Key Metrics that Investors Care About. Part 2. Revenue and Growth
In my previous article “Key Metrics that Investors Care About. [Part 1. Market and Users]” I talked about the market and users metrics that you need to know while building your business. As promised, I’m coming back with more metrics, and this time will talk about revenue, profit, and other financial metrics.
Having worked with dozens of early-stage startups at FAS | Fintech Advisory Services, I noticed the same mistake all over again. Founders are not paying attention to their financials. They think that if they don’t have any numbers yet, they don’t need to do anything. But that’s not the right mindset for the entrepreneur who has a business to plan and build.
If I want to understand whether the founding team has everything under control, I only need to look at their financials.
Poor statements, no projections, no real estimations, no forecasting models, no risk scenarios, (and I can continue this list further) will tell me that no one actually took the time to sit and think.
Yes, I’m majored in Quant Finance and spent some good time in this field. But no one expecting you to follow certain rules or certain models. Personally, I want to see that team really understands what they’re doing on paper.
From an investor’s perspective, you want to know that your money will be wisely allocated for business needs.
There’re numerous financial metrics as each startups has different business models together with some special and unique features. Thus, financials should always be tailored to a specific company and its business. In this article, I would like to cover a few basic metrics that will be handy for investors pitch.
I listened to a large number of startups presentations that didn’t include this basic metric. Why is Burn Rate important? It indicates the amount of cash that is spent monthly by the company before it starts producing income.
And this metric is also closely connected to the next one.
Runway shows the number of months left with the current burn rate till the company runs out of cash.
These two metrics together can be very helpful for calculating a required fundraising amount that is equal to a product of burn rate and a target runway.
For example, if the company Unicorn B has a burn rate of US$ 100,000 and it wants to go on for another 10 months (runway) on venture capital funding then they would be looking to raise US$ 1 mil.
The earlier you start generating revenue the better it is. The selection criteria will highly depend on your investment stage, industry, location and some other factors. Overall, of course, the more traction you got, the better it is for investors as it shows validation of your project.
When you already getting some real numbers, then it’s time to calculate your EBITDA. It stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. This metric is used to analyse a cash flow from operations and its efficiency. Revenue itself does not give you any information about profitability if you don’t have an understanding of potential costs.
A company XYZ can generate US$ 1 mil in revenue and have costs of US$ 0.95 mil while a company WAS can generate the same US$ 1 mil in revenue but have costs of US$ 0.65 mil, which would make the second company more profitable according to its EBITDA.
This is a financial ratio that is calculated as a company’s enterprise value (EV) divided by its EBITDA. It’s commonly used for a quick comparison of similar businesses.
EBITDA Multiple can be also used for startups business valuation.
Let’s begin with investors favourite SaaS business model and talk about its main revenue metrics.
EAT — Earnings After Taxes [Net Income]
Finally, everyone wants to see how much cash is left after all expenses, taxes, interest and other payments. EAT is this last metric on your Profit and Loss statement that indicates your Net Income. Companies have various timelines for when they are achieving positive EATs on their statements depending on the business specifics.
Similar to Revenue and EBITDA, EAT alone is not a useful performance measurement as it is difficult to compare some SaaS startups’ EAT to a manufacturing startup’s EAT due to major differences in business models.
Two different companies can generate an annual EAT of US$100,000 but have completely different expenditures. One company can spend US$500,000 to operate and generate US$100,000 of Net Income while the other one can only spend US$200,000 to generate the same amount of Net Income.
CMRG — Compound Monthly Growth Rate
For early-stage businesses, some metrics are not as representable as their CMRGs as the growth rate shows the target audience’s demand and the business potential. Thus, I would like to mention CMRG. I already shared earlier such basic financial metrics as revenue, EBITDA, and EAT, and here where CMRG would be very useful.
For startups founders and their stakeholders Revenue/EBITDA/EAT CMRG can provide many insights on how well the market is accepting the product and how well the company is capturing the target audience.
The difference in the CMRGc of these 3 metrics can also be informative for the financial team as it can indicate some internal problems and be a signal for better cost optimisation.
Personally, I pay special attention to growth metrics in general, as they have powerful information indeed that can be an early signal for a business to take some actions.
IRR — Internal Rate of Return
IRR is a widely-used performance measurement for investment projects and that’s something you might be asked when you are having some traction. The simplest way to calculate this metric is in Excel, there’s even an in-built formula that makes it quite easy. There’re plenty of youtube videos that also explain the whole process. Generally speaking, IRR is a discount rate that makes NPV (Net Present Value) equal to zero and is a part of discounted cash flow analysis.
Investors usually aim for an IRR of 20%+ depending on the investment stage. In reality, many funds are ending up with an average IRR of 9%-12%.
Additionally, I would like to pay extra attention to a few metrics that are mostly used by startups with SaaS and Subscription business models
MRR — Monthly Recurring Revenue
You can calculate MRR by simply multiplying the average revenue per account by the total number of accounts in that month. Alternatively, you can multiply the total number of subscribers by the average billed amount in each month.
ARR — Annual Recurring Revenue
Once you’re done with MRR, it will be very simple to calculate ARR. It’s just an annualised version of MRR.
Gross MRR Churn
Some investors would ask you to calculate a Gross MRR Churn. The formula is also quite straightforward. It’s calculated as MRR lost this month divided by MRR at the beginning of the month. This metric will be applied mainly to SaaS startups.
I’ve been advising and mentoring Blockchain and Fintech startups since 2017 and always keep my “doors” open to talk about financials and performance metrics. The easiest way to reach out to me is to simply drop me a message on LinkedIn. I do always reply.