Last week, Bessemer released interesting new research regarding the return on invested capital. Three key take-aways from their analysis:
- Founders and CEOs should evaluate how effectively they are turning their capital into ARR instead of the size of their funding rounds.
- A new metric, called the Cash Conversion Score (CCS), shows the return on investment for each dollar ever invested in the company.
- Bessemer found that the CCS is a good indicator of internal rate of return (IRR) for investors.
As funding rounds have been getting larger and larger, amount of invested capital has become a point of honor all most among hot SaaS companies. How many LinkedIn profiles and resumes state how much an individual has raised, as compared to presenting what’s been accomplished with the investment? Bessemer (hardly investors sitting on the outside of the funding frenzy!) is making the counter-intuitive point that founders should be very careful about how much they are raising. “The data, however, shows that CEOs are better served by only raising capital if and when that capital can generate a meaningful return, which often means not raising money.” So, it’s not the size of your raise but what you do with it.
Bessemer’s Cash Conversion Score is calculated by dividing a company’s current ARR by the total equity and debt capital raised to date net of current cash (i.e., equity and debt minus the cash on the balance sheet).
The CCS calculation shows the return on investment for every dollar ever invested and ties the return to valuable annual recurring revenue.
Bessemer analyzed its portfolio of investments and found a correlation between CCS and internal rate of return (IRR). In the blog post “The Cash Conversion Score for Cloud Companies,” dated 11/27/19, Bessemer sorted returns into three buckets: Good, Better and Best:
- Good: Bessemer-funded businesses with a CCS of 0.25-0.5x yielded an approximate internal rate of return of 40%.
- Better: Bessemer-funded businesses with a CCS of 0.5-1.0x yielded an approximate internal rate of return of 80%.
- Best: Bessemer-funded businesses with a CCS of 1.0x+ are best-in-class and yielded an approximate internal rate of return of 120%.
Looking outside Bessemer’s portfolio, public cloud companies had a median Cash Conversion Score of 1.3x at ~$100MM of revenue. Of the approximately 50 public cloud companies, fewer than five had a Cash Conversion Score below 0.5x at that scale.
Focus on Operations is Fundamental
Like any metric, the CCS can’t be looked at alone. Bessemer’s point is that companies should be careful about taking too much investment before they have a clear product/market fit, and scaleable go-to-market structure that can absorb the capital and turn it into results. In order to track whether your product/market fit and go-to-market are ready to scale, myriad other metrics are important to track, primarily your sales and marketing efficiency and your CAC ratios.
It is important to remember the motivations for the CCS analysis. Bessemer’s analysis is valuable for growth investors to analyze the likely return on an investment. For companies, it is helpful to understand how investors will evaluate them AND to assess whether you are ready to put large funding rounds to work productively.
For Cloud companies with a CCS under 1.0, the focus should be on product/market fit and getting the sales and marketing structures to work together efficiently to drive growth in ARR. Getting that right requires good internal measurement of key metrics and comparing to peers and market leaders.
We see a broad range of companies, some that have taken a large amount of capital, some that have taken little or no capital. For all of these companies, first and foremost, the key to building a valuable company is the focus on operational performance.
To find out more about how you can drive operational performance through benchmarks, contact us.