I love Substack, but their recent efforts to hoodwink retail investors got me thinking about how many people there are out there who may be getting unnecessarily fooled into investing or joining a startup that doesn’t make much financial sense. In the past couple years I’ve read at least a dozen “how to join a startup” blogs. So, here’s a new one: how to know when to quit?
Let’s say you’re working at a startup called “HypeCo”. HypeCo is a B2B software company based in Silicon Valley selling high margin recurring revenue software. Lets run some basic numbers to figure out whether to stay, leave, or at least be reasonably worried.
Let’s say you joined HypeCo last year. The company was doing $3m ARR growing 250% annually. They raised $50m in Series A funding from marquee Silicon Valley investors at a $250m pre money valuation, or $300m post money. They projected to end the year at $12m ARR, growing 4x, and burn $30m to get there.
Here are a few key critical points to consider:
Multiple compression: A $250m pre money valuation divided by their revenue of $3M ARR is an 83x revenue multiple! Those multiples might have been kosher in 2021, but not 2022 and definitely not 2023. In today's high interest rate environment, “HypeCo” is looking at a private or public financing with a 5-10x revenue multiple.
Unrealistic outcomes: In order to 3x your money as an employee, you’d need to see the company be worth over $900m. That means either the company must get acquired, go public, or have another investor step in to keep financing the company at an ever higher price. In 2023, the latter option is increasingly rare as most of the funds who used to do this are in big trouble now (and rightly so). The former two will likely see you back at a 5-10x revenue multiple. What does this mean? The company has to grow revenue between 30-60X just for you to make a 3x return!
Efficiency: Say you defy the odds and do grow 30x. The market doesn’t just care about the speed of your growth, but also how you grow too. One key metric to look at is an efficiency score: Net new revenue added in period/ total money spent in period. Say in 1 year, HypeCo ends the year at $12m ARR, up from $3m ARR and spends $30m. This means HypeCo spent $30m to generate $9m in “net new ARR”. That’s an efficiency score of 30%. Another way to think about this: how many cents in new revenue does HypeCo get for every dollar they spend? Spending 1 dollar to get 30 cents back of revenue doesn’t sound that great, especially if those 30 cents of revenue now trade at 10 times, rather than 83. For those curious about efficiency benchmarks for SaaS companies, Bessemer does some great content on this topic (hint, good aint 30%!).
Runway: the scariest question of all, how much time do we have left? Take your monthly net cash burn rate and divide it by total cash on hand. Anything less than 18-24 months means most venture backed loss making companies should already be back on the fundraising treadmill. In HypeCo's example, $50m may seem like a lot of money, but with a monthly net cash burn rate of $2.5m, they only have 20 months left before they run out of money. They need to raise money soon, and also somehow 30x the size of the business, all with revenue multiples that are likely a fraction of what they were when the first set out.
So, should you quit HypeCo?