Startup Financial Roadmap
Last week I had a meeting with a great startup. The founders know their business well, and they are motivated, knowledgeable and hard working – great founders. It was a surprise for me that the picture changed when we started to discuss investment issues.
They did not understand the issues, and they had not planned. Frankly, they were quite ignorant. We talked step by step through the primer to the financial roadmap and venture capital investments. Such situations are quite common, and I decided that it would be good to write a blog post on this subject.
Let me write a short disclaimer. Valuations vary, companies are specific, and investors are of different breeds and characters. There is no one investment situation exactly like another; nevertheless, there are common factors. I would like to consider an imaginary company with an SaaS business model and analyse its life cycle and financial roadmap. I choose an SaaS company not only because our portfolio at Innovation Nest is primarily SaaS, but also because it is easy to illustrate the logic behind investments.
As we know, a startup is a temporary organisation designed to search for a repeatable and scalable business model, and in its journey a startup proves several hypothesis. The main hypothesis are as follows:
- The product works and delivers the value it promised.
- The product is really useful and customers pay for it.
- The startup is able to sell the product.
- The startup is a real business.
Let us go through these important moments in the company:
Hypothesis 1: The product works and delivers value it promises.
After several MVPs, weeks of beta tests, and interviews with dozens of customers, there comes a moment when the founders know they can prove that the product works and delivers value to their customers.
Hypothesis 2: The product is really useful and customers pay for it.
The next challenge is to check whether customers want to pay for the product. The product has to be clean, because the relationship is no longer with beta testers, but with real clients. The product and the startup faces the world and checks whether clients will choose its solution instead of others, and whether they will prove their choice with dollars paid.
As I stated in the disclaimer above, defining this threshold and any other in this post is risky. Let us treat all the numbers as a rule of thumb. In most cases, a monthly recurring revenue (MRR) at a minimal level of $1500 indicates that hypothesis 2 is proven. Depending on the pricing, it might be from three customers paying $500 monthly, or up to 100 customers paying $15 monthly.
Hypothesis 3: The startup is able to sell the product
After proving that the product is really useful and customers are paying for it, typically the focus moves to sales. Which distribution channels work? Is it paid ads, content marketing, direct emailing or some other way of reaching customers? When the startup hits $15,000 MRR, it usually shows that it is able to sell.
Hypothesis 4: The startup is a real business
The next step is proving that the startup is a real business ready for scaling. The amount of data grows, the understanding of the sales process grows, the product matures, and the team is expanding. Growth to an MRR of $150k is a sign that the business is real.
The above stages of development correspond to the financial roadmap for SaaS companies.
- MRR $1k-$1.5k is a rational argument to raise Seed 1 Round, an investment of $100k–$300k.
- MRR $10k-$15k is a rational argument to raise Seed 2 Round, an investment of $0.5–1.5m.
- MRR $100k-$150k is a rational argument to raise Round A, an investment of $2.5–8m.
There are a few conditions the financial roadmap proposed above depends on:
- The leader is charismatic and makes the investors believe that the growth will be achieved.
- The team has the main competencies necessary for running the company.
- Monthly growth is 15%–20% before Seed 1 and Seed 2, and above 10%–15% before Round A.
- Monthly churn is below 5%.
- Customer acquisition cost is below 30% of life-time value of the customer.
- There is a convincing big vision – the big market, the competitive advantage, the roadmap to achieving $50 million to $100 million revenue.
Dear entrepreneurs, if you are planning to raise money, I encourage you to benchmark against the figures above and to consider honestly which hypothesis you have already proved.
Investors are simple folks looking for businesses that are growing. Investors want to avoid unnecessary risks. Therefore, in the early stages of company growth, investors do not want to risk more money than is necessary to prove the a hypothesis listed above. By the way, the incentives of entrepreneurs should be similar. Entrepreneurs give away equity for each financial round. Therefore, they should give away the minimum amount of shares necessary to prove the next hypothesis, thereby increasing the valuation of the company.
Fundraising is a painstaking and long process. By making the company’s stage of development clear and transparent with confirmation in terms of revenue figures, entrepreneurs will make the fundraising processes much faster.
Originally published at pw.innovationnest.co.