Metrics 101: What VCs look at while evaluating startups

Executing startup investments is hard. Wiring the actual investment may be easy, but figuring out which startups to fund is tedious. It is so tedious that it takes 2–6 months for the funds to be released.

In recent weeks, I have been exploring how this process can be expedited. My findings have been quite interesting. Eventually, it comes down to what metrics investors look at while evaluating startups they shortlist for investment. Depending on the stage and investment thesis, there are three broad metrics VCs look at while making investment decisions:

1. Founder Metrics — About the founders and why they are the right people to start and scale the business.
2. Growth Metrics — This one is quite self-explanatory i.e. what it takes to grow from 0 to 1 to 100 and so forth.
3. Operating Metrics — All the accrued costs fall into the operating metrics.

I look at all of these metrics closely while investing and am sure that VCs also look at evaluating these while making investing decisions. Let’s take a look at each of these metrics closely.

Founder Metrics

While raising early-stage investment, founder metrics are extremely important. To many, the VC founder fitment is extremely crucial and VCs always ask themselves why they are the ones starting the business. Or also, why they are the right people to be solving the problem faced in the industry. Examples of some of the founder metrics are:

1. Educational Background — If you went to Harvard, chances are that raising money will be very easy. Of course, you will have to have a few basics in place, but access to capital becomes a lot easier. An old acquaintance managed to raise capital right after he graduated with a master’s in management from a tier 1 institution. The startup would unfortunately shut down a few years later, but having good educational credentials gets a foot into the door.
2. Domain Knowledge — Should you not have good educational credentials, it is important to have good domain expertise. Individuals from consulting backgrounds find access to capital easier because of having heavily researched certain industries. Individuals who have worked in the same industry for 15+ years also tend to have unique insights into user problems. It is important to communicate unique insight while raising the first round.
3. Strong networks — This is an obvious one and quite literally goes without saying. Raising money is tantamount to sales. Therefore, having contacts within VC funds always helps. A VC also looks at the connections the founder has for the initial sales to happen.
4. Bias for execution — In a podcast, Rajan Anandan (Peak XV) shared that one cannot coach for hunger. Hunger is what drives founders to execute.

I’ve covered the rest in this post about the VC and Founder Fitment here.

Growth Metrics

This bucket of metrics becomes crucial for a growth-stage startup. For a founder raising anything between Seed and Series B, investors tend to look at Growth Metrics. The following are some of the growth metrics investors look for in startups:

1. Revenue Growth — Historical revenue growth is the most important metric a VC would look at. This can be used to project future revenue and look at valuations as well as predict how market share can increase based on future revenues.
2. GMV/LTV — Netflix has a retention rate of 72% over six months. VCs know how difficult it is to acquire new customers/users. This makes customer lifetime value and gross billing/gross merchandise value extremely critical metrics to track. The lifetime value can be determined by the gross amount of billing divided by the number of months the customer has purchased the subscription/service.
3. MRR/ARR — This is tied to revenues but in a slightly different way. For instance, understanding why revenues in certain quarters are higher or lower; or why revenues in certain months are higher/lower. This helps in marketing but also in projecting when the revenues are up and down.
4. Average Revenue per User (ARPU) — This is an extension of the LTV metric but a lot more generalized. This usually helps determine the median price or price point.

Operational Metrics

This bucket is usually used for late-stage startups that look at raising beyond Series C to the IPO. Operational costs directly affect the bottom line and are the reason for the number of layoffs happening in the industry today. Some of the metrics I look at include:

1. Customer Acquisition Cost — CAC is a famous metric tracked by VCs and is a good indicator of whether the startup will be profitable soon. Swiggy, Byjus, and several other startups have a negative CAC which essentially means that it costs more to acquire a customer than the product cost. This is a fundamental issue in the Indian startup ecosystem with most startups burning money.
2. Sales & Administration Costs (SGA) — This is an extension of the CAC and accounts for employee salaries (to some extent). Employee churn is a key metric when looking at investing.
3. Profit Margins — The key metric most financial analysts look at. This is found by subtracting the Cost of Goods Sold (COGS) from the total Revenue. This is also an extension of the CAC. Another metric within the profit margins VCs look at is the EBITA for governance and reporting purposes.

Disclaimer — These are some metrics I look at. Other VCs might look at others. Also, sometimes, I ask startups I am investing in to give me a P&L summary that can include all three metrics. This is the usual practice among VCs irrespective of the stage of the startup/founders.