Simply put, capital efficiency means getting by with less capital rather than more. It’s not cheapness for cheapness’ sake — that’s not a good strategy in any market. Instead, it’s a careful assessment of what cash resources your company needs to reach meaningful value creation milestones while guaranteeing a safety buffer.
Let’s stop for a second. What’s a “meaningful value creation milestone?” Far too many people hold onto the false belief that raising a round of money is a value creation milestone. It is certainly a milestone, perhaps even a rite of passage. But it’s not one that necessarily creates value. Similarly, graduating from college is a life milestone. But getting your first job is a value creation as well as a life milestone. Raising money doesn’t create value for your company by itself. However, securing referenceable, paying, happy customers certainly does.
Capital efficiency is a time-tested approach for successful enterprises of all kinds. In a startup environment, it helps you build a sustainable business that can weather changing market conditions and other forms of unpredictability. It requires you to build momentum and growth in a thoughtful and strategic way, rather than simply pumping money into the venture machine and expecting that megagrowth will follow. And it’s a strategy that some of the most successful companies and founders in the world have followed. WhatsApp bootstrapped itself and raised money only once it was profitable — all of the venture money it raised was still in the bank when it was acquired by Facebook for over $20 billion. Google raised a total of $26 million in venture capital funding before its IPO. Veeva (currently worth $23B) raised only $4 million, and Atlassian ($30B) didn’t raise a single dollar aside from some secondary sales.
In future posts, I’ll get into some of the strategies and metrics I’ve found particularly helpful for ensuring capital efficiency in high-growth technology businesses. But it’s worth pausing first to reflect on the why — as well as the how — of capital efficiency.
We are at a moment in time where money for young companies seems to rain down effortlessly from the heavens. So why would an entrepreneur (much less an entire venture capital firm like Aligned Partners!) focus on capital efficiency right now? Why not just raise as much as you can, at the highest possible price, and just shoot the moon?
A short, philosophical answer is that at its core, entrepreneurship is fundamentally about resourcefulness. Which I think is true. But as true as it might be, I’m not sure it’s a satisfying answer for most founders.
Luckily, capital efficiency offers many other benefits for founders and young companies that line up behind that pithy answer. Here are just a few:
- It significantly increases founders’ degrees of freedom on exit. A lower final post-money value and smaller liquidation preference stack give you far more liquidity options.
- Counterintuitively, it substantially mitigates your fundraising risks. Markets change. A market that seeks growth at all costs will eventually become a market that wants to staunch the high-burn cash bleedout. The only sure way for young companies to weather that storm is to position themselves for profitability.
- It forces you to focus and encourages good decision making by your leadership team. Constraints breed creativity. Excess cash will always get spent, often in ways that fail to create the most value.
- It reduces the tyranny and treadmill of continual fundraising. The higher your company’s unprofitable burn rate, the more you are at the mercy of investors’ goodwill. Keeping the burn in check helps you control your own destiny.
- Across a very wide range of exit values for venture-backed companies (spanning 75% or more of all exits), the exit values don’t correlate with the amount of capital raised. In other words, whether you raise $10 million or $100 million, it won’t necessarily influence the exit value of your company. However, raising more may paradoxically leave you with less when it’s all said and done.
All of these factors point to a simple and elegant truth about capital efficiency: The more resourceful you are, the more value you’ll be able to create and keep for yourself and your employees. Which is exactly as it should be.