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SAAS STARTUPS

Capital Efficiency

Capital efficiency is an absolutely vital consideration for nearly every company — however, few companies can benefit as much from being capital-efficient as SaaS startups can. Capital efficiency is a concept that deals with how well a company is using its money.

Leading a SaaS startup to success can sometimes feel like the world’s toughest juggling act. Many different considerations are essential to keeping a young SaaS company afloat, and you may be working with just a very small team early on. It can be difficult to know how to divide your time and efforts and where to focus the majority of your attention. Wasting your energy on the wrong tasks could have disastrous consequences during the most precarious stages of a startup’s journey. Different startups have different goals and needs and, therefore, usually benefit from different priorities — however, one area that nearly every SaaS startup should prioritize highly is capital efficiency.

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Process of Capital Efficiency

In more specific terms, capital efficiency is usually described as the ratio of the amount of money the company generates in revenue to the amount of money the company spends to generate that revenue. A company that is generating $200 in revenue for every $100 dollar spent has a capital efficiency ratio of 2:1. Obviously, the more revenue a company generates and the less money it spends, the better — in other words, a business that has a high ratio of revenue generated to money spent is a capital-efficient business.

The reason capital efficiency ratios are so important for SaaS startups, in particular, is because growth potential is directly related to capital efficiency, meaning SaaS startups should be paying close attention. The more capital-efficient a startup is, the more quickly and efficiently it can grow. Since exponential growth is typically high on the list of goals for most SaaS startups, capital efficiency can be one of the most valuable areas for SaaS startup founders to focus on.

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Capital Efficiency SaaS

There are more factors that are important for a startup besides just capital efficiency. SaaS startups (as well as many other kinds of startups) should take a balanced approach to running a startup. However, capital efficiency should be a central consideration throughout the entire process. At Golden Section, we partner with founders to empower them to use capital efficiently to scale their companies. Raising capital is important in building a startup, but it’s not all about how much money you can raise.

What’s even more important is that you use that money as efficiently as possible. Many SaaS startups fail to consider capital efficiency during the early stages of growth. Some founders may simply not realize the value of carefully managed capital efficiency, while others may believe they are better off raising and spending large amounts of cash in pursuit of the highest possible valuation.

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Benefits of Capital Efficiency

In truth, capital efficiency is an extremely important concept, and running a capital-efficient business can benefit your startup in a few significant ways. For example:

It allows you to retain more control over your company.

Obviously, raising money from investors is good on one hand because it provides your business with more money and, therefore, more fuel for growth. However, the downside that some SaaS founders fail to consider is that more investment also usually means less control for the founder or founders. The more capital investors contribute to your business, the more of your company they will own. Diluting ownership of your startup too much can make it much more difficult to control. A capital-efficient mindset enables you to retain more control of your startup by doing more with fewer investments.

It creates sustainable growth.

Plunging ahead with a growth-at-all-costs mindset can get very expensive and lead your company into dangerous territory quickly. Prioritizing capital efficiency enables measured growth that drives your company forward at a sustainable pace. Many companies have found out the hard way that spending money faster doesn’t automatically mean faster growth.

It forces founders to think strategically.

Doing everything you can to maximize your returns forces you to think more carefully about your company’s financial moves. This can not only lead to better business strategy in the short-term, but it can also help you become a more savvy and capable founder. By doing as much as you can with as little as possible, you’re investing in skills and practices that will help your business grow sustainably and achieve a high ratio of revenue to expenses.

Types of Efficiency Ratios 

As we mentioned previously, capital efficiency is usually expressed as a ratio of revenue generated to money spent. However, capital efficiency is a much more nuanced concept than is summed up in this simple ratio. There are actually several types of capital efficiency ratios that companies use to track how well they’re utilizing their financial resources. Here are a few of the most important types of efficiency ratios: 

Burn Multiple

Burn multiple measures how much money a company is spending to generate new revenue. Dividing the total amount of money your business spent during a period of time (net cash burn) by the amount of net new ARR (annual recurring revenue) gained during the period of time. Many startups calculate burn multiple on a monthly or quarterly basis.

Hype Ratio

Hype ratio gets its name from the fact that it quantifies the amount of excitement a company is able to generate among investors. This ratio uses capital raised from investors instead of total money spent. To calculate your business’s hype ratio, divide your total amount of capital raised by your annual recurring revenue.

Bessemer’s Efficiency Score

Bessemer’s capital efficiency score, developed by Bessemer Venture Partners, is one of the most straightforward types of efficiency score. The Bessemer score is simply a ratio that divides net new annual recurring revenue by net cash burn.

Of course, once you start paying attention to your company’s efficiency ratios, the question that usually follows is: what is a good capital efficiency ratio? The answer to this question depends heavily on your startup’s industry. For a startup in the SaaS industry, an overall capital efficiency ratio of 3:1 (revenue to expenses) or higher is ideal, but anything above 1:1 is acceptable.

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Capital Efficiency Formula

Capital efficiency should be on nearly every company’s radar. But before they can benefit from monitoring and improving capital efficiency, startups need to understand how to actually measure capital efficiency. Using a capital efficiency formula, SaaS companies (and many other kinds of startups) can determine how effectively they are using the money they’ve raised for the company. While you can track your startup’s capital efficiency in general by considering the ratio of total revenue generated to total money spent, there is not exactly one definitive “capital efficiency formula.” In truth, there are several useful metrics you can track to help you put together an accurate picture of your company’s capital efficiency.

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Capital Efficiency Metrics

There are numerous metrics a business could track to help evaluate capital efficiency. The best way for SaaS businesses to measure capital efficiency is usually not to rely on a single capital efficiency score, but rather to combine a variety of SaaS efficiency metrics into a holistic view of spending and revenue at the organization. Here are a few of the most useful capital efficiency metrics for growing startups to track:

There are numerous metrics a business could track to help evaluate capital efficiency. The best way for SaaS businesses to measure capital efficiency is usually not to rely on a single capital efficiency score, but rather to combine a variety of SaaS efficiency metrics into a holistic view of spending and revenue at the organization. Here are a couple of useful capital efficiency metrics for growing startups to track:

Cash Conversion Score – This metric measures how effectively your business converts invested money into revenue. To calculate cash conversion score, use the following formula:

Cash conversion score = ARR / (total capital raised – total cash on current balance sheet)

Return on Capital Efficiency – Return on Capital Efficiency (ROCE) looks at your business’s net profit to evaluate its success. To calculate ROCE, divide your business’s earnings before interest and taxes (EBIT) by your business’s total capital employed (the current difference between your assets and liabilities).

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How to Improve Capital Efficiency

A capital efficiency calculation isn’t very useful if you don’t know how to improve capital efficiency. Here are a few tricks for improving capital efficiency at your company:

Pay attention to the data.

One of the best ways founders can improve capital efficiency is by tracking the right metrics and leveraging the data effectively. Pay attention to what your capital efficiency ratios are telling you and use the insights to inform better financial decision-making.

Develop clear goals for your business’s growth and spending.

It’s difficult to make better financial decisions when you have no objective in mind. One of your very first steps should be to figure out what your growth goals are for your business and what your financial strategy is to reach those goals. Then, you can monitor the changes you make and compare your progress against your efficiency goals.

Accept support from others 

All startup founders need help from time to time, whether financial or otherwise. Golden Section’s community of entrepreneurs can provide a wealth of expertise and support, including playbooks to help you navigate challenges (like improving capital efficiency), lessons from seasoned founders, and opportunities for growth-stage financing.

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