There are 10 key metrics I look at when determining to invest in any startup. Here is some insight into what I, and other investors, might look at when deciding to invest in your startup.
Startups and small businesses regularly need cash injections from investors like myself who can provide the capital they need to expand or become stable for long-term success. As an angel investor, I’ve made my career by providing startups and small companies with the cash they needed to survive and thrive.
But I decided on those companies by carefully analyzing multiple metrics relating to their business model, operations, executive decisions, and how they spend the money they already have. If enough metrics give me warning signs, I’m more likely to pass up on a potential investment in favor of another one.
Table of Contents:
Things I Look for When Deciding Whether to Invest
- Liquidity on the Balance Sheet
- Gross Margin
- MRR: Monthly Recurring Revenue
- Revenue Growth
- Net Income
- Customer Acquisition
- Churn Rate
- Compound Annual Growth Rate
- Return on Assets
- Revenue per Employee
Things I Look for When Deciding Whether to Invest
Making an investment is never a gut decision. In fact, I look at 10 major metrics when I decide whether or not to invest in a new company, in addition to a capitalization table (also called a cap table), which gives me an in-depth analysis of what each founder or investor of a company owns.
Let me break these down for you one by one so you know what I might look for if I decide to check out your new business.
Liquidity on the Balance Sheet
One of the first things I look at when analyzing a new potential investment is the liquidity on the balance sheet. If a company gives me their balance sheet, I can see what the company has liquid in terms of cash.
Put in other terms, this is the immediate spending power of the company. I usually check for specific things like:
- whether the company can cover expenses over the next year
- if the company has enough cash to survive the current year
- how much cash the company has overall
- if the company has overextended and is now in a cash deficit
All of this can provide me with valuable insight as to a company’s management style, its business model, and the potential of its overall enterprise.
Here’s another metric I frequently check whenever I meet with new potential founders: the gross margin.
It’s exactly what it sounds like. A company’s gross margin tells me how expensive it is to offer their services or products on average. Since the gross margin is expressed as a percentage, this boils down the useful information to a single number rather than a dollar amount that I then have to compare against total sales revenue and other factors.
To find the gross margin, I’ll take the total sales revenue for a given business, subtract how much it costs to make any goods or services sold, then divide that by the total sales revenue. This essentially tells me how big the gap is between what a company sells and what it spends to make those sales.
The bigger the number, the more profitable the company is in theory.
MRR: Monthly Recurring Revenue
A company’s monthly recurring revenue gives me a good idea about how much they earn every month, rather than in a snapshot format. Sometimes new companies have excellent months as a result of extensive marketing campaigns, and then sales drop off a cliff due to a lack of follow-up or other factors.
By looking at a startup’s MRR, I can see if their success is consistent and likely to stay the same, or if it’s more of a fluke and I need to look elsewhere. If you want my attention or the attention of any angel investor, try to get your MRR up as high as you can.
While raw revenue isn’t something I look at per se, I do check the revenue growth for a company. Revenue growth is also fairly self-explanatory, though some business students will recognize it as the “top line” for a company.
It’s a metric that shows the expansion potential or growth potential for a given business. In a nutshell, it illustrates increasing and decreasing sales over a set timeframe (usually a number of months or years). For my purposes, I usually try to find the revenue growth for a particular company using the timeframe when they reached their maximum productive potential given their available resources.
In other words, I look at how much a company’s revenue has grown once all of its gears are turning and it is in full production. That gives the company a fair shake, as executives can’t say that they didn’t have all their product available or their infrastructure working at the time.
More importantly, looking at the revenue growth allows me to identify trends that may affect a company or even an entire industry. One basic example is a gift card company (not that this is a real example I’ve ever interacted with).
You might expect a gift card company’s revenue growth to spike on the approach to major holidays like Christmas, then to drop off. I can look at the revenue growth and see if the trend indicated is due to company management (positive or negative) or because of other factors.
This is most often referred to as the “bottom line” or “burn rate”. A company’s net income is simply its total earnings. You calculate it by adding all of the costs for running the company, including taxes, interest, depreciation on property or infrastructure, the cost to develop products or services, employee wages, and anything else, then deducting that from the total revenue amount.
What’s left should theoretically be positive (unless the company is heavily in debt). This tells me how well the company is managing its expenses versus its profits. But a negative number isn’t necessarily a “no-go”.
Indeed, lots of startups remain heavily “in the red” (that is, they operate in debt) for the first few years of business. This is normal, so I really look for exorbitantly low net income or other worrying signs.
A company’s customer acquisition metric is, put simply, how much it costs to attract new customers to that business. It’s true that across industries it’s almost always cheaper to retain existing customers than it is to attract new customers, but you can’t really avoid acquiring new customers if you want to grow and expand.
This means companies must spend money to produce more of their product or service, upgrade that product or service, or expand what they offer in order to draw in new users or consumers.
Another good way to think of this metric is the CAC or “cost of acquiring a customer”.
How much money a company needs to spend, however, is heavily dependent on management, business plans, and other factors. If I see that it costs a company less to acquire new customers, I’ll be impressed. The reverse is true if it almost bankrupts a company to acquire new customers and reach its expansion goals.
The churn rate for a company is a simple metric that boils down the total revenue potential for each customer. It refers to how quickly you “churn” through your customers – that is, it indicates how quickly you burn through your customers and they stop giving you money.
Remember, it’s almost always cheaper to keep existing customers. But this being said, there are some businesses and industries where it’s almost impossible to get repeat customers, at least for the short term.
Take a video game company, for example. With the exception of a few online games that require subscriptions, most videogames are single purchases. You attract a customer to your product, they buy it, and that’s it. This means your customer’s churn rate will be relatively high, meaning you’ll constantly need to be putting out new products and attracting new customers to stay in the black.
Specifically, I’ll look to see if your churn rate exceeds your number of new customers or the reverse. I’ll be impressed if your new customer rate exceeds your churn rate – this indicates that you bring on more customers faster than you lose them.
As a side note, I may also look at the ARPU or average monthly revenue per customer when determining whether a company’s churn rate actually exceeds its customer revenue or vice versa. Sometimes, companies with particularly high ARPU metrics can also have a high customer churn rate but still be worthwhile given how much money each individual customer brings in.
Compound Annual Growth Rate
One more complex metric I often look at when deciding on a new investment opportunity is the CAGR or compound annual growth rate. This is a target rate of return that new businesses need to grow from their beginning balance to an ending balance. Furthermore, this rate assumes that all profits are reinvested at the end of the year.
I find it by using the following formula:
- I divide the value of a potential investment at the end of a given period (usually a single year) by the value of the investment at the beginning of the same timeframe
- I raise the result using an exponent: one divided by how many years are in the timeframe
- Then I subtract one from the overall result
This gives me the CAGR and tells me how quickly an investment might have grown if they grew at the exact same rate every year and all profits were reinvested properly.
Now, I’ve been in business for a long time and I know that most companies don’t perform as well as their best year consistently, over and over. But this can still be a valuable metric so I can see how a company spends its money and come up with predictions for a company’s long-term performance.
Company performance and value should fluctuate a bit from year-to-year, but it shouldn’t tank or spike dramatically.
Return on Assets
Here’s another valuable metric I and other angel investors look at: the return on assets. This essentially involves looking at how much value different assets return. Alongside looking at the return on equity and the return on capital, I can see what a business’s earnings are really accomplishing for that business, especially compared to how much money the business spends for the performance of the first place.
This metric doesn’t necessarily need to be high to impress me. Indeed, even companies that have a return on asset percentage of 30% return per year is exceptional, particularly for startups with entrepreneurs or inexperienced executives.
Put another way, a company’s return on assets allows me to see how profitable that company is compared to its total asset value. This is a useful tool if I’m looking at a potential investment with really high asset value, such as a lot of tech or infrastructure used to get the business going.
Revenue per Employee
One last effective metric I can use to see whether a given investment is a good idea is the revenue per employee. As the name suggests, this allows me to see how efficient a business is when it comes to using their employees, and whether or not it’s inundated with too many employees or the reverse.
If a company has a high revenue per employee metric, that means that each employee produces a ton of value and that there may even be an argument to hire more employees in the future.
On the flip side, if a company has a low revenue per employee metric, that means either too many people are working or the employees currently working aren’t producing a ton of value by themselves. Which is which is also heavily dependent on industry – for instance, some IT companies may not need tons of people to produce a lot of value. But the foodservice industry requires thousands of employees to create the same kind of value given the nature of the work.
As you can see, there are lots of things that I look for when I meet with company executives and decide whether or not to invest in their company to help them achieve great success. I won’t necessarily use all of the above tools for every company I investigate, but the above 10 key metrics are a good overall summary of my process.
If you want me or any investor to take a serious review of your company, you should know your key metrics. If some of the metrics are not as good as you hoped, then have an explanation and a plan to turn things around.
The good news is that you can also use these metrics to see how your company is doing aside from your own perspective. Math never lies, so feel free to use the above metrics to carefully and objectively analyze your company before approaching any investor for a deal.
Many investors, including me are betting heavily on the founders first and foremost. If I think you’ve got what it takes to succeed then I’m likely to invest in your startup, these metrics help to seal the deal by giving me a quick insight into the overall health of the company and its potential to succeed.
About the Author
Jonathan Hung is one of the most active angel investors in Southern California, his mission is to drive value creation within each portfolio company. In support of this mission, he serves as Co-Managing Partner at – Unicorn Venture Partners.
Jonathan and his team target investments in US companies that have global market potential with a focus on long-term growth expansion to East Asian markets.
Jonathan developed his investing prowess as a Managing Member for his family office fund, J Heart Ventures, which made investments in startup companies such as Gyft, ChowNow, Miso Robotics, Clover Health, Bitmain, to name a few startups he funded.
Jonathan has various degrees from the University of Southern California, London School of Economics, Massachusetts Institute of Technology, and The Wharton School at the University of Pennsylvania.