Startups have more things to worry about than they have time — product-market fit, whether to invest in performance marketing or not, how much inventory is too much inventory, whether to hire that staff engineer from Google, just to name a few from a list that usually runs longer than the most well-funded startup’s runway.
One thing that rarely makes this list is thinking about the balance sheet. After all, no great company was founded on the bedrock of capital efficiency. And CFOs have better things to think about (see monthly burn and runway). Does it really matter if working capital is efficient? If the startup is running a positive cash conversion cycle? If it’s capturing market yields?
For a young, pre-product-market-fit company, the answer has always been, and remains, no. Focus on product-market fit. Make customers want what you have to sell. Make them rip if off the shelves. Once you get the formula right, you can worry about capital efficiency. Until then, conserve burn, extend runway, and try to hit the witchcraft of product-market fit.
Make customers want what you have to sell. Once you get the formula right, you can worry about capital efficiency.
For a scaling company in 2020 and 2021, the answer was, “It’s doesn’t really matter.” Risk-free yields were at less than 50 bp (a bp, pronounced “bip,” is 1/100th of a percent; 50 bp is 0.5%). Why bother? So you run a bit more efficient and make a few thousands of dollars/pounds/euros. That’s one kit for a new engineering hire. Gone in a heartbeat.
For a scaling company, in Q4 2023, the answer is a strong yes. Why? Two reasons:
- You have meaningful capital at hand. Your raise probably wasn’t $5 million. Your balance sheet runs past the seventh digit.
- No matter where in the world you are, your local federal bank (whether the fed in the U.S., the BoE in the U.K. or the ECB in the EU) is paying you for capital efficiency.
These things add up, and every bit helps. Running 5% more performance ads sounds good, doesn’t it — and you can do that without taking additional risks. It is now valuable to have capital and to deploy that capital to risk-free (remember, you’re not a hedge fund), government backed securities that yield 3% to 6%.
Do this well, and you’ll make money for nothing. In fact, you’re probably doing this in your personal lives (you marvel at the nonzero “interest” that hits your bank account every month) — why not do this for your company as well?
How should the star VP finance/CFO best do this? Here are few levers to pull today.
Squeeze your working capital in your favor
Working capital is (simplistically) the money you need to sustain short-term imbalances in the flow of cash. You sell a product for $1,000 but aren’t paid for 90 days. However, the bill for a $1,000 laptop you bought is due today. Guess what, you need to “use up” $1,000 of working capital to cover the 90 days before you even out.
Even though those transactions net out, you need to find $1,000 today, for 90 days. This is working capital working against you. Make it work for you (or at least, work less against you). Extend your “accounts payables” — these are bills/invoices you need to pay. Call up your supplier (e.g., Slack, Zoom, AWS) and extend the terms of payment.
Threaten to switch. Tell them there’s more business to be had. While you do this, shorten your “accounts receivable” — get paid faster. Incentivize customers to clear invoices sooner. Maybe offer them a discount.
All in all, you want to flip the situation in our example — you’re paid $1,000 today and owe $1,000 ninety days later. Now you have the $1,000 to work for you.
Get permission from your board to buy short-dated Treasuries (or equivalent, if you’re outside the U.S.)
We just found ourselves $1,000. Left in the company’s checking account, this is not very helpful. Buy some short-dated Treasuries, and you’re making 5%+ on the $1,000.
Before you do that, though, remember to check with your board. Some boards will prohibit the buying of any form of securities, but most will be on board. After all, why not when there is a riskless 5%+ rate of return to be had.
You’ve got that board permission; now find a enterprise broker of your choice, and buy short-dated Treasuries. Remember to “ladder” up — that is, buy maturities at different dates so that you have a constant flow of principal maturing and you don’t need to sell one early.
What that could look like is buying $200 of the four-week, $200 of the eight-week, and so on. Treasuries often have minimums, so you won’t actually be able to buy $200 of Treasuries in our fictitious example, but you sure will be able to buy $20,000 of Treasuries.
Examine the true cost of capital for all transactions, make use of low-cost debt
Going back to our example, when a supplier is willing to accept payment in 90 days, they are in effect giving you 0% debt for 90 days. Compared to ~5% on Treasuries, it makes sense to use the 0% debt (you’re borrowing at 0% to invest at 5%). The same logic can be expanded to anything — say a supplier offers a 10% discount for paying the invoice immediately. What should you do? Five percent over 90 days is, say, 1.2%, which is far less than 10% discount, so you take the discount. If the supplier was offering a 0.5% discount, you don’t take that. If someone’s offering you a buy now, pay later deal at 0%, you take it all.
For debt at 12%, only take it if you absolutely have to. In a nonzero interest rate world, build this logic into every decision your startup takes and you’ll soon be collecting some real returns from across all your regular day-to-day activities.
Where does all of this leave us? Is capital efficiency the elixir to startup success? No, it never was and never will be. That’s product-market fit, and efficient positive LTV/CAC scaling.
However, using the simple principles and yardsticks described here, your company can add a little extra to its coffers, which means more product-market fit, more customers, and more growth — all for limited effort and literally zero risk.