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✋ Heartcore Insights
Welcome to the 106th edition of Heartcore Insights. Curated with 🖤 by the Heartcore Team.
If you missed the past newsletters, you can catch up here. Now, let’s dive in!
Metrics That Matter – Three Analyses for Startups and Scaleups to Track on the Path to Profitability
The rallying cry among the tech community in 2022 has been a shift from growth at any cost, to an increased emphasis on profitability.
Metrics which provide helpful diagnostics for startups:
1) Cash Burn Efficiency: if you are earning an incremental dollar of total Net New ARR for each dollar of cash burn you are in a strong position with a Burn Ratio of 1, indicating a healthy ratio relative to benchmarks. A Burn Ratio greater than 1.5x is best in class and below 0.6x Net New ARR to burn indicates that a closer look is warranted.
2) Incremental Profit Margin: often profitability is discussed in absolute terms but it’s important to keep in mind that companies typically show a progression towards profitability. One way to analyze this is to analyze the Incremental Profit Margin - at what rate revenues are converting to Operating Profit. Anything at or above 40% is best in class and anything at or above 20% is beginning to look healthy. It’s worth taking a very close look at your cost structure if your Incremental Profit Margin is trending at 10% or lower.
3) Pre-S&M Profit Margin: if you have a highly retentive product, Sales & Marketing (S&M) costs could be considered an investment in future growth and a variable expense as opposed to a fixed expense. One helpful metric to analyze cost structure is Pre-S&M Profit, which takes Operating Profit Margin and adds back Sales & Marketing Expenses. This tells you how much margin you have before making the decision to invest in Sales & Marketing. A Pre-S&M Profit Margin of approximately 20% or higher can be considered quite healthy because it means your company has the adequate budget to invest in S&M. 40% or higher would be considered best in class.
Discussing a bridge round/extension is one of the most challenging conversations between founders and investors. To get to that answer of a yes or no on a given bridge, many investors ask themselves (and often the companies) a subset of the following questions.
Is the company still going after a venture-scale outcome?
A venture-scale outcome is a company with a path to reaching $100M in revenue with good margins in the next decade. When the initial investment is made, most investors believe the companies they invest in can hit that target. Over time, investors and founders learn a lot about the probability of achieving that outcome.
Deciding not to pursue the venture-scale outcome shouldn’t be seen as a mark of failure though. Sometimes the market timing is such that it will be very difficult to create a company of that scale in your category. This does not mean that you should quit; there might be a sustainable, profitable business to be built or a smaller outcome available to the founders.
What’s the rationale for the extension?
Extension requests where the rationale boils down to the company wanting to keep going, largely on the same trajectory, with the same strategy, same team size, and the same burn rate fail to generate investor interest. A strong bridge financing ask paints a clear picture of what the company will do with the money that will change the company’s trajectory and answer some of the big outstanding questions about the business.
How much progress did the company make with the capital invested to date?
Did the company fail to achieve the milestones it set out initially? Or did they mostly achieve what they set out to do but find themselves in an unfriendly fundraising environment where investors have higher expectations for performance? From the investor’s point of view, it can often be difficult to believe that a company that was not efficient with the previously invested capital will become more efficient with the next tranche of investment.
Is this bridge coming on the back of a failed fundraise?
Bridges or extensions that come on the back of a failed fundraise are difficult decisions. The challenge for investors is figuring out whether the reasons why the company failed can be rectified with more time and resources or whether investors have identified a fatal flaw in the business that will continue to make it difficult to finance. In many cases, founders believe that more traction or progress is what’s needed to unlock the next round. But in many cases, investors can deduce other reasons why the fundraise failed and conclude that there are bigger issues at work and that more traction or progress is unlikely to change the decision the next time the company goes out to fundraise.
a16z guide to growth metrics
The Difficulty Ratio
The Most Common Go-to-Market Questions
How Notion Used Community to Scale to 20M+ Users
Learnings exploring the GPT/ LLM space
Uncovering Anti-Retention Patterns
Hustling to Save the Planet at Lowercarbon