Capital Efficiency & SaaS: A Path to Sustainable Growth

Capital efficiency is a financial metric that measures how well a startup uses its capital to generate revenue. It’s an especially important metric for SaaS startups because it can help attract investors, ensure resilience, and develop engaged and thoughtful leadership. But capital efficiency and SaaS are about more than just numbers. The metric can also be used to align financial data to tell a larger story about your startup that can appeal to investors, customers and the board of directors.

In this post, we’ll cover the importance of capital efficiency, common capital efficiency ratios, challenges in maintaining capital efficiency and how to grow it. Read on to learn more or contact Graphite Financial today for help with your startup.

What is Capital Efficiency?

Capital efficiency is more than just a metric that measures a startup’s ability to generate revenue, it’s also a method for financial storytelling to attract investors and customers to truly grow a young startup.

The basic capital efficiency formula divides total revenue generated by total capital invested. For startups to succeed long-term, they must be able to demonstrate a path to lasting profitability and sustainable growth. Determining capital efficiency can help leaders better determine how they allocate resources and make more informed, empowered decisions.

How to Calculate Capital Efficiency for SaaS Companies

So how do you calculate capital efficiency for SaaS startups? First, you have to measure capital efficiency — and there are three key formulas that you can use to measure metrics. These are:

• The capital efficiency ratio formula (Total Equity + Debt – Cash) / Annual Recurring Revenue (ARR)
• A lower ratio is better and indicates a more efficient use of capital to grow revenue.
• The burn multiple (Net Burn / Net New ARR)
• This metric indicates how much cash a startup needs to generate each new dollar of ARR. The lower the burn multiple, the better for the startup.
• Cash conversion score: ARR / (Total Capital Raised – Cash on Hand)
• This is a metric that’s often used to measure future success.
• A good cash conversion score for SaaS companies is usually between 0.25x and 0.5x, indicating an internal rate of return of around 40 percent. A cash conversion score of 1.0 or better is considered best-in-class.

Key Metrics for Measuring Capital Efficiency in SaaS

SaaS companies can use various other key metrics to track capital efficiency. They include:

• Burn multiple: This is a measure of how much money is spent to generate each dollar of ARR. The higher the score, the better for your SaaS.
• Burn multiple = Net Burn / New New ARR
• Cash conversion score: This metric tracks how efficiently a startup converts invested capital into revenue. A good cash conversion score for a SaaS startup tends to be 0.25x to 0.5x, which indicates an internal rate of return of 40 percent. The higher the internal rate of return, the better.
• Cash conversion score = Current ARR / (Capital raised – Cash on Balance Sheet)
• Return on capital efficiency (ROCE) gauges net profit relative to capital employed and is directly related to capital efficiency.
• ROCE = EBIT / (Total Assets – Liabilities)
• Bessemer’s efficiency score: This metric focuses on net new ARR generated against burn rate. A good score for SaaS startups is considered to be anywhere from 0.5x to 1.5x, with the higher the score, the better.
• Bessemer’s efficiency score = Net New ARR / Net Burn

Early-stage SaaS companies should focus more on product-market fit, churn and retention metrics. These metrics tell the story of a startup’s potential for growth and capital efficiency. As companies mature, profitability metrics become crucial.

Why Capital Efficiency Matters for SaaS Startups

Showing good capital efficiency metrics is especially important for VC-backed SaaS startups, as venture capital tends to only invest in startups that have a profitable growth trajectory and show the potential for significant growth over the short term.

Capital efficiency is also important to plan a financial runway, maintain control over your operations and grow sustainably. Since capital efficiency helps to show how long a startup can operate without additional capital, it can help leaders understand their financial future and better time cash injections or when to seek further investors. Failure to focus on capital efficiency can lead to a shorter financial runway, less transparency over your startup’s financial situation and potentially even a dilution of ownership.

The Role of Financial Storytelling in Capital Efficiency

Capital efficiency can also be used to align financial data to tell a larger story about your startup that can appeal to investors and customers. Financial storytelling is the practice of transforming complex financial data into a narrative that’s engaging, easy to understand and informative. The end goal is to use financial storytelling to spur action, especially considering that numbers alone may not be enough for some investors.

Some tips for putting together a good financial story include understanding your audience and tailoring your story and simplifying the financial data to their needs, using visual elements to tie the narrative together, contextualizing the data to tell more of a story behind the numbers, and capping things with a conclusion and recommendations. Good financial storytelling should be able to engage the investor or customer and simplify complex metrics like churn rate improvement and growth rate.

One example of a compelling story is how a startup’s investment in customer success improved churn rates, showing ROI on capital spent. This ties into the strategic aspect of capital efficiency, where tracking the right data allows SaaS startups to demonstrate how their financial strategy leads to sustainable growth.

Common Capital Efficiency Ratios

There are several specific ratios that SaaS startups should be using to monitor their efficiency. They are:

• Capital efficiency ratio: The lower the ratio, the better it is for startups.
• Capital efficiency ratio = (Total Equity + Debt – Cash) / ARR
• SaaS magic number: This metric analyzes sales efficiency. Startups should strive for a number above 1.
• SaaS magic number = New ARR / Previous Quarter’s Sales and Marketing Costs
• Human capital efficiency: This helps measure how efficiently human resources are contributing to overall revenue. SaaS startups tend to overlook this metric. The more monthly recurring revenue a startup generates per person, the more capital-efficient it is.
• Human capital efficiency = Total ARR / Full-Time Employees

How to Improve Capital Efficiency in SaaS

Improving capital efficiency is likely to lead to more investors, happier existing customers, and potentially even more customers, both of which can help grow a young startup and put it on a path of success. Some practical strategies for improving capital efficiency include:

• Monitor data: It’s important to routinely track efficiency metrics like burn rate, ARR growth and sales efficiency.
• Set clear financial goals: Make sure your startup is establishing specific and measurable financial goals that can help track growth and efficiency. Then make sure that you’re regularly revisiting your goals and holding your startup’s performance accountable.
• Leverage support networks: Rely on your investors, partners, financial advisors and other support networks to optimize your capital use.
• Right size your resources: Does your startup have the right balance of human and financial capital? Striking this perfect balance can help maximize efficiency and minimize waste.

Challenges in Maintaining Capital Efficiency

Maintaining capital efficiency can be challenging — and it’s something that most startups have to work hard at. Some of the common obstacles that SaaS startups must overcome include:

• Scaling too fast: This can lead to high burn rates and short cash runways.
• Inefficient resource allocation: Overspending on certain departments before product-market fit is achieved can represent poor or premature resource allocation.
• Lack of data: Make sure that your startup is tracking key metrics, especially any that you identify as financial goals. Failure to do so can lead to poor overall decision-making.

Driving Sustainable Growth with Capital Efficiency

Capital efficiency metrics are more than just numbers — they’re numbers that can be used to tell a story about your SaaS startup’s growth and financial health. It’s important to select the right metrics — not just generic ones — that are most relevant to a SaaS business and tell a cohesive financial story using those metrics. These metrics may include retention, burn rate and human capital efficiency.

Good financial storytelling can help present these metrics to your investors and stakeholders, tying the numbers to strategic decisions and outcomes while creating an engaging narrative for your startup.

Maximize Your Capital Efficiency with Graphite

If you need help identifying the right capital efficiency metrics to help your SaaS startup tell an effective, engaging story, contact our experts at Graphite today. As professional accountants experienced in working with SaaS startups, we can crunch your numbers and assist in helping with your storytelling to attract investors and partners. Contact Graphite today for more information and a free consultation.

FAQs

What is capital efficiency in SaaS?

Capital efficiency is a financial metric that measures how well a SaaS startup uses its capital to generate revenue. It’s an important metric for startups because it can help attract investors, ensure resilience, and develop engaged and thoughtful leadership while creating a narrative for financial storytelling.

How is capital efficiency different from operational efficiency?

Capital efficiency is used to measure how efficiently a startup uses its capital to generate revenue. Operational efficiency is used to measure how well a company uses its resources to deliver goods or services.

What is a good capital efficiency ratio for SaaS startups?

It can depend on many different factors, but generally speaking, the lower the ratio, the better for a SaaS startup. In general, a good capital efficiency ratio is considered anything from 0.5x to 1.5x.

How do you calculate the burn multiple for SaaS companies?

The burn multiple formula is Net Burn / Net New ARR.

Why is capital efficiency important for early-stage startups?

SaaS startups are valuable because they generate recurring revenue, which tends to be as predictable as it is sustainable. Showing good capital efficiency metrics is especially important for VC-backed startups, as venture capitalists tend to only invest in startups that have a profitable growth trajectory and show the potential for significant growth over the short term. Capital efficiency is also important to plan a financial runway, maintain control over your operations and grow sustainably.

How can I improve my company’s capital efficiency?

Some practical strategies for improving your SaaS startup’s capital efficiency include regularly monitoring data, setting clear financial goals, leveraging your support networks for help and right-sizing your resources.