For Aydin Senkut, the founder of Felicis Ventures, operational insight and efficiency require a closer look at capital efficiency. To that end, Senkut has developed a pair of startup metrics that examine revenue per employee and per investment dollar.
The measures have been very helpful and are “giving us stronger signals, or at least indications of what further questions to ask to get to a high confidence level,” he said. But “one needs to be very specific and careful. These things are never in isolation.”
Senkut says his efforts are a work in progress. But so far they appear to lead to a better understanding of startup performance and pricing power.
“None of these things are hard and fast rules; they are just leading indicators,” Senkut says. “They allow you to ask more questions.”
VCJ recently spoke with Senkut. An edited transcript of the conversation follows:
Q: What are the metrics you’ve developed to better understand capital efficiency?
A: The kinds of things we are measuring are revenue over dollars raised. What we want to see is, for the amount of capital raised, what amount of traction a company can generate.
We also want to measure revenue per employee. The reason it’s really important is it’s essentially a leading indicator of a company’s pricing power. If the revenue per employee is not a very high number, and it is not a static number and obviously changes over time, it could be a leading indicator of a couple things, including whether a company needs a lot of people to generate a certain level of revenue, or, even if they have product-market fit, that they cannot price the product at a premium level.
Q: How do you use these metrics?
A: Several things. Number one, none of these things are hard and fast rules, they are just leading indicators. They allow you to ask more questions.
Also, I’ve been surprised at two things. … [At] the board level, when we have conversations, I’m surprised at how subjective the conversations are. One of the things we are working on very hard is when we give advice to our companies, at or outside the board level, the advice or recommendations have to be objective. In other words, if you tell a company you have to cut burn, or you need to increase burn because you need to grow faster, that has to be accompanied with objective data so that the CEO has enough information to draw his or her own conclusions and determine his or her own path.
But a lot of the dialog or dynamics I’ve seen have been very subjective and reactive to what’s happening in the market, such as, “Oh, my God, things are going terrible, let’s immediately cut burn. No, things are going really well, let’s increase burn.”
It should be more like, “We have 100 companies in our portfolio and you guys are in the top 20 percent, or the bottom 20 percent, or you’re just average.”
I feel that kind of a signal is much more helpful because it then basically tells the CEO, relative to all the other interesting companies, where he or she stands.
Q: What is another metric?
A: I may be overly conservative, but ever since I started being on boards, I’ve been more religious at looking at cash runway. We always start by telling our CEOs that nine months is essentially a yellow flag. And six months is like an orange flag (where) let’s be very careful. I feel it is the last point [at which] you can still make adjustments and extend things a few months if need be.
After that I feel three months is a red flag. The boards have to be a lot more conservative and a lot more on the ball. Even if it is not reported, ask every CEO to report the cash runway and track it.
Q: Is capital efficiency a predictor of success?
A: It’s not like it’s a precise formula to predict which companies are more likely to do better than others. But there are some indicators that stand out and have higher correlation and, as such, more predictive power than others.
Initially we had our doubts because we have companies in different sectors and we saw that if you are [looking only] at capital efficiency, companies that have a hardware component, like connected devices or Internet of things, some of those businesses might be at a disadvantage.
But what we found, in Fitbit for example, was we thought because of the hardware angle they would not necessarily be at the top of capital efficiency. … [What] surprised us is they were. They were at least in the top quartile. They might even be higher than that.
Q: Would you say founders and investors aren’t focused enough on capital efficiency?
A: I can’t speak for other investors because I’m not tracking how they make their decisions. I’m focused on how we make our decisions.
In terms of founders, there is obviously a tendency that if they get inbound requests from 10 or 20 investors and all the investors care about is revenue growth, they’re going to react at a certain level.
What I am trying to do is come up with tougher metrics that maybe are not going to be a walk in the park to meet and will be tough to track. And obviously those numbers will be hard to optimize. But if they can do it, I feel like it is a much better indicator, and comfort for the CEO, that the company has a lot better long-term potential of success.
Q: You mentioned three months of cash runway is a red flag. Are you coming across more red flags today?
A: I am seeing a surprising number of companies that are trying to push things to the three-month mark or below the three-months mark, thinking they can just go out and raise just when they need the money and everything is just going to work out.
That is the one thing, as an investor and fiduciary, I always tell our founders, and it is always their decision: Managing the cash burn is very big deal.
Q: How do you quantify your new metrics?
A: It is still work in progress. There are some early signals that I think are indicative.
Without being too specific, one of the things we try to look for, everything else being equal, is if companies are able to generate $1 of revenue per $1 raised. That seems to be a good strong indication because there are many fewer companies that can meet that bar than companies that can’t.
In terms of dollars of revenue per employee, that’s a tough number because it could be trending over time. I think the very best companies I’ve seen, including some of the public ones and some of the very best in our portfolio, $1 million per employee is a very high bar. Very few companies get to that level. But anything between $100,000 to $1 million, obviously closer to $1 million, the indication is getting stronger in terms of the company’s pricing power and how good the product-market fit is. Now I just want to be super careful. There are sometimes companies like Atlassian or others that have low prices.