What Is capital efficiency? Why does it matter?

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.

On Alignment

Thanks for joining me! I’m a venture capitalist who has been investing in early-stage technology companies for over 20 years. I’ve also been a founder or key member of leadership teams for three startups and a mentor to hundreds of entrepreneurs and technology businesses.

Over time, as I’ve developed my own point of view on how venture capital works and why young companies succeed or fail, I’ve come to see that my perspective is, well, different from many others in my field. 

I didn’t really expect to be such a contrarian. There’s so much that I admire in the startup world. And yet, in this high-stakes venture game there’s also a great deal of hype, misinformation, and fear. Sometimes a lens on the data can clear things up. That seems especially true at this moment, when almost two-thirds of all venture money is being invested into rounds of $50 million or more while median exit values still hover around $80 million.

I’ve shared some of my views in articles and interviews for TechCrunch and other publications, podcasts like Venture Confidential, and other venues. From the response to those articles, and from many conversations with founders, LPs (limited partners, who are the investors in the venture funds themselves), and other VCs over the years, I’ve heard a lot of requests for a fuller articulation of this contrarian, data-driven viewpoint. (They usually sound something like this: “Dammit, Jodi, why the hell aren’t you writing about this!?!”)

I believe that the interests of founders and investors can and should be aligned.

My perspective on entrepreneurship and the best role for venture capital in early-stage companies is shaped primarily by three things: 

  1. Growing up in a family of incorrigible entrepreneurs and experiencing the highs and lows as a founder myself, all of which leave me with enormous respect for the treacherous, exhilarating, slightly insane process of starting and growing a business;
  2. A philosophical desire to create win-win outcomes wherever feasible — which is possible more often than people realize. This is probably not unrelated to point (1) and the awe I have for the entrepreneurial journey; and
  3. A bit of self-awareness (gained, as these things always are, through time and through mistakes) about what I’m good at, what I’m bad at, and how I can help entrepreneurs the most. 

These experiences and ways of thinking led me to co-found the venture firm Aligned Partners with my partner Susan Mason in 2011. Our core approach has been to align our interests with founders to help them build high-growth businesses that deliver value to customers, investors, employees, and the founders themselves. The key element that enables this approach — our secret sauce, so to speak — is capital efficiency.

I’m calling this blog Alignment in honor of my venture firm and a philosophy that guides my work with founders and LP investors alike. In the posts to come, I’ll cover a variety of topics on entrepreneurship, venture capital, and startup life — always from the perspective of someone who cares about alignment and win-win outcomes.