What is Capital Efficiency?
At the most basic level, capital efficiency is a measure of whether a company uses its cash wisely. We don’t invest in either of the two most common forms of capital-inefficiency:
- A management team who focuses on raising as much VC as possible. This strategy makes sense for companies which fit the blitzscaling model, which typically means they operate in a winner-take-all market with network effects. But raising too much VC can cause serious damage or kill a promising company. Steve Cheney highlights that founders raising more money than they have a clear plan to spend tends to push them to spend unwisely. In a startup, a focus on doing fewer things well is imperative to winning.
- A management team which doesn’t understand how to think analytically about their financing and ownership options. By definition, such a team is not sophisticated enough to build an impactful company.
Formally, you can measure capital efficiency as:
|ROCE (Return on Capital Employed) =||(EBIT (Earnings Before Interest and Tax) /
EBIT=Earnings before interest and tax
Capital employed=Total assets less current liabilities
How do you benchmark capital efficiency for SAAS Startups?
Specifically for SaaS startups, Bessemer Venture Partners suggests a simple rule-of-thumb called the BVP efficiency score: Efficiency Score = Net New ARR / Net Burn. The table below gives you benchmarks for founders with under $30M ARR to think about capital efficiency:
Allen Miller of Oak HC/FT suggests these benchmarks for founders as they grow from $0 to $100M ARR:
On the other hand, David Sacks of Craft Ventures prefers to flip the Efficiency Score and call it the Burn Multiple.
Burn Multiple = Net Burn / Net New ARR
The higher the Burn Multiple, the more the startup is burning to achieve each unit of growth. The lower the Burn Multiple, the more efficient the growth is. For venture-stage startups, these are reasonably good rules of thumb:
For further reading:
The myth of capital efficiency (not exactly on point)