If you are an angel investor evaluating a startup investment, some metrics may help you building a decision. These metrics also may give an idea about the health of that business. As a prerequisite, perhaps you should have all the financial figures and related data. Let us assume that you did so and go on.
This can be easily calculated by subtracting the monthly total costs of the startup from their monthly total income. A positive value means that the startup is not burning any money; they rather earn money.
A negative value, which shows that the startup is losing money every month is closely correlated with our next metric, runway.
This metric is calculated simply by dividing the total cash that the startup has in hand by its monthly burn. So, you can see how many months they will survive before running out of cash. It is possible to use runway before the investment is made and without it, or after the investment made and the startup's budget is extended by you. Also, can be calculated in weeks if data allows.
If no data is provided to you or formed yet, or runway is negative it means that you are considering a very risky investment.
As an angel investor, you expect a high return for your investment. Every industry has an average multiplier of return on investment. Thanks to the nature of a particular industry, it may be higher or lower than the other industries. You can find this multiplier in open sources and use it to adjust your expectation of return. A significantly higher or lower return commitment from the startup is a point that should be examined carefully and be supported with data or any evidence.
Lifetime Customer Value (LCV – also called LTV or CLV in some sources)
This is one of the most favorite metrics of Venture Capitalists. There are different approaches in calculating this, but they all show the same thing: Amount of total money that a customer will pay to the company in whole life for its good or service. Calculating LCV is rather easy for SAAS companies with the availability of direct financial measurements and data gathering. For other companies, although indirect measurements and predictions decrease the accuracy, it is still an important assessment metric.
It does not show the profit, though. Closely related to this metric, you also should consider the following metric, CAC.
Customer Acquisition Cost (CAC)
It simply measures how much a company spends to acquire one new customer. As usual, it is easier to calculate CAC for SAAS companies and may be harder to calculate for others. Although fixed costs are excluded and marginal costs are considered in its math, you can use all the costs in your assessment to achieve a more real-world conclusion.
The handiest use of LCV and CAC is to consider their ratio. Being LCV the numerator, a value bigger than 1 means every new customer will generate profit, and vice versa. Bigger the ratio, better it is.
For a ratio bigger than 1, you should predict and compare the profit to be gained in the investment period with your expectation. A ratio smaller than 1 should be carefully examined. Most startups may lack a ratio bigger than 1 in the early days of their lives, and it is not weird that this period can be months or years before profitability. However, this may also be the sign of a business that will not succeed in no sense.
To conclude, the above metrics will give you a general understanding of the startup's financial health as well as the chance of survival in time and the possibility of generating your expected return if you are an investor who requires only basics to decide. On the other hand, if you are an investor with an analytical and detailed approach who seeks probability rather than possibility to decide, please keep in mind that there are tens of other metrics varying from conventional ones such as profit margin and overhead to contemporary ones like customer retention rate, annual and monthly recurring rates, which are beyond the scope of this article.
Originally published 09 July, 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.