One of the biggest mistakes I see junior investors make, particularly when they come from a purely financial background, is they look at numbers in early stage companies as points, or as simple trend lines. I don’t think this works.
In the early stages, so much is changing that the numbers don’t tell you that much. You have to dig into the business and understand where it is, how it’s moving, what the market and competitors are doing (and likely to do) and how all that will change the metrics as they are today. Using CAC as an example, here are some ways I think about early stage company numbers.
- When a company brags about how they have almost no sales and marketing spend, it’s usually a meaningless statement because to grow a large company they will almost certainly have to spend that money eventually. So all this statement means to me is that they haven’t really started marketing yet. The one exception may be if a product has some viral or consumerish characteristics, then maybe they will be right, but that’s the rare exception.
- When CAC payback is really high, it doesn’t really mean it’s a bad business. There could be a few reasons for it. One is that the ASP may be artificially low because the product is new and the sales are really paid betas priced for adoption. Or sometimes the first channel the company is using to drive sales is a more expensive channel than they should be using initially for their product category, but they started there because they were most comfortable with that channel. As they move to better channels CAC may come down.
- When CAC payback is really low, it doesn’t mean it’s a good business. It might be, but CAC changes a lot over the life of the business. If the company has started with a very efficient but not-that-scalable channel, then I expect CAC to go up over time and have to estimate what I think that will look like in a couple of years.
- Competition can both positively and negatively affect CAC. If you are in a market where you are a clear market leader, but other competitors are big enough to spend decent marketing dollars, then you may get a boost from those marketing dollars as well. Your competitors make people aware of the category but then the buyer does research and disproportionately chooses you. It can negatively affect CAC if your market becomes more competitive, or big players come in to compete with you, or one competitor raises a boatload of money and spends like crazy.
- You also have to think about how saturated is the market for the target buyer’s attention, and where do you fit in the priority of their attention stack? You aren’t just competing for your product category, but for attention against the other things that buyer is buying, as those companies are trying to get their attention too.
My point is, I don’t really pay much attention to the metrics of early stage companies, or the trend lines they are on. I mostly use them to connect those metrics to the operations of the business and make some educated guesses on how those metrics will changes as the business grows, based on the items above. If I invest, it’s because I think CAC is going to be good in a few years, and whatever CAC is at this current moment is less relevant.
If I share a deal with an investor, I hate when they say something like “CAC is too high.” I’d rather hear them explain why they think the number will stay that way.