Which of the following do you think are most important to an investor?
Let’s look at each individually.
Many of the pitches we see match the first. After two years of struggles and a year of breakthroughs the rocket ship takes off in years 4/5. After all isn’t that what investors want to see – a huge return on their bet?
The reality is this scenario rarely if ever happens. And when I see this, it makes me doubt your integrity and business sense. Better to say you value the investment received and confidence placed the team and as a result, you will do everything possible to make sure nobody loses money.
Why is this a powerful statement? Because it means you are aware of the many twists and turns needed to navigate the complex future of a growing a business. And if we are all lucky, you will cross the finish line with a fair return for everyone.
The second statement, a huge potential market is also a common argument. What is overlooked is the concept of addressable market. This market is limited by your available capital, experience of the management team, customer adoption rate, etc.
Better to say you are focusing on a niche of this huge market with a product that is crafted to suit the needs of a unique market segment. Think of a big fish in a small pond. And there’s lots of small ponds that are easier to dominate than one large one.
I’ve found that the third scenario is rarely encountered. But it’s the most important data point for an investor. For if you can get and keep customers, your business model will be successful. All the other things that will be needed to grow the business can be figured out but if this ratio is out of whack, nothing else matters.
So, what ratio should you aim for? If your revenue in year one for a new customer equals or exceeds the cost of acquiring that customer you’re off to a good start. Revenue equals gross margin for this example and acquisition cost includes sales and marketing expenses. Then calculate the lifetime value of the customer or said another way, figure your churn rate. Obviously, the longer the client stays the more valuable your income stream. And with this information, you can get a good feel for your cash needs as the business expands.
Lastly a word to the wise, if you can’t talk intelligently about the above, you’re not ready to raise capital beyond a seed round.