Startup Series: Capital Efficiency

Founder: We are budgeting 300K USD from the raised funds towards marketing mostly digital media.

Jane: This is more than half of the funds you are trying to raise. Do you think for your business model and target clients (B2B) spending this amount on marketing on social media will be expedient?

This is a sample conversation I had with Start-up founder trying to raise funds. In our meeting, I could tell with some of the proposed allocation of funds, capital efficiency was a red flag. Investors are looking for pre-seed companies that can turn an investment into a 100X multiple in a couple of years but yet use the funds they raise efficiently . When startups do this they stand a chance of gaining traction, becoming profitable and ultimately yielding high return on the investment made.

Yes! On one hand, investors will likely have many failed attempts at this high-risk venture. That is why there is so much scrutiny on the capital allocation and spend. On the other hand, founders raising funds do not stand a chance if they are raising money for the wrong reasons. Seasoned investors can smell it if you are forecasting to spend your raised capital in an inefficient manner.  Let’s dive into some thoughts around “capital efficiency” .I like to frame it around two scenarios.

Where are you spending your funds.

The first scenario is spending so much on non-core-related activities (non revenue generating).  Are you spending on activities geared to the goals you have for that phase (  i.e Revenue, Profitability, Scale). Which might interpret as customer acquisition,  Increasing GMV, increased subscriptions, horizontal growth into new markets/industry etc  In the example above with that founder, being in the digital  advert space, I knew that digital media advertisement is not a silver bullet for some business models like B2B. For example, if you are targeting Mid size and large enterprise B2B clients, you are better off with a sales team or indirect sales channels rather that paid social adverts. How many times have you seen mid size/large businesses engage a product or service because of its social media adverts? That is not the best place to prospect or close those deals. While I am not here to give you a guide on marketing budget ,the agreed census is that Marketing Budget for a growing startup ( approximately 5 years and less) is higher that that of a well established company. My argument is to really check your spend allocation. Make sure it is effective and bringing returns. Is that spend giving you a  commensurate return on your investment? If  not then look for other effective ways. Spend your funds on what is truly important for the stage you are in. Spend it on revenue generating actions tied towards growth, profitability or scalability.

How fast are you spending the funds?

Second scenario is having a high burn rate especially when you do not have much runway. Burn rate being the rate at which a new company is spending its (Venture/raised) capital to finance overhead before generating positive cash flow from operations. If your are revenue generation the question you should answer;  for every one dollar your company earns, how much of that goes to growth. A good way to track this is using metrics like Burn rate, burn multiple, but also  to benchmark your startup agains cohorts or peers in your sector. A great example is when Stripe tried to raise IPO in early 2023 and investors benchmarked how capital efficient it was compared to Ayden.

Capital efficiency Stripe -vs Ayden

What is the ideal burn rate for a startup ? The truth is that factors like; are you angel funding or have a strong VC lead to the strength of your balance sheet ( Cash in the Bank) matter. Read  Mark Suster‘s  article on “What is the Right Burn Rate at a Startup Company?” When you have a low burn rate, then Investors dollars go along way when applied to your Startup capital.  If you face unexpected circumstance like the current recession triggering unavailability of cheap funds ( Zero interest funds). You stand a better chance to beat the storm.

Rule of thumb; have  a runway of 6 to 12months worth of expenses in the bank.  I know many Founders in this current economic climate cannot say the same. The recession has made Raising funds very difficult. When raising funds, investors worry when they see you do not have runway to keep you in the game. You are susceptible to financial distress .

Your can also check out my first published article on my start-up conversations : The Distribution problem.