Why CreativeCo invests in capital efficient companies
Today, company X raises $Y from A, B and C.
While the news of financings all sound similar on the surface, the details of the companies, the investors and the deals are increasingly diverse. As founders, you are choosing your best path for your company— and as investors, we are choosing the companies that best match our investment thesis. When that match is made, our financing hits the press and sounds similar to all others.
CreativeCo’s seed and series A financings may sound like others, but our goal is for our portfolio companies to share a common and unique business characteristic. CreativeCo invests in capital efficient companies.
What is capital efficiency?
CreativeCo considers the following attributes to be core to capital efficient management.
- Revenue-first approach. We like to see operators that view revenue as the absolute first priority in building the business. A focus on growing revenue each month regardless of other constraints (such as product or team) demonstrates a culture of building a business independent of funding.
- Burn as a function of revenue. With revenue growing, a team can choose the level of burn that makes sense. We like to see operators that view burn as an adverse condition to their company’s health, and have a clear plan for how the business will be profitable based on demonstrable unit economics. SaaS metrics such as the Rule of 40, which connects the dots between growth rate and profitability, plus other published metrics (such as Bessemer’s GRIT) should allow you to determine the appropriate burn for your business.
- Operating with a funded growth plan. The most capital efficient entrepreneurs are those without capital who are forced to make it work with what they have. CreativeCo invests in places like Charlotte, Atlanta and Dallas where operators learn to grow a business with limited early stage capital. We like to see this capital efficient mindset as the foundation for a growth plan — a small investment generates solid growth due to the efficiency of the business — and achieving profitability is part of the plan.
How do you be capital efficient?
The great thing about being an entrepreneur is that your business is your business and what you build is under your control. Capital efficiency can be achieved with some key choices:
- Business model design. Selling a customer is difficult and costs money, so maximizing what you keep for each dollar sold is the first step towards a capital efficient business. Your target market, service pricing, and delivery costs should all be designed so you make a high gross margin (SaaS gross margins are ~85% for example) and target a model where net revenue retention >100% is achievable. Also be realistic with your real revenue — for example if you are a marketplace, build your business around your net revenue, not your GMV, and avoid marketplace business models where your take rate makes it difficult to build a business (less than 20%).
- Organizational scrappiness. Build an organization that fits within your gross margin assumptions, and build this organization with “scrappiness” at heart. Keep in mind that salaries generally run between $50-$150k per head and will be your primary cost driver, so establish a team and a culture where lower salaries work. You can benchmark your revenue per head against public companies and other startups, and realize that you can optimize this number with more revenue, a smaller team, and less expensive team members. For example, we’re huge advocates for running engineering teams in Eastern Europe.
- Spending discipline. Regardless of what is happening in the Bay Area, limit your non-core spending across the board until you can pay for it from your company’s operating income. Be open to remote working and other less-than-ideal setups for running and growing your business. If you start a lean culture from the beginning, it’s easier to remain lean as more team members join and shape the organization.
The upside of running lean
The benefits of building a capital efficient business are longer-term in nature and accrue to founders and early stage investors:
- Investor flexibility. With a modest burn, companies have longer periods of time to explore and compare sources of capital such as non-dilutive revenue based financing or other forms of debt, which can defer the next equity financing until more progress is made. Bad things can happen when a company has a high burn and a limited runway before the next round is needed — read this from Paul Graham on the topic. However, with the time and flexibility that a low burn affords, companies can focus on building the business versus being in the business of raising money.
- Path to profitability. We live in a world where EBITDA is incredibly valuable, and having profits ensures that a company can perform without additional capital investment and more importantly — that it can access capital when it needs it. You have to be about 30 to have worked through the great recession. You have to be over 40 to remember working in the dot-com crash. Operating on a profitable basis allows a team to leverage these inevitable peaks and valleys to their advantage.
- Long-term control. We all admire founders that run their business successfully for decades and build a lasting legacy. The odds of being in this enviable spot are greatly increased with capital efficiency, as founders bring on new investors on their terms and retain a significant ownership position over time. While it’s difficult to think really far ahead, especially when grinding it out in the early days, try to keep in mind that the most inspiring value (not just monetary) is generated over periods of decades.
- Shareholder liquidity optionality. Founders no longer have to sell their company to get liquidity on founder shares. The growing presence of private equity investors in the smaller software market is opening new doors to shareholder liquidity that reward capital efficiency. Keep in mind that competing priorities between founders and investors can lead to less attractive outcomes, and this dynamic grows the more money is raised at higher valuations. So the trick is to balance the upside potential with investor expectations so that attractive offers for liquidity can all be entertained.
CreativeCo is looking to invest in seed and series A companies where the founding team has made a distinct choice to build a sustainable business with capital efficient characteristics. While our financing press releases may sound similar to others, CreativeCo and our founders will know that we’re going in a direction together that we all believe makes tons of sense.
CreativeCo is a growth equity studio. We invest capital and capabilities in early-growth stage business cloud companies. Feel free to contact us directly at email@example.com