Key Performance Indicators for Startups

Entrepreneurs as well as people in the general market are often left perplexed about how investors decide to value any company. It is common for two companies with very similar asset bases and value propositions to receive a very different valuation from investor groups. This may seem confusing to common people and the entire valuation process might appear to be a black box. However, this is often not the case. There are very clear reasons behind the differences in valuation. These differences are often reflected in the key performance indicator of startup companies.

In this article, we will have a closer look at what key performance indicators mean and how they impact the overall valuation of a firm.

• Customer Acquisition Cost: Customer acquisition cost is the cost that a startup company has to pay to acquire a customer. For instance, a startup company may have to undertake certain marketing activities or might have to offer certain freebies to prospective customers in order to induce them to try the product.

  A lot of the time, startups sell their products at a deeply discounted rate in order to get positive word-of-mouth going for the product. The customer acquisition cost is one of the metrics which allow the startup to gauge the efficiency of its marketing programs.

• Customer Lifetime Value: The customer lifetime value is an important concept and it needs to be understood in relation to customer acquisition cost. One-time acquisition of a customer can lead to recurring financial benefits in the future for the startup firm. Hence, the ratio between the customer acquisition cost and the lifetime value is very important. It helps investors understand how profitable the company is going to be in the long run.

• Recovery Time: Recovery time is the amount of time that the startup company will take to recover the initial customer acquisition cost. It needs to be understood that a short recovery time is highly desirable because as the period of time increases, it becomes unlikely that the company will be able to retain the customer and hence may not be able to recoup its initial investment. Recovery time is one of those metrics which is keenly observed by the investor community.

• Customer Retention Rate: The acquisition of customers is just one part of the story. The company loses money when they first acquire the customer. The company makes money when they are able to retain the customer for a long period of time and sell products and services to them repeatedly.

  Companies that have a high retention rate are preferred by the investors because it means that the customers have tested the product over time and believe that the company is giving the best value for money over the years.

• Overhead Ratio: Overhead can be very dangerous for a startup business. This is because overheads are payable regardless of whether there are any sales or not. Startup companies should try to keep their overheads at a minimum level. The focus for these companies should be the minimization of overheads even if it costs them more in the short run. Startup companies in which overheads form a small part of monthly expenses are considered to be more efficient and resilient. This is the reason that such startup companies tend to obtain higher valuations as compared to their less creative counterparts.

• Conversion Rate: The conversion rate is another important indicator for the investor community. The conversion rate measures the number of customers obtained vis-a-vis the number of customers who have been contacted. For instance, if a company contacts three prospective customers and is able to obtain one customer, then their conversion rate is 33%. A 33% rate over a sustained period of time tells the investors that the startup has a unique selling proposition. Hence, if they are given the money to serve a wider market, they will be able to scale up the number of customers at a rapid speed. Since customer acquisition rate is the predictor of profitability, this metric convinces investors to provide a significantly large valuation to the startup firm.

• Gross Merchandise Value: A lot of startup companies sell products with a very high value for a small margin. For instance, e-commerce portals such as Amazon earn a relatively small portion of the sale price as revenue. Hence, looking at the revenue for such companies distorts the situation from an investor's point of view. Hence, investors tend to look at the gross merchandise value of the goods and services which were sold. Companies with higher gross merchandise value tend to receive higher valuations even though they may have lower revenue compared to their peers.

• Average Active Users: A lot of websites and applications launched today do not earn money from the users. Instead, they earn money from other people by authorizing them to sell services to the user or by selling the user’s information. In such startups, the number of active users is considered to be a key performance indicator.

  A high number of average active users over a sustained period of time tells the investor that the application is providing a good value proposition vis-a-vis its competitors. Hence, startup companies that have a high number of active users tend to receive a higher valuation than their counterparts.

The bottom line is that there are a lot of intangible factors which are taken into account while coming up with a valuation. These factors may seem mysterious at first but thorough research easily reveals them and allows a startup company to use these factors to their advantage.