Measuring Metrics that Matter

Ideally, a seed-stage due diligence process should add value to the companies that the VC is interacting with and not just be a waste of time for entrepreneurs. Early in our due diligence process, when we engage with entrepreneurs, we like to go through a simple exercise with them. We’ve found that this has been beneficial for them as well as us. The entrepreneurs are usually able to get focused on what’s important and crystalise some of their strategic objectives, while we’re able to get a better understanding of how they’re thinking about growing the business. It’s likely useful to explain this exercise here so anyone can pick it up and run with it if they want!

When I started angel investing, I was talking to an angel with significantly more experience than me and he asked me “How do you know that the company will be able to reach the right metrics for the next level of funding?” While I considered myself pretty diligent, I wasn’t able to answer the question. He said that he would typically get the entrepreneurs to create the pitch deck for their next round. This would force them to consider their ask and whether their expectations around growth were justified.

Personally, I hate creating pitch decks so I didn’t want to push that work back on to entrepreneurs. Instead, I started to use a simple 3x3 metrics matrix, which pulls together the information from the current pitch deck, what the pitch deck for the next round would look like, and the financial model.

While the metrics matrix is relatively simple, there’s a bit to unpack. The first layer is the three key levels that are important for the businesses that I’m looking at (early stage from Seed to Series-A); Product-Market Fit, Scaling, and Growth.

Product-Market Fit

In the first phase, I’m looking for evidence that the company has found their market and there’s demand for what they’re creating. This could be compared to building an engine. You might not have a lot of gas in the engine but you need to demonstrate that it works. If you were to feed it a bit of gas, you’ll start to see all of the moving pieces together as it generates power.

Generally, the KPIs in the first stage will be based on a derivative of revenue. There might be a KPI around the amount of contracts in the pipeline or the users on the free tier of the product. The product and features will be relatively simple and focused on one market.

Scaling

The second stage is scalability. This represents the next funding round and could be a pre-A or series A raise. It’s the stage where a company has proved that there’s demand for the product and now the focus needs to shift to scaling that opportunity.

Continuing the car analogy, this is dropping the engine in and pouring some fuel into the tank to take it for a test spin. As you begin to put your foot on the gas, you should be able to see a commensurate boost in power generated.

I would expect the KPIs in this stage to start to focus on the ability to generate cash. It could be related to the unit economics or the gross revenue that the business is able earn on a recurring basis. This is where I’d start to question the team that’s in place as the company will need to start putting in specialists who will be directly responsible for developing the product and ensuring that prospects are moving through the funnel efficiently.

Growth

The final stage is the growth stage, where a company is able to prove out profitable unit economics but may not be profitable at the bottom line because they’re still putting everything they can into growing the business. This is where you’re fine tuning the car to create more torque and power while at the same time expanding the range that it’s able to achieve.

I’ve seen these concepts broken down into Team, Product, Repeatable Sale and Unit economics before as well. I also like this breakdown but for the purposes of what I’m trying to demonstrate, it’s probably easier to stick with three stages because a lot of the time the team and product come together at a similar time.

Using the Metrics Matrix

The first thing that you need to do is work out what you need to raise at each stage to be able to hit the right milestones that will allow you to easily raise the next round of funding. There have been a number of times when I have gone through this exercise and the founders themselves realised that the ask for the next round was too ambitious with the amount that they were looking to raise in the current round so they adjusted their trajectory.

To determine that amount that you need to raise, you need to work out what features that you need to build into the product at each point. Typically, this product roadmap might be a separate document or it could be iterative and determined by customer demand. At this stage it’ll also be evident about whether the product is being built internally or externally. If the product is customer facing, generally it’s going to be better to have an internal team building the product to enable quicker iterations.?

If the roadmap is determined by customer demand, then it could be useful to start by looking at the milestones that need to be achieved at each level to get the next level of funding. This will likely be a derivative of revenue, something like customer sign-ups. When we look at how that metric expands in each phase (it might be customer leads increasing 5–10x in each funding round) then we want to ensure that it’ll have a sufficient amount of growth to justify an uplift in the valuation at each round.

As you move down the lifecycle, through scalability and then growth, the KPIs will become closer to the actual cash that the business is generating. In the scaling stage, I would expect revenue to be one of the KPIs but it could also be something that drive revenue and is arguably more important, such as volume of customer inventory onboarded.

Setting Milestones

Setting milestones will help you measure what’s important. It’ll give you something to report to your investors and other stakeholders and it’ll give you an early warning system if your growth engine is no longer packing the same punch as before.

If you determine the milestones that you’re going to pursue earlier (and you’re welcome to change these if they’re no longer relevant) then you can also direct investors to these metrics. If you don’t have any metrics that you direct investors to, then it’s likely that investors will want a massive amount of information and might try to parse some metrics that may or may not have any bearing on the success of the business. Often, I see investors asking for LTV/CAC in businesses where it’s far less relevant but if they aren’t given any metrics, then they will start to ask about anything that they have recently heard in a podcast.

Once you’ve determined what you need to achieve at each level, you can begin to consider who you need to make that happen. If you know how many people you want to hire, you’ll also likely have some idea about what the market rate is for each of those hires. If you’re a successful cheerleader and able to get talent at below market rates then this will be a benefit at this stage. In the People boxes, you should include the key functions and the annual cost next to each of these functions. This makes it easy to see whether you have sufficient runway to be able to create the products that you need to drive the KPIs that you’re trying to achieve.

Summing Up

Now you can sense check it all:

• Would you be able to build each product/feature or service the given level of clients at each level of funding?
• Will the funding be sufficient to hit each of the milestones and maintain momentum?
• Are you looking at the right KPIs? Is this what the next round of investors will actually want to see?

The execution will be a moving feast as some parts of the company might need to grow faster than others but as long as you’re still moving towards your KPIs, then it’s likely that it won’t impede your ability to raise the next round of funding.

As I mentioned previously, while you may have all of this information in different places (financial model, pitch deck, product roadmap etc). If it’s consolidated into an easy to digest snapshot, it’s likely that you’ll have more success in hitting your milestones and also in convincing investors of your grand plan. Investors at the earlier stages won’t spend as much time in a business as the founder, they won’t be able to appreciate all the nuances so sometimes it’s better to show them what they should be focusing on.