Capital efficiency is back in style for startups, which is a great thing. The habits and mindsets we are forming — and in some cases, forcing — now around capital efficiency will serve founders well.
In my founder journey, it was invaluable.
I was trying to build a software startup in Birmingham, Alabama, in 2013! And in healthcare, where I had no prior experience. So I couldn’t blame the doubters. It took me eight months of fundraising to get my first check. I had to learn how to keep building, growing, and surviving. It took some begging and a lot of borrowing, but thankfully, no stealing. We eventually raised $250,000 from three local angels. That was all we raised to get significant traction. While we were already showing some signs of traction at this point, it was still early, and I will gladly admit our raise probably saved us from dying. Either way, I’m eternally grateful to those who took a chance on us, and I was very determined to make the most of it.
Yes, there are indeed many startups that would succeed with access to more capital. Still, there are also several that easy access to capital becomes the primary driver of failure and bad habits. Constraint breeds creativity. There are some exceptions around capital raising and allocation, and we’ll discuss this at the end.
So what’s a capital-efficient startup? It’s using the cash you’ve gotten from investors, customers, or yourself in a way that produces the highest returns for the lowest investment. It’s the ratio of revenue growth to the investment required to get the growth. Today we will explore strategies around capital efficiency and how to make your startup resilient.
Benefits of Capital Efficiency
Resiliency
Capital efficiency gives you resiliency and makes you less fragile. It helps you and your team think creatively about ways to grow and creates a culture of frugality, results, and stewardship. I advise founders to behave like their company is in a market where they can’t raise millions from a few emails, regardless of the current fundraising environment. The funding environment can turn on a dime. Investors are aware of companies currently struggling to raise in this environment. Just a year ago, the funds were overflowing for some of these same companies.
Outsized Personal Impact at Exit
The personal impact of your success at your exit (if that’s your goal) is maximized in a capital-efficient company. With minimal fundraising, you won’t need to achieve outsized billion-dollar returns for an exit event to change your life and, in many cases, your teams’ lives. Capital efficiency means you’ll have retained a significant share of the business. If you are fortunate enough to accomplish an outsized and significant exit, it can become a vehicle for multi-generation wealth and lifelong impact. That should be worth it to change your thinking.
Greater Chance of Success Outside Major Funding Hubs
When you find innovative ways to grow, you can start a company outside the major funding hubs of California, New York, Boston, etc., and still have a great outcome, even with limited funding. Capital efficiency helped me immensely in my journey, building outside Silicon Valley. The constraints of trying to build a startup in Birmingham, Alabama, forced me to bootstrap and do things as efficiently as possible. Capital efficiency is critical to significant success in a second-tier city.
Key Levers of Capital Efficiency
Capital efficiency in the early days boils down to a few factors: the cost of talent, the cost of customer acquisition, and operating expenses, with the biggest risk being talent and rent expenditure. Nothing will kill an early-stage company faster than too much talent — cost and count — and too much space. And yes, they tend to go hand in hand.
Talent Efficiency
To keep the cost of talent low, be strategic about who you hire and from where you hire. Like Jason Lemkin said in this Twitter thread, something has to be cheap. Look for people with intensity over experience. In the early days, you can’t afford to spend what it takes to get high-experience talent across all functional areas of your company. Instead, optimize for generalists with high intelligence, an attitude of defaulting to action, and high learning potential. Note that this advice applies to early-stage startups with sub $10m in revenue. Eventually, as you grow, you’ll need to bring on experienced talent to scale sustainably. Just don’t lose your capital efficiency. Similarly, be careful with hiring from large companies very early. Large company leaders are fantastic at what they do but will likely struggle to adjust to the realities of a growth-stage startup without the existing processes, teams, and structures they are familiar with.
Leverage talent from anywhere. Thinking globally about talent can set you up for success while staying capital efficient. There are smart people all over the world. You should also consider contractors for certain roles instead of full-time hires. Just note that, at a certain point, relying too heavily on contractors can become a bottleneck around growth, and you’ll need to find the right balance for your stage.
A common mistake with talent is hiring too early or too many on the sales side. Don’t build out a sales team until you have a sales motion that works for you as a founder or works with an evangelist-like first sales hire. If you can’t sell the product yourself, your sales team will be ineffective, and you’ll waste a lot of capital on expensive talent. If you’re not great at sales, learn. As you learn, find an evangelist-like salesperson with a product and customer-oriented mindset to join you. They are rare, so take your time. It’s very hard for me to think of a situation where this rule doesn’t apply. Even non-technical founders selling a technical product should master their own sales motion before hiring a team.
Customer Acquisition Efficiency
Keeping the cost of customer acquisition low requires laser focusing on experimentation. The formula is simple: experiment gradually until you find one channel that works profitably for you. It may be organic or paid. Using paid channels to acquire customers is okay, but don’t rely exclusively on them. They only get more expensive over time. If your profitable channel is a paid channel, continue to work hard to identify an organic channel that will get you customers and build your brand over time. Don’t sleep on SEO, community, and social media. They build your brand, make it easy for customers to find and talk about you, and lower your aggregate customer acquisition cost. At one point, SEO and direct visits were responsible for over half of our new customers. Even at Copysmith AI today, most of our customers across our three products come from organic and direct traffic.
When experimenting with paid channels, prioritize the ones you can master quickest and with lower customer acquisition costs over other channels in your experimentation cycle. It will make a big difference in your acquisition efficiency. For example, we never did trade shows in the early days of TheraNest. Trade shows were a common customer acquisition channel in our space. However, with our limited capital and my inexperience in maximizing trade show impact, I couldn’t justify the cost for the number of customers I could acquire visiting trade shows. We eventually invested in trade shows a couple of years after launch as we gained traction. In my opinion, if you’re using a product-led growth approach, trade shows should not be a focus of experimentation in your early days.
Operating Expenditure — No Empire Building
Lastly, be extremely cautious about spending on extravagant office space and all that comes with it. I wrote about this in the early startup mistakes newsletter, and it bears repeating. It’s a harsh truth, but it’s much better not to have a cool office space and survive than to have the coolest office space in town and not survive.
We are in a game that requires surviving till we figure it out. Be focused on the genuine needs of your team, not mimicking the startup giants you see or read about.
I believe a healthy, comfortable workspace is critical to great work. I’m not saying startups shouldn’t invest in their workspaces, but when you do, it should be to serve your team, not build an empire. We never went crazy on office space, but everyone had a sit-stand desk, whatever laptop and equipment they needed to get the job done (within reason), and a stipend for a home office. We also had free snacks and drinks without going overboard. However, I would rather be generous with our insurance offering in the early days than spend our funds on having large open, unused spaces. No one will remember your cool office space if you fail.
So What Do You Do If You’re Already Significantly Inefficient?
What do you do if you’ve been around for a while, built up some bad habits, and now realize you need to become much more capital efficient to survive?
Unfortunately, it will be painful. You’ll need to revisit the key levers mentioned and do some hard things.
The first is your headcount. It’s probably the most significant expense you have. It’s not easy, but as a founder, you must make tough decisions, including what you’re paying yourself, what talent level you need, who is right for the stage, and nothing more.
If you are spending heavily on office rent, can you renegotiate your rent? Or, if you have unused space, can you sublease?
Revisit your growth efforts. Be brutally objective about return on customer acquisition costs. If you don’t know the numbers, work fast and figure it out. Shut down channels that aren’t working and restart the journey with what you’ve learned.
Exceptions to the Rule
Every startup can be capital efficient no matter what you are building. However, I want to get some exceptions out of the way. Building certain kinds of businesses in today’s environment is hard without a significant infusion of capital.
In winner-take-all (or almost-all) consumer markets, you need to get as much capital as possible and spend that capital as fast as possible in the most efficient way possible to gain market share. You can’t build an Uber, a Shipt, or Landing the same way you would build a typical SaaS company. In heavy research industries with little chance for error and several years of product development, the cost of talent can be very high, with little return on investment for an extended period. You can still be highly resourceful and capital efficient, but the calculations you have to make around early talent and capital expenditure are very different from other types of startups.
In summary, stay focused, stay diligent, be paranoid, and optimize for survival and maximizing long-term growth.