Metrics That Matter - How to Build a Startup

Summary

The transcript emphasizes the importance of focusing on key metrics over traditional financial statements for startups. It suggests that while investors may request income statements and balance sheets, founders should prioritize understanding metrics that directly impact their business, such as customer acquisition costs, conversion rates, and lifetime value. The speaker also highlights the significance of market type, operating costs, and revenue streams, urging founders to be intimately familiar with these figures to effectively navigate their business model and avoid relying on speculative forecasts.

Takeaways

• 📊 Traditional financial metrics like income statements and balance sheets are important for visibility and forecasting, but they may not be as valuable for startups that are still defining their business model.
• 🔍 Startups should focus on deriving the key metrics that matter for their specific business, rather than just following standard accounting practices.
• 📈 Understanding the value proposition, including product cost, market size, potential market share, and competition, is crucial for strategic business planning.
• 💰 Customer relationship metrics such as customer acquisition costs, conversion rates, and lifetime value are essential for assessing customer relationships and growth potential.
• 📉 The type of market a startup is in (existing or new) can significantly affect its revenue curve and should be considered when planning and forecasting.
• 💼 Investors may require traditional financial documents, but founders should also ensure they understand the operational metrics that directly impact their business.
• 🛒 Knowing the cost of the channel, including promotion and any additional charges, is important for calculating margins and setting pricing strategies.
• 💡 Revenue stream metrics, including average selling price, number of customers, and sales cycle length, are critical for understanding and managing revenue generation.
• 🔥 Awareness of the burn rate and the timeline until the startup runs out of funds is vital for financial planning and sustainability.
• 📝 Founders should be able to list and understand the key metrics that are most relevant to their business, as these will guide decision-making and strategy.
• 🔄 Recognizing that these key metrics may change over time is important; founders should be proactive in seeking out and adapting to these changes.

Q & A

What are the traditional financial documents that investors often ask startups to maintain from the beginning?

Investors typically ask startups to maintain an income statement, a balance sheet, and a cash flow statement from day one to provide visibility and forecasting.

Why might traditional financial metrics not be as valuable for startups as they are for existing companies?

Traditional financial metrics are execution metrics, which are more relevant for existing companies that execute known plans. For startups, these metrics may not be as valuable because they are often based on assumptions and guesses rather than actual execution.

What is the primary focus for startups when working with investors and their management team?

The primary focus should be on deriving the key metrics that matter for the startup's business model and operations, rather than just focusing on traditional financial documents.

What are some examples of key metrics that startups should focus on according to the script?

Examples include product cost, market size, potential market share, competition pricing, customer acquisition costs, conversion rates, and customer lifetime value.

Why is understanding the type of market a startup is in important for forecasting revenue?

The type of market (existing or new) affects the revenue curve and growth trajectory, which in turn influences the startup's financial planning and investor expectations.

What are some of the operational costs that a startup should consider?

Operational costs include fixed and variable costs of the business, channel costs, margins required by the channel, and expenses for channel promotion and other channel-related charges.

What is the significance of knowing the average selling price and the number of customers per year for a startup?

Knowing the average selling price and the number of customers per year helps a startup to estimate achievable revenue, which is crucial for financial planning and understanding the business's growth potential.

What is the 'burn rate' and why is it important for startups to monitor it?

The 'burn rate' refers to the amount of money a startup spends per month. Monitoring the burn rate is important because it helps founders understand how long their current funding will last and when they might need additional capital.

How many key metrics does the script suggest a startup should focus on?

The script suggests that a startup should focus on between 5 to 15 key metrics that are most relevant to their business.

What exercise is recommended for founders to better understand their business model?

The exercise recommended is for founders to go to a whiteboard and list the key metrics of their business, which helps in identifying and understanding the parameters that are crucial for their business model.

Why is it suggested that founders should experience the business model canvas and customer development process firsthand?

Experiencing these processes firsthand allows founders to find and understand the key metrics that matter for their business, rather than having assumptions made for them or relying solely on guesswork.

Outlines

00:00

💼 Importance of Metrics in Startups

This paragraph discusses the traditional focus on financial metrics like income statements, balance sheets, and cash flows in startups, which are often considered execution metrics for existing companies. It emphasizes the need to identify and track metrics that are truly relevant to the business, such as product cost, market size, competition, and customer acquisition costs. The speaker suggests that founders should work closely with investors and management to derive these key metrics, which are more important than speculative future revenue projections. The paragraph also touches on the importance of understanding the business's market type, operating costs, channel costs, and revenue streams, as well as the burn rate and when the startup might run out of funds. It concludes by stating that founders should know these critical numbers and that they will change over time, reflecting the dynamic nature of startups.

Keywords

💡Costs

Costs refer to the expenses a company incurs in the process of production and operation. In the context of the video, costs are highlighted as a critical factor to track from the inception of a company. The speaker emphasizes that while investors traditionally focus on financial metrics like costs and revenue, startups should prioritize understanding the metrics that are truly impactful for their business model.

💡Revenue

Revenue is the income generated from the sale of goods or services. The video script discusses how investors often seek visibility into a company's revenue from day one, but the speaker argues that startups should focus more on deriving metrics that matter for their specific business rather than just tracking revenue.

💡Income Statement

An income statement is a financial statement that summarizes a company's revenues, costs, and expenses during a given period. It is one of the traditional metrics investors expect startups to track. The script suggests that while income statements are important for investors, they might not be as valuable for the startup in terms of strategic planning.

💡Balance Sheet

A balance sheet is a snapshot of a company's financial condition, showing its assets, liabilities, and equity at a specific point in time. It is another traditional financial metric discussed in the script. The speaker implies that while balance sheets are necessary for investor reporting, they may not provide the actionable insights a startup needs.

💡Cash Flow

Cash flow refers to the net amount of cash and cash equivalents being transferred into and out of a business. The script mentions cash flow as a key metric that investors want startups to track, but the speaker suggests that startups should also focus on other operational metrics that directly influence their business growth.

💡Execution Metrics

Execution metrics are performance indicators used to measure how well a company is executing its business plan. The video emphasizes that while existing companies use these metrics to track performance, startups need to identify and focus on metrics that are more relevant to their growth and development.

💡Value Proposition

A value proposition is a promise of value to be delivered through a product or service. In the script, the value proposition is discussed in terms of product cost, market size, and potential market share, which are key metrics for startups to understand their positioning in the market.

💡Customer Acquisition Cost (CAC)

Customer Acquisition Cost is the cost associated with convincing a customer to buy a product/service. The script highlights CAC as a critical metric for startups to understand and optimize, as it directly impacts profitability and growth.

💡Lifetime Value (LTV)

Lifetime Value is the total worth of a customer to a company over their entire relationship. The video script underscores the importance of LTV as a metric for startups to gauge the long-term profitability of their customer relationships.

💡Burn Rate

Burn rate refers to the rate at which a startup is spending its capital. The script mentions burn rate as a key metric that founders need to monitor closely, as it directly relates to the financial sustainability and runway of the startup.

💡Business Model Canvas

The Business Model Canvas is a strategic management tool that helps businesses understand, design, and innovate their business models. The script suggests that the canvas is a useful framework for startups to identify and understand the metrics that are most relevant to their business.

💡Channel Promotion

Channel promotion refers to the marketing efforts made to increase visibility and sales through various distribution channels. The video script discusses the costs associated with channel promotion as a metric that startups need to consider when planning their go-to-market strategy.

Highlights

In the early days of a company, investors often request financial statements like income statements, balance sheets, and cash flow for visibility and forecasting.

These financial metrics are execution metrics, useful for existing companies with known plans, but may not be as valuable for startups.

Investors need financial documents for their own reporting, even if they may not be as useful for strategic planning.

The focus should be on deriving metrics that truly matter for the business, rather than just preparing financial documents.

Examples of key metrics include product cost, market size, potential market share, competition pricing, and customer acquisition costs.

Metrics related to customer relationships, such as conversion rates and lifetime value, are crucial for startups to understand.

The type of market (existing or new) impacts the expected revenue curve and should be considered when setting business goals.

Operating costs, including fixed and variable costs, are fundamental to understand for any business.

The cost of sales channels and the required margins are important considerations for revenue generation.

Knowing the average selling price, number of customers per year, and achievable revenue are key to understanding the revenue stream.

The burn rate, or how much money is spent per month, is a critical metric for startups to monitor.

Startup founders need to know when they will run out of money based on their current burn rate.

Startups typically have a small set of key metrics, around 5-15, that are essential to track.

Founders should be able to list these key metrics from memory, as they are central to the business model.

The business model canvas and customer development process are tools to help identify and understand these key metrics.

Metrics should be actively sought out and understood by the founders, rather than passively waiting for them to emerge.

Once the key metrics are known, creating financial spreadsheets becomes a more straightforward task.

Starting with a spreadsheet based on assumptions can lead to unrealistic expectations and is not recommended.

The process of finding and understanding key metrics is essential for the success of a startup.

Transcripts

One of the interesting thing about costs is that in the old days costs and revenue,

the minute you started your company, your investors said oh, we know how to track all this.

We want you to fill out an income statement, a balance sheet, and cash flow,

and we want you to do accounting from day 1 which gives us visibility and forecast, etc.

The problem is these were execution metrics.

Existing companies execute known plans.

You could in fact do all the spreadsheets you want for every board meeting,

but in fact they're not worth the paper they're printed on.

But you and your maybe rent-a-CFO or accountant have spent a lot of time.

Now understand that your VCs or investors, if their professionals,

need them for their investors.

But what you really need to be doing is working with your investors and your management team

is to derive the metrics that matter.

If your investors really want to see income statements, balance sheet, client referral,

great you could give them fantasy documents all they want.

But what your really interested in is trying to understand,

what are the metrics that matter for your business?

I'll give you some examples.

In value proposition, what was the product cost?

What was the market size? What share could you take?

What is the competition? What are they charging?

In customer relationships all the get-keep-grow metrics, some of which we talked about,

some of which you'll discover, what were the customer acquistion costs?

What were the conversion rates? What was the lifetime value?

These are key metrics.

This is a lot more important than what is revenue in year 4,

because you're just guessing about that.

But these are numbers you're going to be living with every day.

By the way, what market type are you in?

If you remember from our earlier lectures, if you're an existing market,

that's a different type of revenue curve than being in a new market.

Do your investors still agree?

What are your operating costs? What are the basic fixed and variable costs of the business?

What's the cost of your channel? What's the margin, the channel needs?

How much are you going to have to spend on channel promotion,

shelf space, any other channel extra charges?

Then again for your revenue stream.

Do you now know with certainty the average selling price, the number of customers per year,

achievable revenue, how long it takes to close a sell?

Here's the number that actually intersects with one of the ones that your investors

are worrying about all the time.

How much money are you spending per month?

Often called burn rate.

Not only how are you burning per month, but when we just calculate that out,

when will you run out of money?

All these numbers are ones that you as founders need to have on the top of your head.

No startup has 300 numbers. There's probably somewhere between 5-15 that matter.

Maybe you could be the exception, but you as the founder need to know all these parameters.

In fact the exercises, see if you could go up to a white board and list them.

If you can't, understand that that's your job in searching for the business model.

When you know these numbers, the spreadsheets fall out of these.

But trying to do it ab initio from some guessing spreadsheet just is some fantasy.

You need to get these metrics that matter known, searched, understood, and don't worry,

they will change, but the whole game of the business model canvas and the customer

development process was for you to find them out firsthand and to experience them,

not to have them happen to you.