We recently published an article in the Business Journal about capital efficiency. I take a deeper look at the subject in the below blog post.
To say there’s a lot of money available for tech entrepreneurs is an understatement. As startup valuations rise, founders often assume that everyone is raising as much money as possible and spending it like there’s no tomorrow.
I advise young companies to raise money cautiously. Raising too much, too fast can make it difficult to find capital further down the line. I encourage them to first chase capital efficiency, which I define as a high level of financial return on capital deployed. Establishing capital efficiency early and maintaining it to scale (and beyond) helps a company develop passionate, insightful leadership, as well as a targeted and loyal customer base.
A startup that holds the line on capital efficiency through its angel rounds demonstrates a track record of sound money management. Institutional investors are much more likely to throw their money behind a startup that has used its angel funding prudently than behind a devil-may-care spender.
Below are some best practices for maintaining capital efficiency.
Don’t splurge on sales and marketing
I’ve seen many startups hire large sales and marketing teams, then launch huge campaigns, before they fully understand their business model. This is a setup for failure. In a company’s early days, the founding team should be making most sales.
When your company is small, it’s not efficient to hire a sales manager. Your CEO, who has a much stronger understanding of the industry problem your company is trying to solve than anyone else, should be your number-one salesperson. Customers take a huge risk when they bet on the product of an early-stage company. They want to see the whites of the CEO’s eyes to know he’s committed to their success.
The founders of WageWorks, where I was VP of sales and partner development, did a great job on this front. They were tax policy experts, not salespeople, but WageWorks’ commuter benefits services were in such high demand that despite having no prior sales experience, they were able to sell to major clients, such as Ernst & Young, Pitney Bowes, and Bank of America within the first two years. Such customers gave WageWorks credibility when the company began marketing to Fortune 500 companies. By 2003, when WageWorks hired its first professional salesforce, 50 of the Fortune 500 were customers.
Likewise, when life sciences software maker Veeva Systems launched, it focused primarily on selling to just the top 20 companies in the pharmaceutical industry. When it went public in 2013, Veeva was a $4 billion public company few had heard of. Its leaders had targeted customers personally, building meaningful, long-term relationships, and felt no need to pound their chests in Silicon Valley. Then, with a meaningful base of customers and product validation, the company benefited from word of mouth and became the industry standard for pharma CRM despite spending very little on marketing.
Hire the most eager talent, not the most senior
In a company’s early days, you need employees who want to execute, not delegate. Capital-efficient startups tell me they turn down a lot of applications from seasoned engineers who haven’t coded in at least five years and are used to delegating. They realize they need employees across all functions who will roll up their sleeves.
A startup I know churned through three senior sales leaders in two years before realizing that it should promote its top sales representative. He had been helping the company define product-market fit and had been speaking with lots of customers; he had more credibility to lead the team than any outsider.
In these early days, you want people who will be motivated more by equity or potential bonus than guaranteed wage. They’ll have more conviction in what you’re doing and will want to do more to increase the value of your company than an executive who’s in it for an unnecessarily high wage. They’ll set the company culture and grow into bigger roles over time.
Solve an industry pain point
A startup should focus its resources and attention on one product that solves a really important pain point. Customers tend to pay for products that solve their top one or two problems; many startups waste money trying to build a portfolio of products, each with a thin layer of functionality. These companies don’t produce the top product in any area.
So take a methodical approach to your product plans. It’s better to have small successes than try to win the entire market at once. Develop other products over time.
Cornerstone OnDemand, where I was VP of channel management, developed and launched its employee learning software before turning its attention to other cloud-based talent management products. Building a single best-of-breed product gave Cornerstone the credibility to later sell its customers recruiting, performance, onboarding solutions, and other products.
Likewise at WageWorks, we first focused on a commuter benefits product. Our success in this realm gave us enough credibility to later develop and sell health savings account products, among others. In the early years, we focused on one area where we knew we could provide the best product, and we became the top company. Customers had such a great experience that they trusted us when we began to offer more.
Keep money in the bank
Many entrepreneurs who raise a lot of money early believe attracting investors will always be easy. This isn’t so. Investors want to see that you’ve been successful with what you already have. They want to see that you have channeled money you’ve saved on marketing and recruiting into developing the best product in the marketplace. They want to see that you are spending prudently.
10 ways startups can establish and maintain capital efficiency
- Develop the best product addressing one key problem to start.
- Ensure that the problem is a top pain point for many stakeholders.
- Hire talent that wants to execute, not delegate.
- Promote from within.
- Have your CEO lead sales efforts to secure the first 10 customers.
- Ensure that those first 10 customers are not your friends or family.
- Establish your sales model before expanding go-to-market efforts.
- Quantify the return on investment before spending anything on marketing.
- Test your marketing messages with small audiences before running major campaigns.
- Don’t spend everything you raise.