As the economic crisis deepens, capital efficiency becomes a more pressing issue for startups. Not only is it necessary to maximize runway, it also plays a larger role in how investors evaluate companies. While growth is always prized during good times or bad, investors increasingly scrutinize burn and margins during downturns. Startups whose burn is too high relative to their growth will find it hard to fundraise. Founders should be prepared for this shift in emphasis. This post provides a framework for how to think about capital efficiency.
How to Measure Capital Efficiency
Two simple ways to measure capital efficiency are the Hype Ratio and Bessemer’s Efficiency Score:
- Hype Ratio = Capital Raised (or Burned) / ARR
- Efficiency Score = Net New ARR / Net Burn
I think Bessemer has the right idea but I prefer to flip the numerator and denominator, so the ratio is an annualized version of the Hype Ratio. I call this the Burn Multiple:
Burn Multiple = Net Burn / Net New ARR
This puts the focus squarely on burn by evaluating it as a multiple of revenue growth. In other words, how much is the startup burning in order to generate each incremental dollar of ARR?