A Founder’s Map for Capital Allocation — No Shipwreck
In my Podcast, Sanity Check, I have emphasised the crucial role of mastering Capital Allocation in building a 100 million revenue business. This knowledge is not just a strategy; it’s a beacon of hope and a pathway to unprecedented growth for your startup.
Capital allocation is not just Accounting. It’s not about keeping your startup afloat but steering it towards unprecedented growth. As founders and CFOs, you are the captains of this ship. Let’s explore the essence of capital allocation through critical metrics and forward-looking strategies, ensuring your venture survives and thrives.
Let’s start with the basics.
Understanding the Pulse of Your Startup: Net Burn
The net burn rate is at the core of startup financials, indicating how your venture consumes its cash reserves. Imagine this: your startup is a ship sailing the open sea. The net burn rate tells you how fast you use your fuel. If the rate is high, you’re heading towards potential danger; if it is low, you’re on a path to sustainability. Balancing speed and endurance is crucial to reaching the shores of success. ‘Net’ is relevant as you may have some revenue but are spending up. Hence, your income and outgoings net off, and the monthly deficit reduces your cash balance to zero. If you don’t discover a product market fit, reach profitability or shore up investors in the next investment round.
The Beacon of Sustainability: Annual Recurring Revenue (ARR)
ARR acts as a powerful lighthouse, guiding your venture through the uncertain waters of startup life. It represents the steady, predictable stream of revenue your company generates, like a favourable wind propelling your ship forward. In the tumultuous waters of startup life, ARR is a testament to your venture’s value proposition and market fit.
Navigating Customer Acquisition: The CAC Compass
The journey to acquiring customers is an expedition filled with trials and triumphs. Customer Acquisition Cost (CAC) is your compass in this endeavour, indicating the resources expended to attract each new customer. A low CAC suggests efficient navigation and marketing strategies, whereas a high CAC might reveal rough seas ahead, necessitating a course correction. How full your nets are directly reflects your prowess with capital allocation.
The Payback Period: Charting the Return Voyage
Every investment is a voyage into the unknown, and the payback period helps chart the return journey. It determines the time taken to return with the bounty, or specifically break even on your marginal investment in marketing or whatever you spend on resources to make the company perform better.
A Startup has a series of bets it can place before it burns out. This sequencing, including the speed, direction, and increments, must be sufficient and measured so the bets can pay off big enough at the necessary time.
The Cost of Funds: Financing Your Expedition
Embarking on a startup journey often requires securing capital, akin to gathering provisions before setting sail. The cost of funds reflects the price of these provisions, encapsulating the interest and fees associated with borrowing capital. Wise navigators seek the most favourable terms, ensuring their venture remains financially sound and ready to face the high seas. A founder’s ability to create value relative to net burn is a topic for another post.
Charting the Course: Forecasting and Iteration
The true mark of a seasoned captain lies in their ability to chart a course not just for the immediate horizon but for distant lands. Forecasting allows you to envision future challenges and opportunities, making strategic bets on technology and teams. Yet, the sea is ever-changing; iteration enables you to adjust your sails, ensuring that today’s decisions lead to tomorrow’s successes. Even initially, it is essential to model some specific business to reverse engineer the journey.
When Your Revenue Hits a Plateau: Finding New Winds
When your revenue hits a plateau, it’s time to reassess your value proposition and market fit. Dive deep into customer feedback and market trends; there might be unmet needs or emerging niches you need to look into. Consider experimenting with pricing models, enhancing your product, or exploring new marketing channels. It’s also an opportune time to strengthen relationships with your existing customers, turning them into advocates. These strategies can act as a new wind, propelling your startup out of stagnation and into a new growth phase.
When Facing Unrelenting Storms: Steering Through Adversity
When a team starts to lose faith, the direction the wind is coming from seems unclear. Every venture, at some point, faces periods where, despite best efforts, nothing seems to work. It’s akin to navigating through a relentless storm. In these moments, resilience and adaptability are your greatest allies. This is not the time for blind persistence; it’s a call for strategic pivoting. Remember, you have the power to steer your venture through these storms, emerging more robust and resilient.
The Journey from $0 to $1 Million, and then to $10 Million ARR
The voyage from zero to $1 million in ARR is an exhilarating challenge of proving your concept, achieving product-market fit, and laying the foundation of a scalable business model if you can build something people love and are willing to pay for. Congratulations! You have conquered one of the most challenging hurdles.
Achieving this first million is a monumental milestone that validates your startup’s potential.
However, scaling from $1 million to $10 million is a different expedition altogether. It’s like transitioning from climbing hills to scaling mountains. Securing the right people at the right time (capital allocation) allows for sustainable growth. Key strategies include expanding your team with individuals who bring expertise in scaling businesses, investing in sales and marketing to widen your reach, and continuously innovating your product to stay ahead of the competition. It also involves refining your customer success processes to ensure that as your customer base grows, their satisfaction and the value they derive from your product grow, too. Building a strong culture that sustains innovation, agility, and customer focus, which got you to $1 million, is crucial as you scale. The sequencing of your bets (capital allocation) will dictate your success in most circumstances. This journey is challenging, but achieving this tenfold growth is a testament to your startup’s resilience, adaptability, and enduring value proposition. Mental acuity and agility help challenge your beliefs, not prove yourself right, but find the truth serums you require.
The journey of a startup from inception to significant revenue milestones is fraught with challenges, learning opportunities, and moments of validation. By strategically addressing periods of stagnation, embracing flexibility in the face of adversity, and methodically scaling your operations and offerings, you can chart a course through the unpredictable waters of startup growth, aiming for the horizon with confidence and determination.
Mastering the Art of Capital Allocation
The role of a founder or CFO in managing capital is akin to that of a captain navigating uncharted waters. It demands a deep understanding of where you are, where you’re heading, and how best to get there. By mastering the metrics of net burn, ARR, CAC, payback period, and cost of funds, and by forecasting with a keen eye on the future, you’re not just surviving the journey but charting a course towards creating a legacy.
Remember, managing capital is not just about numbers; it’s about vision, strategy, and the relentless pursuit of excellence. Let your startup’s journey be guided by these principles, and may you navigate to the shores of success. If everyone gets capital allocation and how the business fits together, team intention, strategy and tactics (individual contributions) click.
Every CEO will choose the most essential specific metrics that indicate the company is on the right path and warrants further capital. The story the numbers tell will light up the journey for your investors, staff, and stakeholders and keep you on track. A CFO may well illuminate this for a CEO, and a great CFO can explain to the whole team how they are going and how they can win in terms everyone gets. No one wants to be drowned in data here.
Will you hit rocks, sink or reach the port ready for even bigger things and deliver value for all who sail with you?
