost of Acquisition
According to Investopedia, cost of acquisition is “the total expense incurred by a business in acquiring a new client or purchasing an asset.”
“Total expense incurred” means exactly what it says. The more accurate your accounting practices, the easier it is to calculate your acquisition cost. Finding all of the line items that go into getting someone to say “yes” is much easier with carefully kept books.
Common acquisition spend items
- Advertising/marketing: PPC, social media ads, and marketing materials (e.g. content production) are all part of the marketing process. Any dollars spent to draw in potential customers should go into your acquisition cost.
- Sales team: Salary, commissions, and benefits of your sales team also adds to the number. A couple of great metrics to track here, as well, are revenue per rep and margin per rep to see how well your sales team is performing.
- Cost of leads: How you acquire leads differs. B2C is likely more from social media and B2B may be purchasing the contact data. Lead gens cost may also come organically, too (word-of-mouth, SEO).
2. Customer Retention (Churn)
If your startup is on a recurring revenue model, you understand the term “churn”. It’s the percentage of customers leaving in an average timeframe (e.g. “monthly churn” at the company is 10%).
A company with 10% churn completely turns over their client base every 10 months (10% X 10 months = 100% of clients).
Subscription-based E-commerce, subscription-based content, and SaaS companies looking for investors must focus on churn. High retention (low churn) of your users is an indication of lower risk for investors.
3 ways to reduce churn
- Engage Your Customer: improve onboarding and implement programs to help your customer understand the benefits of your products/services. Once someone pays for your product or service they need to reach an “aha!” moment as quickly as possible. The moment the customer identifies value, they are likely to stay much longer.
- Service Your Customer: A complex software or a recurring product/service subscription needs highly-trained reps ready to help field questions and handle certain issues. Live chat, email and even phone support allow for your customers to get the help they need and stay with your service/product longer.
- Analyze Your Customer Churn: Ask for feedback via survey, email, or direct phone call.
Further reading: Check out more than a dozen examples of “aha!” moments from real SaaS companies.
3. Lifetime Value
The next step is to determine, again on average, how much each customer pays you for the life of their account. This is the lifetime value (LTV). A quick search will tell you, there are a number of different formulas, constants, and methods to get to your number.
It’s not terribly difficult to come up with your own.
- Calculate the revenue/expenses
- Choose your constants
- Run your equation
An LTV example
An incredibly simple formula is to take your average income from a deal/recurring client. Then, multiply by the average amount of time the client stays with you.
If a SaaS company charges $200/mo for their product and the average client hangs around for 3 months — the LTV is $600.
Again, this is a ridiculously basic equation. There are a number of other factors to include that will make the number a bit better, including:
- Churn rate (the previous metric)
- Include expenses (costs to deliver the product/services or costs that are included in your gross margin calculation)
Further reading: This monster guide shows multiple formulas and offers a deep dive into various formulas.
4. Run Rate
A run rate is essentially a forecast of future revenue based on current financial status. If you did $250,000 in the last 3 months, your annual run rate would be $1,000,000. Again, a prediction based on recent performance.
Unfortunately, many founders use this as the biggest drum to bang, when it comes to pitching VCs or lenders. Investors want a closer look under the hood, not just multiplying your last quarter by four.
It is best to utilize a fully developed model to show forecasted revenue growth. Using a financial model is a great idea for any business.
Benefits of predicting revenue
Creating a forecast allows for better decision making. And not just revenue. Factor in your costs, churn, growth rate and LTV for a full-fledged financial model. Investors will take a quick look at the projections, but you’ll be able to use the numbers to:
- Understand how quickly you need to hire (and where)
- Find costs that are eating into the metrics covered in this article
- Plot the way to profitability or improved profitability (another very important thing to investors)
Understand your numbers
Investors love to understand founders and their ambitions. They’ll pay attention and think seriously about the opportunity based on a compelling story. But as they’re listening, whether or not you know the financial health of your company will ring clear.
The data and metrics will ultimately make the difference, whether you’re trying to raise another round of funds, or even if you’re focused on maximizing growth.