In the dynamic world of venture capital (VC) and private equity (PE), quarterly reports serve as crucial checkpoints for investors to assess a company's performance and growth potential. Unlike public market investors, VC and PE investors often deal with private companies or early-stage startups, which requires a different set of metrics to evaluate success and potential. This blog post will explore the top five metrics that every VC and PE investor should look for in quarterly reports, helping you make more informed investment decisions and better manage your portfolio companies.
1. Revenue Growth Rate
For VC and PE investors, revenue growth rate is often the single most important metric to track. It provides a clear indication of a company's market traction and scalability, which are crucial factors in determining the potential return on investment.
Why Revenue Growth Rate Matters
In the world of startups and high-growth companies, rapid and sustainable revenue growth is a key indicator of product-market fit and the company's ability to capture market share. For PE investors, a strong revenue growth rate can signal the potential for value creation through market expansion or improved operational efficiency.
When analyzing revenue growth rate, consider the following:
- Year-over-Year (YoY) vs. Quarter-over-Quarter (QoQ): YoY growth provides a longer-term perspective, while QoQ growth can highlight more recent trends or seasonality.
- Industry Benchmarks: Compare the company's growth rate to industry averages and competitors. Top-quartile SaaS companies often see YoY growth rates of 100%+ in early stages, declining to 30-50% as they mature.
- Sustainability: Assess whether the growth rate is sustainable or if it's driven by one-time factors. Look for consistent growth over multiple quarters.
- Scale: Remember that maintaining high growth rates becomes more challenging as a company grows larger. A 50% growth rate for a $100 million revenue company is often more impressive than a 100% growth rate for a $1 million revenue company.
While a high growth rate is generally positive, it's crucial to consider it alongside other metrics. Rapid growth at the expense of profitability or customer acquisition costs may not be sustainable in the long run. Additionally, for more mature companies in PE portfolios, steady growth combined with improving profitability might be more valuable than rapid top-line growth alone.
Studies have found that revenue growth was the single largest determinant of total shareholder return for PE-owned companies, accounting for 61% of the value created.
2. Burn Rate and Runway
For venture capital investors, especially those dealing with early-stage startups, understanding a company's burn rate and runway is crucial. These metrics provide insight into how efficiently a company is using its capital and how long it can sustain operations before needing additional funding.
Why Burn Rate and Runway Matter
Burn rate indicates how quickly a company is spending its cash reserves, while runway shows how long the company can continue operating at its current burn rate before running out of money. These metrics are essential for several reasons:
- They help investors assess the company's financial efficiency and discipline.
- They indicate whether the company needs to raise additional capital soon.
- They can signal potential cash flow issues that need to be addressed.
Burn Rate: There are two types of burn rates to consider:
- Gross Burn Rate = Total monthly operating expenses
- Net Burn Rate = Total monthly operating expenses - Monthly revenue
When analyzing burn rate, consider the following:
- Industry Standards: Burn rates can vary significantly by industry and stage of company. A SaaS startup might have a higher burn rate than a bootstrapped e-commerce business.
- Growth Stage: Early-stage startups often have higher burn rates as they invest in growth, while later-stage companies should show improving capital efficiency.
- Funding Environment: A longer runway is crucial during challenging funding environments. VCs typically advise having 18-24 months of runway.
- Burn Multiple: This metric compares net burn to net new ARR (Annual Recurring Revenue) added. A burn multiple below 1 is considered excellent, while anything above 2 may be concerning.
Burn Rate and Runway in Context
While a low burn rate and long runway are generally positive, it's important to balance these with growth metrics. A company that's too conservative with spending might miss out on crucial growth opportunities. Conversely, a high burn rate can be justified if it's translating into strong, sustainable growth.
For PE investors dealing with more mature companies, the focus might shift from burn rate to cash flow metrics, but the principle of monitoring financial sustainability remains crucial.
Studies have found that running out of cash is the second most common reason for startup failure, accounting for 38% of failures. This underscores the importance of closely monitoring burn rate and runway.
3. Customer Acquisition Cost (CAC) and Customer Lifetime Value (CLV)
For both venture capital and private equity investors, understanding the economics of customer acquisition and retention is crucial. Customer Acquisition Cost (CAC) and Customer Lifetime Value (CLV) are two interrelated metrics that provide deep insights into a company's sales efficiency and long-term profitability.
Why CAC and CLV Matter
These metrics help investors assess:
- The efficiency of a company's marketing and sales efforts
- The potential profitability of each customer
- The sustainability of the company's growth
- The overall health of the business model
When analyzing these metrics, consider the following:
- CLV:CAC Ratio: This is a key indicator of the return on investment for customer acquisition. A general rule of thumb is that the ratio should be at least 3:1, meaning the customer's lifetime value should be at least three times the cost to acquire them.
- Payback Period: This is the time it takes to recover the CAC. For SaaS companies, a payback period of 12 months or less is often considered good.
- Industry Benchmarks: CAC and CLV can vary significantly by industry. For example, B2B SaaS companies often have higher CAC but also higher CLV compared to B2C companies.
- Trends Over Time: Look for improving efficiency (decreasing CAC or increasing CLV) over time as the company scales and optimizes its operations.
- Segmentation: Consider how these metrics vary across different customer segments or product lines.
CAC and CLV in Context
For venture capital investors, rapidly declining CAC or increasing CLV can be strong indicators of product-market fit and scalability. This can justify higher burn rates if the unit economics are favorable.
For private equity investors, optimizing these metrics can be a key value creation lever. Reducing CAC through more efficient marketing or sales processes, or increasing CLV through improved customer retention or upselling, can significantly boost a company's valuation.
Studies have found that companies with top-quartile CLV:CAC ratios grow significantly faster and have higher valuations than their peers. Specifically, a 10% improvement in CLV:CAC ratio correlates with a 12% increase in two-year forward revenue CAGR.
It's worth noting that while these metrics are powerful, they have limitations. For early-stage startups, CLV can be challenging to calculate accurately due to limited historical data. Additionally, these metrics don't capture the full picture of a company's health and should be considered alongside other financial and operational indicators.
4. Gross Margin and Contribution Margin
For both venture capital and private equity investors, understanding a company's profitability at various levels is crucial. Gross Margin and Contribution Margin are two key metrics that provide insights into a company's operational efficiency and scalability.
Why Gross Margin and Contribution Margin Matter
These metrics help investors assess:
- The fundamental profitability of a company's products or services
- The efficiency of the company's production or service delivery
- The potential for scale and improved profitability as the company grows
- The company's competitive position in its market
When analyzing these metrics, consider the following:
- Industry Benchmarks: Gross margins can vary significantly by industry. For example, SaaS companies often have gross margins of 70-80% or higher, while e-commerce companies might have gross margins of 20-40%.
- Trends Over Time: Look for consistent or improving margins over time. Declining margins could indicate pricing pressure, increasing competition, or operational inefficiencies.
- Scale Effects: For many businesses, particularly in tech and software, gross margins should improve as the company scales due to economies of scale and operational efficiencies.
- Contribution Margin vs. Gross Margin: Contribution margin includes all variable costs, not just COGS, making it particularly useful for businesses with significant non-COGS variable expenses (like sales commissions in a SaaS business).
- Unit Economics: These metrics are crucial for understanding unit economics, especially when combined with CAC and CLV.
Gross Margin and Contribution Margin in Context
For venture capital investors, high gross margins are often a key indicator of a scalable, potentially high-growth business. This is particularly true in software and technology sectors where the cost of serving additional customers is typically low.
Studies have found that public SaaS companies with gross margins over 75% traded at an average revenue multiple 4.4 times higher than those with gross margins under 75%.
For private equity investors, improving gross and contribution margins can be a significant value creation lever. This might involve:
- Optimizing pricing strategies
- Improving operational efficiencies
- Renegotiating supplier contracts
- Investing in automation or technology to reduce costs
Reports have shown that for PE-owned companies, margin expansion accounted for about 36% of total shareholder return, second only to revenue growth.
It's important to note that while high margins are generally positive, they should be balanced with other considerations. For example, a company might strategically operate at lower margins to capture market share or invest in growth. Additionally, unusually high margins might attract competition or indicate underinvestment in the business.
5. Net Dollar Retention (NDR) or Net Revenue Retention (NRR)
The final key metric that venture capital and private equity investors closely monitor is Net Dollar Retention (NDR), also known as Net Revenue Retention (NRR). This metric is particularly crucial for companies with recurring revenue models, such as SaaS businesses, but it's valuable for any company with a subscription or repeat purchase model.
Why Net Dollar Retention Matters
NDR provides insights into:
- Customer satisfaction and product stickiness
- The company's ability to grow revenue from existing customers
- The overall health of the business and its potential for sustainable growth
- The effectiveness of customer success, upselling, and cross-selling efforts
When analyzing NDR, consider the following:
- Benchmark: An NDR over 100% indicates that the company is growing revenue from its existing customer base, even accounting for churn. Top-performing SaaS companies often have NDR of 120% or higher.
- Trends Over Time: Look for consistent or improving NDR over time. A declining NDR could signal product issues, increasing competition, or market saturation.
- Comparison with Gross Retention: Comparing NDR to gross retention (which doesn't include upgrades) can provide insights into the effectiveness of upselling and cross-selling efforts.
- Segmentation: NDR can vary significantly across customer segments. Analyzing it by customer size, industry, or product line can provide valuable insights.
- Stage of Company: Early-stage companies might have more volatile NDR as they're still figuring out product-market fit and optimal customer profiles.
Net Dollar Retention in Context
For venture capital investors, a high NDR is often seen as a strong indicator of product-market fit and potential for efficient growth. It suggests that not only are customers staying with the product, but they're finding enough value to increase their usage over time.
Studies have found that companies with top-quartile NDR (>120%) grow ARR twice as fast as companies with bottom-quartile NDR (<100%).
For private equity investors, improving NDR can be a powerful value creation lever. Strategies might include:
- Enhancing customer success programs
- Developing new features or products for upselling
- Implementing more effective pricing and packaging strategies
- Improving the overall product to increase stickiness and reduce churn
It's worth noting that while a high NDR is generally positive, it shouldn't come at the expense of new customer acquisition. The most successful companies balance strong NDR with continued expansion of their customer base.
Conclusion
For venture capital and private equity investors, these five metrics – Revenue Growth Rate, Burn Rate and Runway, Customer Acquisition Cost and Lifetime Value, Gross and Contribution Margin, and Net Dollar Retention – provide a comprehensive view of a company's financial health, operational efficiency, and growth potential.
While these metrics are crucial, it's important to remember that they don't tell the whole story. Qualitative factors such as market size, competitive landscape, team quality, and product differentiation also play vital roles in investment decisions.
Moreover, the relative importance of these metrics may vary depending on the company's stage, industry, and specific circumstances. Early-stage startups might focus more on growth rates and runway, while later-stage companies and PE targets might prioritize profitability metrics and NDR.
By closely monitoring these metrics in quarterly reports, investors can gain valuable insights into their portfolio companies' performance, identify potential issues early, and make informed decisions about further investment or strategic changes.
References
- Pitchbook, "Benchmarking SaaS Company Growth Rates", 2023
- Bain & Company, "Global Private Equity Report 2022"
- NFX, "What's the Right Amount of Runway?", 2022
- David Sacks, "The Burn Multiple", 2020
- CB Insights, "The Top 20 Reasons Startups Fail", 2023
- Klipfolio, "What is the CAC:LTV ratio?", 2023
- Profitwell, "The Ultimate SaaS Metrics Guide to Smarter, Faster Growth", 2022
- Bain & Company, "Customer Lifetime Value: A Better Compass to Guide Your Marketing Automation", 2020
- KeyBanc Capital Markets, "2021 SaaS Survey Results", 2021
- OpenView Partners, "2020 SaaS Benchmarks Report", 2020
- Bain & Company, "Global Private Equity Report 2021"
- Bessemer Venture Partners, "2021 Cloud 100 Benchmarks Report", 2021
- Bain & Company, "The SaaS Success Playbook", 2022