Editor’s Note: Joe Floyd is a venture investor at Emergence Capital. Emergence focuses on enterprise cloud applications and has invested in market leaders including Yammer, Box, Veeva Systems and Salesforce.
Questions about cash burn have blazed through Twitter like wildfire. Entrepreneurs are asking us: How do I know if I am burning money too fast? Unfortunately, there is no one-size-fits-all answer for an entrepreneur on what level of burn is appropriate for their startup. However, every entrepreneur should consistently assess their runway and revise spending against their strategic goals.
I have designed this short quiz to help enterprise cloud startups analyze their spending levels. It’s critical to monitor your company’s burn rate so you can make those quick adjustments to increase your chances of success.
Select the answers below that best describe your company.
1. Market Dynamics: Does your market have network effects?
a) Each sale is independent. If we sell to one customer it does not impact the likelihood of sale to another customer.
b) Economies of scale are important in our market and we believe that only three or four solutions will achieve scale. Early movers have a small advantage.
c) Every new customer increases the value of our product and becomes a source of new potential customers. Early movers have a major advantage.
2. Competitive Intensity: Who are your major competitors?
a) We are in a dogfight with a number of well-funded startups and large incumbents. Our sales team consistently sees competition for new customers, and we win as often as we lose.
b) We are competing with one or two large, entrenched companies. Our sales organization sees competition more often than not, but we win most of the time.
c) We are carving up a green-field opportunity. We sometimes face competition for new business but it is usually from consultants or internal teams building custom solutions.
3. Customer Retention: What is our churn?
a) We estimate that we turnover 1 out of every 4 customers each year. We haven’t really started tracking churn yet, but I would guess that our net annual MRR churn is ~20 percent.
b) We track churn and we know we retain 85-90 percent of our customers annually. We have increased our average sales price by 10 percent over last year. We also have a customer success team that upsells our most engaged customers, so our net annual MRR churn is only 10 percent.
c) We track each cohort of customers on a monthly basis and our customer success team excels at deploying new customers quickly and getting them engaged. We have negative MRR churn, and each monthly cohort continues to grow over time.
4. Sales and Marketing Efficiency: What is the return on every dollar of sales and marketing spend?
a) We spend $1 – $1.5 in sales and marketing for every dollar of total bookings (new and renewal). We do not worry about gross margins because we know they will increase with scale. We collect some contracts monthly, quarterly and annually.
b) We achieve a 1:1 ratio of sales and marketing spend to new annual contract value (ACV) bookings. We analyze customer acquisition costs (CAC) by channel, and we tend to payback CAC with gross profit in 9 – 12 months. We try to get cash payment up front for annual contracts.
c) We consistently receive $2+ dollars of new ACV bookings for every dollar of sales and marketing spend. We optimize CAC by allocating marginal spend to the highest performing channels. Gross profit pays back CAC in less than 6 months consistently. Our customer success team is deploying signed contracts quickly, and we always collect cash up front for our contracts.
5. Fundraising Capability: Who is in your investor syndicate and how easily can you add new sources of capital if you need to fundraise quickly?
a) We have a group of angel investors or constrained institutional investors. It feels too early to pursue debt. We are heads down focused on sales and product right now and we will think about the next fundraising when we need to raise more money.
b) We have one institutional lead investor with dry powder, and we think we can secure a small debt facility. Our investor can introduce us to venture firms so we can start a fundraising process pretty quickly if we need to do that.
c) We have two or more institutional venture investors and we have a small debt facility with our bank that we can draw down if we need it. We keep a steady dialog going with investors that we would like to involve in future financings so we could start a process tomorrow if desired.
What’s your score?
Give yourself one point for each “A” answer, three points for each “B” answer, and five points for each “C” answer.
0-10 points: Pull the ripcord. You need to evaluate your spending immediately and consider pulling back drastically. You may be too early in a nascent market, and it would be wise to conserve capital until the market develops. You may be facing too many competitors which is forcing everyone to spend inefficiently. You may want to scale back sales and marketing while you pivot your product to find a more attractive competitive position. Lastly, you may not be able to raise additional equity if the current venture environment sours. You should look to secure a debt facility and reduce burn to give your team the longest possible runway to succeed.
11-18 points: Pump the brakes. You are not in trouble yet, but you should quickly assess your situation. If you are targeting a large enough market, then you may be justified in continuing to spend on sales and marketing even if you are not that capital efficient. However, you should drill down and figure out why you are not efficient.
Do you have a churn problem? Do you face too much competition? Do you have too many sales reps? Not enough good sales reps? Are you marketing in the right channels? Is your pricing right? Is your product truly solving a customer pain point? Once you understand the drivers of your current business, you can reduce spend in the areas that are not efficient.
For example, if you do not quite have product-market fit, then you can reduce sales. If you do not have sales functioning perfectly, you can reduce marketing spend. Lastly, you should consider raising a top up round to give yourself 18 months of runway while the venture fundraising window is open or securing a debt facility to give yourself an extra 6-9 months of cushion.
19-25 points: Burn baby burn. Your sales and marketing engine is firing on all cylinders and you have proven you know how to engage customers and keep them renewing. Now is the time to pour fuel on the fire to attack your market while there is little competition. The viral effects are strong enough to justify the investment now, and investors will reward you for your efficient growth. Remember to keep monitoring your SaaS metrics so you can adjust your spend if your business slows down. Lastly, you should consider raising additional growth equity early while the venture window is wide open and valuations are aggressive.