What is Capital Efficiency?
At the most basic level, capital efficiency is a measure of whether a company is using its cash wisely.
More formally, you can measure this as:
ROCE (Return on Capital Employed) = (EBIT (Earnings Before Interest and Tax) /
Capital Employed), where
EBIT=Earnings before interest and tax
Capital employed=Total assets less current liabilities
In his blog On Startup Capital Efficiency, 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, while losing fiscal discipline is the single biggest driver of unintended outcomes.
Founders ignoring capital efficiency can make cardinal mistakes in the business: misinterpreting product-market-fit, over-hiring for the stage of business, and generally burning through too much cash too quickly. “Both growth and capital efficiency are relatively abundant in isolation, but a company having both attributes is incredibly rare.”
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)