It was a combination of luck and foresight that I started talking with Allan Wille and Lauren Thibodeau about capital efficiency as a potential topic for their Metric Stack podcast many months ago. Because now, as the episode is coming out, capital efficiency is the hot topic of the day. Good luck (if not for a bad reason), but I’ll take it.
Here are some of the things we discussed on the podcast:
- If you think of startups as organisms that convert venture capital (VC) into ARR, then we need some metric for how efficiently they do that.
- Bessemer’s cash conversion score (CCS) is one such metric
- I believe Bessemer defines CCS upside-down; I find it more intuitive to use capital consumed as the numerator and ARR (to show for it) in the denominator — as you would do with a CAC ratio.
- Using my formula (= 1/CCS) for aggregate burn, here are some benchmarks showing the correlation between investment IRR and CCS within Bessemer’s portfolio
- < 1 is amazing (i.e., burning <$50M to get to $50M in ARR)
- 1-2 is good (i.e., burning $50M to $100M to get to $50M)
- 2-4 is questionable (i.e., burning $100M to $200M to get to $50M)
- 4+ is bad (i.e., burning $200M+ to get to $50M)
- On IRR, Bessemer companies with a ratio of <1x had an IRR of 120%, 1-2 had an IRR of 80%, and 2-4 had an IRR of 40%.
- At some point, I’d somewhat tongue-in-cheekily defined a metric called hype factor on the theory that startup organisms actually produced two things: ARR and hype.
- The impact of strategy pivots on overall capital efficiency, what that can mean for future funding, and how that sometimes leads to recapitalizations and pay-to-play financing rounds
The episode is available on Apple, Spotify, and YouTube. Enjoy it! And watch that burn!
I find inverting CCS odd. In fact, it seems like a lot of people define CAC ratio as incremental ARR / Sales and Marketing, which is more intuitive to me (my background is in finance, most of it as an institutional investor). Bessemer uses S&M / ARR, but refers to it as “CAC payback ratio”, which I think is useful to delineate between CAC ratio and the inverse, CAC payback ratio.
I guess you agree with Bessemer then so you’re not in bad company. I will say, only half tongue-in-cheek, that I’m left-handed and sometimes look at things in a funny way. Or it could be an investor vs. an operator thing, which I what I actually guess.
To me, FWIW, it’s way more intuitive to say “how many $ do I spend to get $1 of ARR” (buy to get paradigm) vs “what % of what I spent turned into ARR” (extraction/conversion paradigm). No right or wrong here. Magic number is effectively the inverse of the CAC. You tomato, I say tomahto.
However, there is a difference between CAC payback period and CAC ratio IMHO. Payback period uses subscription gross margin (money leftover after you pay for running the services itself) as the balance against the cost. CAC ratio uses ARR — how much did I spend to get $1 in ARR (not $1M in subscription GM).