How to Make Your Startup's Financials More Attractive to Outside Investors

By Min Fang

You and your co-founders have been hard at work building the next hot startup. However, your company needs to hire developers, build out its product, and figure out how to acquire customers. Before your startup can be a self-sustaining business, it will need outside investors to get through the infamous startup J-Curve.

To put together projections that will get investors excited about your business, it helps to understand the six key financial metrics they will focus on. Keep in mind that while these metrics should be optimized, they need to be defensible as well.

1. Unit Economics

Unit economics are your product or service’s direct revenue and cost per unit. Very simply, does what you sell earn more than what it costs to make (and deliver). It is also known as the approximate gross margin per unit (Revenue per unit – COGS per unit) / Revenue per unit.

The unforgiving realities of unit economics has been catching up to many startups recently, particularly in the on-demand category. Some of these startups are even losing money on a gross margin basis, as in companies losing money every time they sell a unit. These companies are operating at a negative margin in hopes of capturing enough market share so that they can eventually raise prices and reduce costs to make their unit economics positive.

Generally, businesses with higher gross margins can afford to spend more on sales and marketing, employee perks, and nice offices (e.g., Google or Nike). However, high gross margin businesses also tend to attract competitors that are interested in capturing some of that margin.

2. Customer Lifetime Value (LTV)

The customer lifetime value or lifetime value (LTV) is the gross profit that the average customer will contribute over the entire period that they are with a business. For instance, if a software-as-a-service (SAAS) company charges $20 per month, and the average user is a paying customer for 10 months, then the company’s average LTV is $160, assuming an 80 percent gross margin—(a common assumption for an SAAS company; lower for non-software startups).

From another perspective, the customer lifetime value is the dollar limit a business can spend to acquire and service a customer. Anything more, and the business model is not sustainable in the long run because it is fundamentally unprofitable.

3. Cost of Customer Acquisition (CAC)

The average cost to acquire a user—mostly a mix of marketing and sales spend—is the cost of customer acquisition (CAC). A viable business model requires the LTV to be greater than the CAC, it's as simple as that. Cost of customer acquisition can include social media advertising, AdWords campaigns, events, salesperson commissions, and affiliate marketing payouts.

For startups just getting started, customer acquisition is almost always underestimated. A good rule of thumb to approximate CAC for your startup is to take your industry incumbent's CAC and multiply it by 5. That may sound enormously expensive (it is), but no ones knows or cares about a new company until they are made aware—and that costs money. The industry incumbent's CAC is so low because they've already established their brand and much of their new customers likely come from word of mouth, which has a CAC of $0.

4. Market Size

If you plan to pitch investors, the addressable market should be large enough to excite them. However, attacking an entire large market right away is usually not realistic and investors know this. Break the market into segments and explain how you will win in a niche first.

For instance, it’s great to claim you’re targeting every U.S. dog owner with your awesome on-demand dog walking app—after all it’s a huge market! But it may be more realistic to first target busy city dog owners who don’t have time to walk their own pets. Maybe drill down further and focus on New York City as your first market. The more thought you put into segmenting your startup's addressable market, the more investors are assured that you are an expert in the space.

There are many helpful online resources for calculating total addressable market.

5. Fixed Operating Expenses

The amount of fixed costs it will take to support your business model. Budget for:

• Employee salaries (but remember to include additional costs)
• Insurance
• Rent and utilities
• Taxes (payroll, Social Security, and Medicare)
• Equipment
• Subscription software services (cloud-hosted servers, sales and marketing automation, accounting, payroll, HR, etc.)
• Ongoing legal expenses
• Accounting and tax preparation (if outsourced and not included in employee salaries)

Fixed operating expenses are where you can truly practice discipline and not go overboard budgeting in perks that some startups are becoming notorious for.

6. Monthly Cash Burn

After deducting marketing, sales, and fixed operating expenses from gross profit, what’s left in your model is monthly net cash burn. This is literally how much cash your company needs over a month (or produces if it's profitable). Investors want to see that you know how to project out your business’s cash needs. This ties directly to how much money you will need to raise. Investors want to see that you have enough cash on hand after fundraising to cover your losses until your startup begins turning a cash profit or raises money again.

For companies that are generating revenue, alternative forms of financing like business loans, venture debt, or accounts receivable financing can complement equity fundraising. Pre-revenue startups, particularly those selling consumer products, can turn to crowdfunding platforms like Indiegogo and Kickstarter to fund their initial product launch. Most investors will like that you’re using non-equity funding because it demonstrates resourcefulness and doesn’t dilute their ownership.

Optimizing these financial metrics will make your business more attractive to outside investors. Alternatively, if you're not raising money, analyzing your business using these metrics will allow you to take an investor's view. They serve as important tools to support strategic decision making.