Growth vs. Efficiency: How to Weatherproof Your SaaS Startup for Tougher Times | Christoph Janz

What I'd like to talk about today is growth versus efficiency and how to weatherproof your startup for, for tougher times. But really, really quick intro about what we're doing at Point Nine. We're an early-stage venture capital firm. We've been around for about 12 years. We focus on SaaS investments at the very earliest stages, and we invest in startups from pretty much all over the globe, mostly in Europe, but also in the US, Canada, and other countries. So we're very geo-agnostic. And if you haven't heard about PointNine yet, you've probably heard about some of the companies that we've been an early investor in, such as Algolia, ChartModule, Incident.io, Loom, Typeform, Zendesk, and many others. So the topic that we, that I'd like to talk about today is growth versus efficiency. In these tougher times. And I'm sure you had— you heard a lot of talk about this already, a lot of VC advice on Twitter and elsewhere. I hope you're not sick and tired of talking about this yet, but I'll try to avoid the very generic advice like everybody needs 5 years of runway, because I think it's great if you can have 5 years of runway, if you can be default alive, but it just doesn't work for every company. And so I'll try to to take a closer look at the balance between growth and efficiency, and we'll dig into that. So a few months ago, I wrote a blog post titled Hypergrowth is Great, But Don't Die While Trying. I'd like to start by quickly walking you through the key concepts of that blog post. I try to do it as fast as possible because you can look that up online. And after that, I'll talk a bit about what investors are looking for in 2022 based on some surveys that we did and some other benchmarks. Then I'll dig into some metrics that you can use to measure growth and efficiency, and then there will also be some time for, for Q&A. All right, let's go. Um, a question for you all: who of you has been in a situation where things were going well, you were growing fast, you were crushing it, you were getting calls from Tiger. Your VCs probably told you that you should burn money faster. And then just a few months later, things look drastically different, drastically worse. Your growth rate has tanked, your runway got very short, you started to get nervous about the next financing round. Does that sound familiar to everybody, to somebody here? Put your hands up. Oh, awesome. It's awesome to see some honest people in the room. Let's try to dig in a bit deeper here. To sort of unpack how that, how that can happen, and ideally how you can try to avoid that next time. So how come companies can go from boom to bust sometimes in a matter of months? That's the, that's the question. So if you suddenly find yourself in a much worse situation, it's probably because two things happened. Number one, your growth rate went down, and number Number 2, you kept spending cash according to your original plan. So this is what typically happens, or at least one of the reasons that can lead to like shit basically hitting the fan. And if we try to understand this formula a little bit better, slow growth plus high spend leads to higher burn, shorter runway. You have less ARR, less investor interest, so you have to raise your next round earlier. You have to do have to do it with a lower level of ARR, you have to do it with, with less growth. So that's a pretty bad formula. And in a red-hot VC market like the one that we had until last year, um, you can probably get away with this. But in a much, much tougher market like the one that we entered this year, this is a formula for disaster. In the best case, you'll raise at a much lower valuation than you expected, and in the worst case, you might literally go So let's try to dig in a bit deeper into the metrics of an imaginary SaaS company to get a better understanding for how this formula can work out. And again, I'll run through this pretty quickly because you can also look this up online if you want to look at all the numbers. So what you can see here on the screen is the ARR projection of ACME. Of course it's called ACME. And ACME is at $4 million in ARR. The company has raised $12 million, wants to use that to triple ARR to $12 million in 12 months, and then grow another $7 million to $19 million in ARR in another 6 months. You can see the ARR projection here. And here you can see the projection for incoming cash, the green bars, outgoing cash, the, the red bars, and then the, the red line indicates the net burn. And then here on the top right, you can see what that means for the bank balance. And according to ACME's planning, they are in a pretty comfortable situation, have an ambitious plan but 18 months of runway. So that's looking pretty good. Now let's fast forward, um, 6 months and see how ACME has been doing. So the company has grown in those 6 months from $4 million in ARR to $6.2 million, which is pretty awesome. It's not quite as fast as expected, but definitely pretty respectable growth. You can see that there is a tiny little difference between the plan numbers and the, and the actuals, but it's not a big difference. Here are the updated cash charts and the updated bank balance. So it all looks pretty good. But nevertheless, the, the founders, the management team of Acme is smart, so they take a closer look and decide that they should do a forecast, a reforecast, based on the slightly lower growth. So the company had projected to grow 9.6% month over month, which corresponds with a 3x growth ambition that I mentioned earlier, but they actually grew only 7% month month over month. So they do a new forecast based on that. You can see the dotted line here, and you can see here what it means to the cash flow projections and ultimately to the bank balance. And what you can see here is that if the company keeps spending according to the original plan, um, but keeps— keeps growing revenue as per the trend of the last 6 months, it'll run out of money in 7 months. So it's pretty dramatic. What? The company started with 18 months of runway, 6 months later, ACME has only 7 months of runway left? What happened there? So there is a very simple answer to this, and it's the company was burning too much, it didn't have enough buffer. That's all very true, but nevertheless, let's dig in a bit deeper to see what maybe the founders could have done to detect that even earlier. One of the issues, and it's, I don't know if it's too obvious to even mention it, but it's, there are definitely, I've definitely seen people get this wrong, is that if you look at the total ARR figures and compare the actuals to the plan, the difference is not that visible. You can see here, on these charts here, if you look at the difference between the dark, darker green and lighter green bars, which show like the targets and the actuals, there is a small difference, but it definitely doesn't look dramatic. But if you then plot a chart for net new ARR, which is like the net new that you keep adding every month, and it's a much, much more visible difference. It's, it's the same underlying numbers, but depending on which of these metrics you're looking at, it becomes much easier to spot that difference. And another way of looking at it is, is this. Again, it's the same numbers, the numbers from the charts on the previous slides. And here it shows the goal achievement percentage. And if you look at ARR, all of these goal achievement percentages are 90%, 95%, 100%. So you could easily easily fool yourself into thinking that you're hitting your plan and that everything is in the green zone. But if you look at the net new ARR goal achievement percentage, you can actually see that you're at much lower values—60%, 70%, 80%. And so with that simple trick of making sure that you always keep a very close eye on net new ARR, you might be able to detect, or you will be able to detect, significant deviations from that plan much earlier. Now I hope you are all focused on the right metrics and adjust to changes quickly, but let's also talk about the case when things aren't going that well. So when you're kind of a bit, a bit too close to that iceberg and try to navigate a tougher situation. So As I said in the very beginning, I think there is no one-size-fits-all answer. If you're planning to be default alive, which is a great goal, it might, depending on your situation, lead you to underinvest in product and R&D, sales and marketing. So the consequence of that might be that you sort of, you don't fail quickly, but you also don't succeed. It's really important to look at the very specifics to determine what you could do to increase your runway if you want to increase your runway or if you think you have to increase your runway. I think there is a great concept which was recently popularized or coined by David Sacks, the founder of Yammer and other companies and investor at Kraft Ventures, and he calls it default investible. And then what that means is that you should always be in a situation where you are not necessarily default alive. You probably need another round of funding, but you have high conviction that by the time you are at the end of your runway, you are in a good position to be raising. So you think about like, where am I going to be in 9 months, for example, if you have, let's say, 12 months of runway. And you think about like, what is my most likely situation going to be? And is that aligned with what investors are looking for in this current market? So let's talk about what makes a company investable. And this is actually a question that we've been looking into for a number of years. And then we always try to capture a lot of data and investor sentiment and all bring this on our SaaS funding napkin, which actually exists in physical form. You might find some of them lying around here at this conference. Investors look at a lot of different things, various kind of metrics, growth, logo churn, revenue churn, net expansion, efficiency metrics, and many other things. And they obviously also look at a lot of more qualitative factors like your team, your product, the competitive situation. And again, like, we try to capture all these things on, on that napkin. Investors always had and probably will always will have very high growth expectations. What you can see here are some numbers from Bessemer Venture Partners, very large data set of cloud portfolio companies. This is data probably going back at least 10 years. And what you can see here is that the average company in Bessemer's cloud portfolio has been growing about 3x between 1 and 10 million ARR, and still roundabout 2x or even more than 2x above 10 million ARR. So that's a pretty, pretty high bar, I would say. And these numbers are not necessarily a snapshot of the current market. It's— these are benchmarks collected over, over many years, but it actually hasn't changed that much, at least based on everything we were able to find out by talking to a lot of investors and having 100 or so or maybe 80 investors participate in our SaaS funding survey earlier this year. The takeaway for us was that at the Series A, to get investors excited, you still need to grow 2 to 3x and probably still the same at the Series B. Maybe there are some exceptions, but generally I would say that the growth expectations, they, they remain very, very high. In that survey that I've mentioned, we also asked investors specifically what matters in 2022 and then asked them to tell us what matters more, what matters less, where do they see no differences across a couple of different categories or aspects. And as you can see here, only 11% of the investors that participated in that survey said that revenue growth is less important in 2022 2022. 26% even said that it's more important in 2022, and the rest of them said that it doesn't— there is really no difference to, to previous years. What's new though is that there is a very, very strong new focus on efficiency. Um, in, in the last years, and especially in 2020 and 2021, there's been so much money in the market driven by like macroeconomic factors and probably a lot of things that you already know and others have already talked about, that investors were quite happy to fund growth at pretty much any cost. This has definitely changed, and it's also visible in, in that survey that we did here. And more than 80% of the investors from that survey said that efficiency, capital efficiency, is more important in 2022 than in previous years. The rest said no difference. And there was nobody who said that it's less important. So you might be looking at this and thinking, wait, investors want the same or even more growth with less capital? And if you think that somehow sounds a bit like a Dilbert comic, it's because there actually is a Dilbert comic saying where the guy says, we have to learn to do more with less. It's probably the reality of a financing landscape where there are— where the costs of capital have increased. Investors can be more, more picky, and trying to achieve more with less is probably what, what many founders have to achieve in these days. When it comes to measuring efficiency in SaaS, there are two metrics that I think are particularly important. Excuse me, um, one is the burn multiple, um, which you might have heard about and which I'll talk about a bit, and the other is the CAC payback period. The burn multiple basically tells you how much capital do I burn, how much do I have to raise in order to add $1 of net UARR. It's a very simple formula that helps you measure the capital efficiency of the entire company in a very holistic way. As a rule of thumb, for earlier stage companies below $25 million ARR— it's probably not, not fair to still call them early, like, let's say early and mid-stage company at less than $25 million ARR— 1 to 1.5 is generally considered to be good or very good, and then lower than 1 is, is great. And I'm going to show some more detailed benchmarks on that in a second. It's important to keep in mind that in the very early days, it's totally, it's totally normal for that multiple to be higher because in the beginning, you of course have to invest in team building, R&D, you have a lot of upfront costs, and you're not bringing in so much revenue. So the denominator in that formula is obviously very small in the beginning. So it's, it's very natural that companies have a higher burn multiple early on. And it's also okay, at least in my view, for the burn multiple to be higher at certain times, like when you've just raised a lot of money and you have a lot of runway and you invest. And obviously it means that you have to, like, have— invest ahead of time and ahead of revenue coming in. So for— there are periods in, in the life of a company where your burn multiple will probably go up, but it's important that you have it under control because By the time you have to raise again, this is one of the things that investors will look at very carefully. Because if you ask somebody to invest $20, $30, $40, $50 million into your company, they will try to understand what is it that the company will achieve with that money. Just to share a couple of benchmarks here, this data set comes from Andreessen Horowitz. And you can see the typical numbers that they can see here in their portfolio. Portfolio for different revenue bands. And as you can see, the median for them in the $0 to $10 million ARR range is 1.6, and then it goes down as you, as you get bigger. But you can also see that there is quite a big variance between the top quartile, meaning the most efficient companies in their portfolio, and the median and the bottom quartile. Tile. There are some interesting benchmarks from Scale Venture Partners who broke this down in a more granular way. So you can see what a typical burn multiple looks like for a company below a million in ARR, 1 to 2.5, and so on. And again, like, what's very clear and it's also quite logical is that you start off with a pretty high burn multiple and then you have to make sure that it goes down over time. You might be wondering, why does it actually matter? Like, why do these benchmarks from other companies, like, why does it matter? Like, why is it actually relevant for me and for my situation? And to maybe answer that question, I did a simple calculation where I showed like the evolution of the cap table table for two companies, imaginary companies obviously, based on a couple of assumptions. And it's probably a bit too small to— for you to read. I can share the slides later on if anybody is interested in. The takeaway here is that if there are two companies growing from zero to about $100 million in ARR, one of them has a burn multiple of 4, the other one has a burn multiple initially starting at about 3 and then decreasing to about 0.75, then just because you have to raise so much more capital if you're inefficient, the founders end up with approximately 2 times the equity in the company compared to the less efficient company. And this is just based on like the fact that you have to raise more capital. It doesn't even factor in the, the fact that if you are less capital efficient, you probably won't get that high valuation, and maybe you're not even able to, to raise at all. So It's— this might, I don't know, maybe explain more from a first principles kind of thinking way to why this matters. It's not just like because others in the market do this. There is, there is a fundamental reason why capital efficiency is important. Now moving on to CAC payback period, which is the, the other equally important capital efficiency metric that I mentioned and would like to to explain a little bit more. What the CAC payback period tells you very simply is how long does it take to earn back my sales and marketing spending. If I invest a dollar in sales and marketing, how long does it take until that has flown back in gross margin to my bank account? It measures sales and marketing efficiency specifically, so it doesn't replace the burn multiple, which takes into account the entire spending of the company. It's much more focused on the efficiency of your sales and marketing operation. As a rule of thumb, if you're selling to enterprises, you have a long customer lifetime, you might have a net dollar retention rate or NDR of 100% or maybe even more. 15 to 18 months of payback is probably okay, probably quite good. You might even want to accept more than that depending on your funding and depending on like how big your NDR is. There are companies with 120, 130, maybe even 140% in net dollar retention. And if you're in that lucky situation, then it makes sense to spend a lot on, on each and every customer. If you're targeting SMBs, you will likely have higher churn, and in these cases you should aim for something closer to 12 months or less. But obviously it depends, so these are just some, some rules of thumb. Now when you take a closer look at what CAC payback actually means, it starts to become a bit complicated because there are various definitions and various ways to look at customer acquisition costs. It's important that when you talk about CAC with your team or with your investors or new investors, you make sure that everybody talks about the same thing when they use that term, because there are various ways of calculating that, that metric, and they are not right or wrong, they just mean different things. For example, you can look at it in a blended way, which takes into account all of your customers, or you can look at paid only, where you exclude include the customers that you get from organic sources or inbound word of mouth and so on. I generally think that the paid-only way of looking at it is more useful because it tells you what you really want to know usually, which is like, if I add another dollar or another million of dollars, how many customers will I get? So that's usually the more interesting and relevant question, although it can become tricky when the attribution isn't so clear. So that's probably a topic for another day. Another way how you can look at CAC payback in different ways is that you can include your entire sales and marketing spend, and if you're at a certain scale, this is what you should do. But if you're early stage and you do a lot of marketing experiments and maybe 80% of your AEs are not yet ramped, then you may want to exclude some of these one-time costs or temporary costs or experimental things and try to figure out what's the CAC at scale or in a steady state. I think that's a pretty useful way of looking at it if you think about the future. It's also a bit risky because you make some assumptions which may or may not be true. And lastly, another two ways how you can look at CAC in different ways is that you can take the accounting lens cents, which tells you something about the profitability of your customer acquisition, again, more at scale. But you can also take the cash-based view, and that might be very different, and it might be more relevant if you have limited runway and you're wondering what kind of sales and marketing investments can I actually afford. So when you look at it in cash terms, you have to think about, I hire this AE and I might have recruiting costs, and then it might take 3 months for him or her to be and then it might take another couple of months for them to bring in significant revenue. And then you have to think about how long does it take to collect that revenue, which depends on your billing cycles and all these things. So the cash-based view might be quite different from the accounting-based one. Now the last thing I want to talk about before we hopefully still have a little bit of time for questions is this two-time 2 matrix. If you put CAC payback period and burn multiple on this 2x2 matrix, I think you can draw some interesting conclusions, especially if you are in a situation where you need more runway and you have to think about where do I cut. If you are in this top left part of the, of the chart You have a good burn multiple but poor sales efficiency. So obviously, I guess if you are in that situation and you need to find some places to cut, you should consider cutting your sales and marketing spend because sales and marketing doesn't seem to be very efficient. And actually, even if you have enough runway, I would consider cutting back on your S&M spend in this situation, or at least not adding to it, because if the sales and marketing engine isn't really working well it probably doesn't make sense to put in more gas into that tank until you manage to make it more efficient. If you're in the opposite corner, it's the opposite. You have a great sales efficiency but a high burn multiple. So if you're in that situation and you need more runway, it's probably a big mistake to cut your sales and marketing costs because the payback is so quick that it might actually decrease your runway if you don't spend on sales and marketing. So if you're you're in on that part of the chart and you have little runway and you want to increase that, you should try to find ways to reduce costs in other areas that R&D and DNA most likely. Now if you're in that part of the, in that left and bottom quadrant in that matrix, it means you have a high burn multiple, low sales efficiency, not a great spot to be in, to be honest. It can be okay temporarily to be in that, in that situation when you've just raised the round and you just have a lot of upfront costs and front-loaded costs. But as I've mentioned before, this can't be a permanent situation. If you are getting towards the end of your runway and you have to raise again, you have to try to move towards the green areas in that matrix in order to be a better or more easily fundable company? If you're in the top right corner, congratulations. So really quickly, the, the takeaways: you can have an ambitious upside case, but I think you have to be really careful when it comes to planning your, your budget and your runway. If you project exponential revenue growth and spend money based on that, that's super risky. As I showed in the very beginning, if the growth just happens to be a little bit slower than you expected because of this compounding effect of exponential growth, there might be a pretty big gap pretty, pretty quickly. What you should do is keep a close eye on net new ARR, be super fast to adapt, and consider having a burn budget. I think that's a term that I've learned from Jason M. Lemkin, which I like a lot. And what it means is that you set a certain dollar amount that you and your team can burn in for each given month, and you basically, you just don't exceed that. So instead of, kind of make sure that you don't spend ahead of revenue, but you only increase your spending when revenue actually comes in, and that kind of ensures that you live long enough. Takeaway number 3 here, If you have enough cash, it's okay to have a higher burn multiple for a few quarters, but you have to watch your steady-state customer acquisition costs. If they aren't good, don't pile in more cash. First, like, build or fix the engine before you add more gas into it, and then make sure that you are investable again by the time you have to raise again. So remember this default investable concept. Concept from David Sachs. Number 4, depending on your burn multiple and your sales efficiency, you may want to move budget from G&A and R&D to sales and marketing, or the other way around, or reduce costs across the board if you need more runway. It really depends on, on where you are. And the, the final takeaway here is that if runway is tight, cash really is king. So you have to think about how long does it take for a new AE that you might consider to hire to pay back his or her costs in cash in the bank. And it might be very different from what you have in your spreadsheet. Thank you very much for listening, and I think we still have 10 minutes or so for Q&A.

So this is, this is all great for a post-product market fit company, like, you know, isn't like Series A, Series B, and trying to grow. What would be your recommendation for a pre-product product-market fit more likely in seed stage, especially in this market, compared to last year?

Yeah, I think for pre-product-market-fit companies, I would say it's always been true that you should have a pretty small team because it's unpredictable how long it's going to take to get to product-market fit. And adding more people doesn't necessarily get you there faster, right? You probably want to build the most effective, most efficient efficient engineering team, which I know maybe it's 5 to 10 people, but definitely not 20 or 30, because you just need time. It might take you a year or 3 years to get the product market fit, and you just want to make sure that you survive long enough. And I would, I would have said this a year ago and 2 years ago, but now it's probably even more, more important because it might be even harder to raise more money in the current environment if you don't have pretty strong signs of product market fit.

And how much runway would you recommend for a, for a pre-product market fit company to aim for?

I guess it depends on the type of product and the R&D that is required, right? Like, there are maybe some, like, some ideas where you have an MVP in, in 3 months, and then maybe 12 months is fine. But if it's a technically more challenging project, then it might take 2 years just to build a prototype. You'll need much more. So, but I would say the more the better, right? Because getting from nothing to product market fit, in my experience, it's really unpredictable because you're— it's kind of like inventing something, and this is by definition something new, otherwise it wouldn't be an invention. So I think the more time you can give yourself, the better. Makes sense. Thank you. All right, I don't know if there are any other questions. If not here, I There are a couple of bonus tips to increase runway if things are really tight. I'm not going to read all of them to you, but I think you'll find the slides online, or you'll maybe find it on YouTube, or you can email me at christoph@pointnine.com. You'll also find me on Twitter or LinkedIn. So if you'd like to dig in deeper into any of this or would like to get the slides just let me know. Thanks again for coming here and for your attention, and I hope you enjoy the rest of the conference.