Recently I spoke to an entrepreneur who said he’d “raised $20mm from X, Y, and Z top tier VC”. The way he said was surprising to me: he was proud of the amount of capital he’d raised and the pedigree of his investors, but his ARR was only at $1mm. We’re looking at the deal but make no mistake, if we get involved it will require a restructuring and unfortunately, a big down round.
While it’s a gift to have access to lots of capital from lots of VC, burning through large amounts of money to get to $1mm of ARR is not ok. Historically the attitude, especially on the West Coast, has been to grow market share at whatever cost and figure out how to make that market share profitable later. More and more, however investors are starting to realize the problems with this approach: aside from the fact that it’s extremely expensive to do, crushes your return unless the exit is truly monstrous, and takes a long time, operationally it means your business model has to pivot at some pint into profitable monetization AFTER your customer base has become used to getting subsidized to use a product or service. That last point is incredibly hard to do and indeed few businesses can pull it off.
At DAN Fund, we can certainly look at situations like this whereby a restructuring is necessary, but obviously as an entrepreneur it’s a horrible position to put yourself in. In our view, unless you have access to enormous sums of capital, a good solid business that wants to give itself a high probability for success should do a few things:
-Use the angel and seed rounds to build a product and small market, but make sure the Series A gets you to profitability. The leverage you give yourself when you’re profitability going into a Series B is tremendous.
-A responsible seed round will be about $1mm and a responsible Series A will generally be $3mm to $5mm. If you can’t get to profitability with this kind of cash on ARR of $1mm to $2mm, you need to rethink the business model.
-If you’re a SaaS business, don’t let the burn to MRR ratio exceed 3:1 and if it’s 2:1, you better be at least doubling year over year. Ideally, your burn to MRR is at 1.5:1 or 1:1 and steadily declining.
-As you build a business, it’s not a requirement that you be profitable at all times, but make sure that if a recession comes tomorrow, there are cuts you can make to get you to profitability quickly without completely killing growth.
-Get to break even or profitability with the Series A round, and then dip back into burning mode with the Series B/C rounds so long as you can revert to profitability if you need to.
-Have a sincere respect for capital and be incredibly cheap. Nothing gets me more excited about an entrepreneur like seeing him/her avoid picking up the tab at lunch or look for parking meters that still have time on them. It means that person runs the business with the same scrutiny on burn. Always try to measure the ROI of every dollar spent.
Growing responsibly and building an actual business that can sustain itself needs to be your goal. Burning a lot of cash and having little traction to show for it is a sure way to a restructuring, a down round, or death.