How to Quantify Capital Efficiency
At Reformation, we spend a lot of time talking with, and thinking about, capital efficiency. We’re big fans of founders who decide to grow on customer revenue — not just external funding — and who prioritize independence over selling down ownership and control.
We’re also obsessed with codifying and benchmarking what it means to be capital efficient. We have the privilege of talking with thousands of companies a year to get an inside look at which metrics best define efficiency. This is useful data as we compare opportunities. It’s also incredibly useful data for founders who want to understand how their company benchmarks to others in their space.
At Reformation, we like to index companies across 5 key metrics. These are the metrics we use to determine, in as objective-a-way-as-possible, how scrappy a team has been in getting to their current level of traction.
1) Net Burn Percentage
Net burn percentage is a simple metric that looks over the past quarter to figure out how efficient a business has been relative to its revenue base. If operating cash flow is hard to come by, net income can be used as a proxy.
Net Burn Percentage =
Prior Quarter Operating Cash Flow / Prior Quarter Revenue
2) Employee Efficiency
Employee efficiency is a very important metric that highlights whether a company is over- (or under-) staffed. You can find more on this metric here. Employee costs are often one of the largest fixed cost line items, and are an important metric to keep an eye on to ensure that costs do not get too far ahead of revenue.
Employee Efficiency =
(Prior Quarter Revenue x 4) / (# FTEs + 0.5 x # PTEs)
3) Growth Efficiency
Growth efficiency looks at a business’ progress over the past quarter in relation to total amount spent to achieve that progress. The higher the ratio, the more efficient the business. It’s important to weight this metric (and all of the following) by gross margin to account for quality of revenue.
Growth Efficiency =
((Current Quarter Revenue - Prior Quarter Revenue) x % GM x 4) /
Prior Quarter Total OpEx
4) Sales & Marketing Efficiency (a.k.a. Magic Number)
Similar to the above but more precise, customer efficiency looks at the progress a business has made over the past quarter in relation to its spend on sales and marketing. This can help hone in on S&M over- (or under-) spend. This metric is otherwise known as the Magic Number.
Customer Efficiency =
((Current Quarter Revenue - Prior Quarter Revenue) x % GM x 4) /
Prior Quarter S&M Expense
5) Funding Efficiency
A final holistic metric to see how efficiently a company has used outside capital, this metric looks at a company’s progress relative to the amount it has burned to get there.
Funding Efficiency =
(Current Month Revenue x % GM x 12) / Outside Cash Burned to Date
We hope the above are helpful metrics to track as you think about the relative efficiency of your business. It’s important to quantify “best practices” for each of these metrics to help benchmark performance against the broader dataset.
