One of my first forays into entrepreneurship was a capital-inefficient business, and I recently had to relive the memories when my son decided it was a good time to ask about what it was like when I was starting out.
It was painful to reflect back on a time where my business spent too much for our scale, invested in the wrong areas, wasn’t profitable, and ran into serious cash issues. Layoffs, debt negotiations, crunching numbers endlessly, counting pennies (literally), sweating payroll, and running to the mailbox every five minutes to see if there were any new customer checks to deposit.
I had always been a bootstrapper, but I emerged from that experience with a new understanding and respect for capital efficiency. From that point forward I developed a deep sense of pride in running a business that balanced spending on growth with profitability. And later when running funded businesses, I maintained that laser focus on making sure we were never spending more than we were making.
My mantra is that I want to earn customers through efficient acquisition, not buy customers through excessive spending. This is hard to do when you are facing funded competitors who seem to be outspending you at every turn.
For any startup, balancing business growth with capital efficiency is a struggle. That struggle has only grown more acute as capital becomes more readily available. The more capital up for grabs, the greater the perceived pressure to raise it, spend it and burn it on growth with little regard for efficiency.
But you can still win while being efficient. And when you do, you can retain more control over your business and be better prepared for the various twists and turns of entrepreneurship.
When I co-founded my first business I didn’t even know what capital efficiency was.
As a financial layperson, I came to think of it simply as not spending more than the company is making.
Technically speaking, capital efficiency is the ratio of how much a company is spending on growing revenue and how much they're getting in return. For example, if a company is earning one dollar for every dollar spent on growth, it has a 1:1 ratio of capital efficiency. You can also call it the return on capital employed, or ROCE.
At the most basic level, capital efficiency is just a question of how efficiently a company is using its cash to operate and grow.
That depends on who you talk to. There are plenty of investors and entrepreneurs who don’t regard capital efficiency as important for startup businesses in the early days.
It isn’t like they don’t have examples to point to, either. Many large, successful companies have had tremendous luck with a spend-your-way-into-growth strategy. Hubspot, Salesforce, and Box come to mind.
The problem is, there are also countless companies that have tried that strategy and failed. You just don’t hear about them as much as the ones that succeeded.
There are numerous benefits to building capital efficiency into your startup from the get-go. Here are just a few.
In my personal experience, capital efficiency forces me to make better business decisions about where to spend. I test and optimize pilot programs to see that they are working before increasing investments.
The constraints of capital efficiency allow me to get creative in finding ways to grow steadily without wasting money.
When doing more with less is a necessity, you’ll force yourself to implement better business practices. You’ll dip your toe in the water to make sure it’s the right temperature before jumping all the way in and regretting it later.