Since the end of Q1, I’ve seen a lot of thought pieces around the internet about what founders should focus on, what VCs will look for in this new market, and what we can or should be seeing in the crystal ball of the future. The reality is, no one really knows — so we’re all clinging to our soap boxes to try to see some signal in the noise.
Perhaps this blog post is my tongue in cheek way of responding, and perhaps its just another VC foghorn, but….
I wanted to distill my advice, into three distinct “tactical” to do’s — specifically for founders who are feeling uncomfortable or fearful in this new market.
Below you will find three simple themes I communicate to all the founders in my portfolio. No sugar coating. I’m hoping some of you will find a nugget that is helpful to you in the next year.
Mitigating Fear with Planning
It’s not a weakness to feel scared in this radically new market. The pendulum seems to have swung in the very opposite direction than it was in the last two years, with very fluid venture dollars now seemingly frozen still. You are not alone in being nervous about your business, your employees or your future. But like most things, the best way to mitigate fear is with planning. I believe that saying you’re too “early” to have a financial plan is just wrong advice. Here are a few things you can do this month to get your company moving in the right direction.
If you are financially inclined as a CEO with some excel or finance experience — you can do this yourself (it doesn’t need to be fancy, I promise.) If not, there are a number of great fractional CFO services you can hire to help get you started. Even a sharp BD intern from business school who wants startup experience can be a good fit for this. So what should you do? The best short term planning device is to build a financial model/forecast for the next two years. 3 years is ideal but it may be too much of a stretch if you are still primarily a pre revenue or early product business. This planning encompasses three simple financial statements (a P&L, a cash flow statement, and a balance sheet.) The output of this financial model should be three key numbers, that should live on a post it note on your desk:
1) Stretch Revenue Goal (what can you hit if all your goals are met?)
2) Board Revenue Goal (What is the number you believe you can hit conservatively? This likely means a number of your milestones were hit, but not all.)
3) Disappointing Revenue Goal (This is the “oh shit” revenue number. A number of your milestones were not met and the team did not progress the way you had hoped.)
A few CEOs I work with never share their board revenue plan with their teams, and instead only work towards their stretch revenue plan. It is a great tactic to keep the team motivated towards a higher number, but perhaps less realistic.
Some other fun facts, to showcase a bit of silver lining amidst the cloudy market is that an IPO slowdown does not necessarily mean a liquidity slowdown — and it is still largely TBD what turn this particular cycle will take. Most analyses don’t take us back to before the post-pandemic market boom — but those of us who have been in venture for more than a decade know it wasn’t always up into the right, even during this “bull run” we’ve had. If you were a public company in the start of 2016, the market was down ~35%. As a newly minuted public unicorn, about $350M of market cap had disappeared. There was a lot of anxiety, we just didn’t complain as much about it on Twitter. By the end of the year, this drop had largely rebounded.
Still, it was clear that 2016 was the worst IPO market since the recession in 2008. But, there was 4x as much M&A in 2016 compared to the time between 2009 and 2016 — in fact, of roughly $300B of cloud market cap, 40% was acquired. That’s insane. A lot of factors are different this time around (stocks are uniformly down, vs. a few companies taking the brunt of the hit) — but it is still an important metric to know.
All of this is to say, don’t believe all the doomsday scenarios you read about. If you understand your business, plan forward, and preserve cash — a tough IPO market does not mean disaster.
Masters of your own Destiny
Once you come up with a high level revenue plan — its important to know how much money you are burning to achieve this top line plan. Most CEOs build a plan based on a net burn number (i.e. what are you burning “if” you hit your revenue goals.) This is where I believe they make a mistake. First, net burn can look inflated if you have a particularly good revenue or collections month — and second, you can’t build a burn number on your stretch revenue goal plan — because that means there’s more than a 50% chance you miss it — and rolling forward a burn plan that doesn’t align with revenue even one quarter can be disastrous.
Instead, track your team towards a gross burn number — how much are you burning this year in total (i.e. operating burn, or how much cash is going out the door)? It is helpful to measure this based on the board revenue plan number or better, the disappointing revenue goal number. That way, you’re under promising and over delivering. In the current market state, its best model out to 18–24 months of cash runway. 24 months is best case scenario, 18 months is a minimum viable scenario.
Another number to track religiously is the Efficiency Score — a take on the Rule of 40 we came up with at Bessemer in 2018. I think Net New ARR / Net Burn is decent, but an even better and more conservative way to measure it is:
Efficiency score = FCF margin of ARR + ARR YoY Growth Rate
If you’re in the $25M+ ARR range, you should be in the 70%+ efficiency score range.
The Customer Knows Best
The last and final key metric that I like to track is NDR (net dollar retention). NDR is multi faceted because you can achieve it in two ways, largely dependent on your business model and go to market plan. You can achieve strong NDR by minimizing churn: low dollar churn on a monthly basis, OR, by maximizing expansion. What % of your customers are paying more after their annual plans have expired, or even better, upgrading mid-plan for more product? NDR is especially important for me because of its ripple effect — strong NDR contributes to growth, strong working capital, and finally great customer testimonials. In fact, even in this challenging software market, some of the best performing public software companies like Snowflake and Datadog boast incredibly strong NDRs which drive up their revenue multiples. Striving towards a 120%+ NDR is a strong goal to have in this new environment. If you cater to large enterprises, pushing to the 135%+ puts you in an even stronger position.