If you go to any consumer or retail-related trade show now, the exhibit floor is almost entirely technology companies, sometimes thousands of them, offering their services to brands and retailers. Those companies are powering the integration of physical stores and online merchants, a critical next step for the retail industry.
To grow, they need capital. But equity values have declined in the last few months and investors buying in now want something different. Most companies are being told to avoid raising capital now if you don’t have to. But those that must are saying that the key performance indicators investors want are very different from the recent past.
In times of economic uncertainty, investors’ criteria change. The focus turns more to earnings and cashflow and away from growth-at-any-cost and market share gains. The emphasis on profit is one of the things happening now.
What Investors Are Looking For Right Now
These are the metrics I am told investors are focusing on for retail technology companies:
Annual Run Rate (ARR) – In a fast-growing, young startup, the annualized rate of the current performance changes constantly. Investors use ARR to assess what annual revenue would be if the current level holds steady for a year. I am told that venture investors want at least $3 million ARR and growth investors want at least $10 million in ARR. That tells them the business has traction which validates the concept and reduces their risk.
Growth – When companies are small, they grow rapidly and that’s important if investors are to ever make money. Growth of 10-40% per quarter is common and companies near the bottom of the range or below it will find it hard to raise money.
Churn is what percent of customers are lost every month. A number under 2% is desirable and more than 2% turns investors off.
Gross Margin is what’s left over after deducting just the cost of what’s being sold without any overhead. For companies selling only information, or software-as-a-service companies, investors are now looking for gross margins of more than 90% under GAAP (generally accepted accounting principles).
Net Revenue Retention (NRR) – NRR is the percent of customers a company had 12 months ago that it still has. Investors are looking for 85% retention. NRR and Churn are measuring the same effect over different periods but churn is more sensitive to sudden changes.
LTV/CAC – Put simply, it’s the percent of revenue that companies spend on marketing. When LTV/CAC is 3x, it means that every dollar spent generates $3 in revenue. Put another way, it means that 33 cents out of every revenue dollar is spent on marketing. When the gross margin is 90%, that’s a good number, if the gross margin is lower, the LTV/CAC needs to be better.
What To Expect, Now And For The Future
These metrics are fundamentally different than what investors were looking for even just a few months ago when growth was king. Getting to scale, getting the leading market share and dominating a market were much more important then. Now with capital harder to source, investors still want growth but not at the expense of profitability.
We are seeing young, fast-growing companies lay off employees that they recently hired to pare costs, improve profitability and get closer to cash flow positivity with the capital they have. That kind of efficiency is much more attractive now than the growth-at-all-costs mentality that existed for the last several years.
Change is the nature of financial markets. It was inevitable that the focus on growth would come to an end just as it will happen that the focus on profitability that we’re now seeing will eventually end as well. The challenge for growing companies is to take capital when it’s plentiful and preserve capital when it’s scarce.
The next time you see a growing company raising money when it isn’t absolutely necessary, you may be looking at a founder with great foresight. We are now going to see companies without that foresight cutting costs to make to a time when capital is easier to raise again.