Ramya Varma is the VP of Finance at Priori. Previously, Ramya held finance leadership positions at LitLingo and Propeller Industries and spent over a decade as a private equity investor.
Venture capital-backed companies traditionally operate with a “spend to grow” mentality, with the expectation that they will be able to raise multiple funding rounds to drive rapid growth. But with interest rates rising and valuations bearing the impact, it’s increasingly difficult to raise new funding on favorable terms. Many startups are considering the potential impact of both declining investor demand and an uncertain growth trajectory as they make plans for 2023.
In this “new normal” economy, even the highest-quality startups can’t guarantee the stratospheric financing outcomes of 2021. Many companies are finding that they need significantly extended runway to grow into valuations set in a much frothier environment. To maximize the possibility of success, startup finance leaders need to take a critical eye to capital allocation.
While private equity (PE) backed companies typically have distinct growth trajectories and exit goals vs. VC-backed businesses, PE’s relentless focus on capital efficiency is a discipline worth emulating for startups in the current funding environment. The best PE-backed companies consistently achieve strong growth while running at or close to profitability. To achieve similar capital efficiency, finance leaders at VC-backed companies can focus on three areas:
Understand what it will take to (eventually) become a profitable business
Although it may not be a primary or near-term focus for most VC-backed startups, it’s useful to understand what it takes to become a profitable business. Scenario plan to understand the impact of paring back spending across various areas of the business. Where do tradeoffs materially impede growth, and where is the opportunity cost of reductions lower?
This exercise can provide insight into how the company can operate on its own terms and timeline while still achieving favorable outcomes. For example, an analysis may show that extending runway by 18 months would require delaying the company’s original revenue goals by 12 months. By understanding tradeoffs on the path to profitability, company leaders can better understand how to make informed decisions about company priorities, execution, and financing alternatives.
Ensure headcount efficiency through sustainable hiring
Hiring sustainably is a vital part of capital efficiency. When planning hires, evaluate your plan against headcount efficiency benchmarks such as revenue per employee. Rather than planning for aggressive expansion and subsequently freezing hiring — or worse, reducing headcount — when bumps in company growth occur, partner with business stakeholders to pre-define growth milestones that trigger accelerated hiring.
When planning headcount, focus on ROI first. Consider what outcomes the business is driving with each new hire and whether these align with your core goals for the budget year. This means requiring department leaders to provide a business case for each hire, and may mean prioritizing the revenue-generating roles required to hit your plan before expanding R&D and administrative teams. Ask business stakeholders: how will this hire generate revenue or reduce cost? What’s the plan for measuring new hire performance quickly and quantitatively? Prioritize hires that can be measured for their impact on the company plan’s success early, allowing enough time to react to market conditions and the business performance.
When expanding the R&D side of the business, understand the concrete impact of that growth. Focus on scaling in a structured way and maximizing the productivity of existing teams. While it may be more challenging to tie engineering, product, or operations hires directly to revenue or margin expansion metrics, Finance can work with business stakeholders to instead understand how these roles will support market share capture and/or improved service quality. For example, are critical features being developed, usability improved, or is the company expanding into a new product or service line? What resources are required to hit those goals? What’s the roadmap to achieving them, and how will success be measured?
Approach Marketing as an investment case
Optimizing marketing spend in a downturn doesn’t mean broad cuts across the board. Assess marketing spend as a percentage of revenue to assess whether your company is overspending, underspending, or on target. Benchmarks such as Openview’s SaaS Benchmarks Report and KeyBanc’s Private SaaS Company Survey provide directional guidance on allocating capital by function. Higher spend vs. benchmarks may signal a need to take a closer look at return on investment. Conversely, underspending on marketing relative to competitors could put the company at risk for losing market share, but could also indicate a highly-efficient marketing organization ready to scale profitably with more investment.
To allocate budget efficiently, Finance and Marketing will need to partner to understand key drivers of customer acquisition, including conversion rates and volume by channel. Lead generation should always be a top priority — it’s a table-stakes component of achieving growth. Leads feed the sales team and turn into deal wins. Often, the equation is as simple as “if we don’t spend a minimum of X, we can’t feed Sales enough leads to hit our revenue goals.”
Finance can also work with Marketing to classify expenses as proven or experimental. Define budgets for proven channels while maintaining an unallocated budget to test new channels and double down on the highest-performing experiments. An unallocated pool allows Marketing to remain agile and invest in future growth without cannibalizing other initiatives.
Marketing and Finance should come to a mutual understanding of the metrics to be measured. What’s the commit for top-of-funnel leads? How long will leads take to mature in each channel? How often will we course-correct based on the data? Ensure that the effectiveness of each marketing initiative will be monitored, shared, and reassessed every quarter.
When economic headwinds make the hyper-growth path more challenging, finance teams that focus on being constructive rather than reactive will come out ahead. Leaders who understand the unit drivers of growth and collaborate closely with functional leads to make thoughtful decisions can ensure their organization remains sustainable for the long term.