In 2022, the music stopped for early-stage SaaS (Software-as-a-Service) companies. And with the music stopping, so did venture capital funding of capital-inefficient startups with high cash burn. This shift is nothing new to some of us who have been in the business for the last two decades, but it is unfamiliar territory for young startup founders. Business planning priorities have shifted in this environment from “growth at all costs” to “capital efficient growth with extended cash runways.”
Let’s examine how, prior to 2022, the typical yearly planning cycle would go for an early-stage SaaS company. The CEO maps out an aggressive YoY growth goal—something like “we have to double, we have to triple, etc.”. Loyal executives fall in line and quickly map out the resources they need to meet that goal. Lofty assumptions are made by the sales and marketing leaders around the money required to generate an inordinate amount of leads, followed by unproven assumptions about the conversion rates of leads into sales. The CFO realizes they need to raise and raise big to fund the growth. The company executives waste valuable time pursuing a costly funding round which necessitates lofty growth assumptions. And a vicious cycle is born.
For many entrepreneurs, a growth funding round won’t be on the cards in this climate. PitchBook recently shared the decline in Series A deal count, down 50% since Q1’22 and we’re not done yet. This is a serious bottleneck and most pre-Series A companies need to adjust their thinking from growth-at-all-costs to growth-at-low-burn in order to weather the storm.
Tip: Check out where you stand on the key metrics investors seek using the Companyon SaaS Benchmark Tool.
Burn-Based Planning Model
To help entrepreneurs transition to growth-at-low-burn, Companyon created a simple planning tool to illustrate the shift in thinking by walking through an all-too-typical example.
Example Company Background
2022 was a challenging year for our example company. Coming off a stellar 3X growth in 2021, the company suddenly faced considerable headwinds in 2022 — slowing growth, burning cash, and declining morale.
Based on their last fundraise, the CEO is determined to get back on a 2-3X growth track that he feels sure is going to make the company more attractive for the next funding round. Forecasted to finish 2022 at $3.0M ARR they would push for 2.5X growth to $7.5M ARR in 2023 followed by 2X growth to $15M in 2024.
The company has a modest NRR (net retention rate) of 110% but is comfortable that it will get to 125% for 2024. It’s been a tough year and the current Burn Multiple is 3.0, but given the need to ramp up additional GTM resources, they can only get to a Burn Multiple of 2.5 in 2023 and 2.0 in 2024.
With $6M in ending cash and debt facility, they know they will need to raise more capital.
About The Excel Tool
The Burn-Based Planning Tool is a simple excel spreadsheet with two tabs that help illustrate the difference between the old way of planning based on ARR growth requiring a large capital raise and the new way based on a projected burn multiple and modest available capital.
Download Companyon’s Burn-Based Planning Tool Here >>
Planning the Old Way: ARR-Based Growth Tab
Looking at the ARR-Based Growth model illustrated above, the challenge with driving higher ARR growth is the capital required to realize that growth. Once it’s clear that the projected burn will exceed opening cash and debt, the CEO is forced to raise money, and given the current burn in this climate, it will need to be an external round that will support an 18-24 month runway. That’s a significant Series A raise of $25-30M. Raising a Series A is tough, but the company is coming off a difficult year and lacks the traction to raise this round. It’s not a viable strategy.
The New Way: Burn-Based Growth Tab
Companyon is encouraging its CEOs to face the reality of this market and adjust their thinking to growth-at-low-burn. Specifically, a burn multiple of less than 2, i.e. for every $2 in cash spent you create $1 in Net New ARR. It’s not an overwhelming ask. With lower burn, a modest investment can deliver compelling growth over the next year with better overall metrics, positioning the company for a strong Series A as markets improve.
The key to success in this approach to growth is GTM (go-to-market) conversion rates. In order to improve burn multiple while still achieving some level of revenue growth, the company must dramatically improve the GTM conversion metrics. That means improving the conversion rates from lead to qualified lead, qualified lead to sales opportunity, and sales opportunity to closed/won deal. Improving these conversion rates requires cracking the code on the optimal product/market fit, customer segments, and improved competitive positioning and sales execution. The list goes on. This is where the hard work comes in: How to build a capital-efficient, optimal execution, and high-output company.
In the Burn-Based Growth tab, we can adjust the amount of capital available to fund the business. With no incremental new capital investment, ARR growth will be low, just 33% YoY, but the company is more viable to weather a poor macroeconomic year. Now we can decide what level of incremental investment we can make as an extension or bridge round, most likely with existing investors. In this case, we estimate $3M is doable and will yield a healthy 83% YoY growth.
Going into 2024, the company is now an attractive business with strong metrics that will support a healthy round as the market conditions improve and the company has proof that it can get back on an accelerated growth trajectory. Of course, the lower the burn multiple in 2023, the higher the ARR growth on that bridge round. With a burn multiple of 1.65 in 2023, the company would be back on a 2X growth trajectory in 2023 on much less capital, at much lower risk, and with far more attractive metrics.
Getting to Burn Multiples < 2
Subscribe to our newsletter and join me and Parthib Srivathsan, Companyon’s Head of Data Analytics and Strategy, as we share more tools and tactics to help you reach a burn multiple less than 2 in order to meet the new realities of capital-constrained growth.
In our upcoming blogs on this topic, we will help you:
- Segment your business to meet your strategic goals
- Instrument and optimize your lead conversion rate
- Build your pricing strategy to drive sustainable growth
- Optimize gross margin by reducing COGS
- Improve cashflow through better payment terms