Many entrepreneurs are often reminded of the importance of knowing their numbers, but what numbers are important, and what do they mean?
Joshua Chin ’19 agrees that while metrics can be confusing, they’re essential for every founder to understand. As a student interested in venture capital, Chin has spent a lot of time learning about relevant metrics as a project manager for Cornell Venture Capital on campus. Furthermore, he and his team just placed second at the Northeast Regional Venture Capital Investment Competition and earned a spot at nationals in March.
Chin explains, “It’s important for founders to know their metrics because it gives solid insights into the state of the company and what needs to change. If a startup doesn’t track their metrics and doesn’t realize they have a high churn rate, for instance, they’re never going to realize that they should be focusing more efforts on retaining their customers. By having a good grasp on metrics as well, it will be a good signal to investors that the team has a solid understanding of the state of their business and market. This understanding will show investors that the team is competent and serious enough to take the company from vision to success, opposed to a team that doesn’t understand their metrics and will likely be unable to capitalize on their idea.”
Below is a (non-exhaustive) list of key numbers that founders should know about their businesses:
Pre- vs. Post-Money Valuation
What It Is: Pre-money valuation refers to the valuation of the company before investment, while post-money valuation refers to the valuation of the company after investment. For example, if a company is valued at $9 million, and then an investor puts in $1 million, the pre-money valuation of the company is $9 million while the post-money valuation is $10 million. Furthermore, the investor would own 10% (and not 11%) of the company because the investor contributed $1 million of the $10 million in post-money valuation.
Why It Matters: Understanding the difference between pre-money and post-money valuation is often one of the biggest differences between a new founder and an experienced founder. Furthermore, an entrepreneur must understand how much their company is worth to appropriately raise money.
What Is It: Margin, a key measure of profitability, represents the excess of revenue relative to some expense category. The 3 most discussed categories are contribution margin, gross margin, and net profit margin. Contribution margin represents the difference between revenue and variable costs, or costs that increase with each unit of output sold. Gross margin is the difference between revenue and cost of goods sold, or the total expenses needed to make the product. Lastly, net profit margin is the difference between revenue and all of the business’ operational expenses (i.e. product expenses, office space, salaries).
Why It Matters: One of the core goals of any business is to profit. Indeed, profits fund future orders and company expansion. Similarly, investors look at profitability metrics such as margin to determine the potential for a return on investment, Not knowing the margins is a huge concern for any investor, as shown in Shower Pill’s pitch on Shark Tank. While the Sharks seemed interested in the business opportunity, most went out since the team did not know its net profit margin.
Net Promoter Score
What Is It: Net promoter score measures how satisfied a company is with a business. To gather data on it, entrepreneurs ask their customers, “On a scale of 0-10, how likely is it that you would recommend [company name] to your friends, family, or colleagues?” Customers who enter a 6 or below are considered detractors, 7 to 8 are considered passives, and 9 or above are considered promoters. The net promoter score equals the percentage (from total respondents) who are promoters minus the percentage who are detractors.
Why It Matters: Understanding customer satisfaction is key to making product improvements and delivering value as a service. Chin adds, “Personally, I think Net Promoter Score (NPS) is one of the most important and overlooked metrics. Having a great NPS will lead to high organic growth, which affects a variety of other metrics. It will help keep customer acquisition costs, churn rate, and burn rate lower, and make customer lifetime value and monthly recurring revenue higher. In other regards, NPS can help establish product/market fit and offer more accurate forecasts for revenue and growth. Even if a startup has an amazing team and amazing technology, at the end of the day, if your startup doesn’t have customers it’s not going to go anywhere.”
For more on startup metrics, check out some of E@D’s other pieces here.