Growth versus capital efficiency

I often see two entrepreneurs executing on similar opportunities, but with two very different capital efficiencies. First, there’s the aggressive one who spends money very quickly, building a large team, buying early growth through aggressive marketing and sales, and hoping for a large upround in the next financing round. Then, there’s the bootstrapping entrepreneur who hires carefully (sometimes too little, too late), trying to get as much runway with the current money as possible and build a “real” business.

Finding the right balance between investing in growth and focusing on capital efficiency is one of the toughest challenges for entrepreneurs and early-stage start-ups. It can be particularly tricky as investors are usually looking for growth and evaluating start-ups as defined by growth.

Here are a few observations and pieces of advice to help you navigate which spending model is best for your start-up:

1. Don’t invest in marketing and sales until you have found product-market fit:

Marc Andreesen once categorized start-ups as before product-market fit (BPMF) and after product-market fit (APMF). When you are BPMF, you should be doing everything you can to get to product-market fit…whether that’s changing out your people, tweaking the product, moving to a different market. However, there’s no point in spending on marketing and sales at this point; until you’ve found the right product for your market, you’d simply be wasting your money.

2. Revisit product-market fit from time to time:

Don’t assume that what worked in the early days will continue to work for years to come. External changes in the market can impact your product-market fit, as may your own growth path. For example, as a SaaS company scales and targets larger enterprise customers, its initial product-market fit may no longer be as strong.

3. Evaluate your market: is it winner-takes-it-all?

If you’re targeting a winner-takes-it-all (or almost all) market, then focusing on saving money makes no sense. You’d be sacrificing market leadership. Think about it. Nobody remembers Ryze, or Spoke as early LinkedIn competitors. But if you’re operating in e-commerce or other non winner-takes-it-all markets, then you don’t have to be overly aggressive in the early stages. In this case, you can take your time to fine-tune your model before aggressively scaling up.

4. Get your metrics under control:

Putting the “pedal to the metal” makes the most sense if you understand your LTV (lifetime value) per customer and CAC (customer acquisition costs). As you scale, you should also have early warning systems in place to see if your new customers and acquisition channels are performing at least as well as the previous ones (weekly LTV/CAC cohorts are the best measure for this).

Final thoughts

As an investor, nothing is more impressive than meeting an entrepreneur that has built a great business in a short amount of time and with very little money. Being frugal and knowing how to spend money is one of the most important entrepreneurial traits – as long as it doesn’t come at the expense of growth. Jeff Bezos/Amazon is probably the best example where the right balance of frugality and growth is engrained in their DNA.

 

Enhanced by Zemanta

Read Next