Your Development Dilemma: Growth vs. Capital Efficiency

Tuesday Dec 11, 2012 by Firas Raouf - Venture Partner, OpenView Venture Partners

The dilemma has become quite acute these days since there’s been an expansion of available capital from VCs to fund growth companies. The more capital available, the more capital is raised, the more capital is spent, and the more capital is burnt.

I spoke with Greg Gianforte last week about this topic. Greg is a huge proponent of building startups organically, and he actively shuns VCs.

His point of view is that companies burning capital in pursuit of hyper growth or market share “land-grab” are copping-out. CEOs should be driving their teams to operate within the company’s capital means, and should be working very hard to uncover efficiencies and differentiations that would drive growth and profit. Spending your way into growth is very risky, and can result in reduced equity value for your shareholders.

Clearly there are many companies that have successfully adopted the spend-your-way-into-growth strategy. Jive, Box.net, and Hubspot come to mind. But there are thousands other companies that have tried to play that game and failed miserably. You just don’t hear about them as loudly as the ones that are successful (for now).

So, if you’re about to raise capital to fund new growth, you must make sure you have the basic elements required to achieve capital-induced hyper growth:

1) Your Market Is Big Enough

Make sure there’s enough perspective buyers of your solution to support your growth plans. Spare yourself the top down market sizing (Gartner says our market is $1B growing at 15% a year). They are meaningless.

Your market size is very simple. Figure out your target buyer. Figure out how many of them exist in your target geography. Figure out how many of them you can convert into customers. Multiply that number by your average revenue per customer. Et voilà!

2) Your Service Is Differentiated

Does your product or solution truly stand apart? Do you regularly win against your competition? (Small tip: Please don’t fool yourself into thinking that you have no competition. You do. You either don’t know it or you’re ignoring it.)

As a company grows, it becomes more challenged to deliver the competitive advantage it used to when it was a smaller company. It starts with the founding CEO spending less time with prospects and customers, and rolls down the organization. So don’t assume what differentiates your company today will be sustainable without a lot of hard work.

3) You Recognize Growth Is Harder & More Expensive the More You Grow

Founders usually think that growing ten-fold from $1 million in revenue to $10 million is as easy as growing from $100 thousand to the first million. It is not. It is ten times harder and more expensive.

Revenue growth rarely scales linearly. And growth percentages drop the bigger you get. Acquiring customers gets more expensive over time rather than less. So make sure to temper your growth projections, and double your cost assumptions.

4) You’ve Achieved Capital Efficiency

Only spend more on acquiring more new customers if your cost of customer acquisition is profitable. A dollar spent in acquiring a new customer should generate at least a dollar in recurring revenue. If your revenue is non-recurring, then that dollar should generate 3-4 dollars in revenue. If not, then don’t spend more money on sales and marketing until you have figured out how to optimize your customer acquisition cost.

The more money you raise to grow your revenue, the less time you will spend on optimizing your operation and improving your product/service delivery. Always be aiming for organic growth, and only spend more if you have a highly efficient and profitable operation.

Firas Raouf is a Venture Partner with OpenView Venture Partners.  You may find this post, as well as additional content on OpenView's blog located here.  You can also follow Firas on Twitter (@fraouf) by clicking here

Homepage Slideshow Photo credit: Alex De Mey

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