The purpose of this article
This article has a two-fold purpose:
- Provide definitions of startup terminology and metrics. My various articles will refer to this article, which means that I don’t have to include definitions and metrics in each article.
- Enable a startup to quickly create its own set of terminology and metrics.
There is no single set of commonly agreed upon definitions. Many startup participants use the same words and acronyms to mean different things. E.g. many founders I’ve met say that they have an MVP (Minimum Viable Product), when what actually exists is some partially written code.
You may download a PDF of this article from: Startup terminology and metrics V2
What is a startup?
A startup is a temporary organization designed to search out a repeatable, scalable, and profitable business model.
What is a business model?
A business model describes how a company creates value for itself while delivering products or services to customers. What are you building and for whom. What customer problems are your solving? What customer needs are you addressing? What benefits and value are you enabling customers to achieve?
What does the evolution of a startup look like?
- The startup phase, which concludes with the determination that you have discovered a business model that can be scaled and that has a large number of potential paying customers. The search for the business model is focused on learning and understanding the customers. This ongoing and rapid learning usually results in many changes to the business model and the business model canvas. The focus it NOT on achieving immediate profits or immediate efficient operations. Many startups fail before this phase completes.
- The getting ready to scale phase concludes with the having the talent, technology, and processes to enabling profitable scaling.
- The scaling phase, focuses on increasing the number of geographies, distribution channels, partners, and customer segments combined with marketing and sales investments. The customers and users are profitable (i.e. life time customer value is much larger than customer acquisition costs). The cash flow and accounting statements may show a huge loss because the customer acquisition costs are incurred upfront while the customer profits are achieved over the lifetime of the customer.
Accelerators, Incubators, Venture Studios
- An Accelerator is a company or organization that puts a start-up company (which already has a Minimum Viable Product) through a very structured 3-4 month process. This process has the goal of quickly growing the size and value of the start-up to enable future funding.
- The accelerator puts company’s through a vetting process so that higher likelihood of success companies are made available to investors. This reduces investors’ due diligence time and costs.
- The Accelerator may take a small financial interest in the company in return for its assistance.
- Mentorship is provided by experienced start-up executives, investors, and others.
An incubator helps take a start-up to the point where there is an MVP (Minimum Viable Product).
The characteristics of an incubator are:
- Co-located office space with other start-ups;
- Links to investors;
- Access to lawyers;
- Provides coaching and mentoring, via successful start-up executives and consultants.
- Networking, based on all of the above
University affiliated incubators usually do not take an equity interest. Investors may do so. The process takes 12 to 24 months, with the pace set by the founders. Once there is an MVP, then an Accelerator may work with the start-up.
A venture studio is an organization that creates startups, typically by identifying a market need, assembling the initial team, strategic direction and providing the capital to launch
What are the steps leading to the repeatable, scalable, and profitable business model?
The startup is learning from each of these stages.
The business model canvas
A business model canvas is a one-page document which easily defines and communicates the business model. There are 9 components to the business model canvas: customer segments, customer value proposition, customer relationships, channels, key partners, key resources, key activities, cost structure, revenue streams.
This is the customers and users perception of value. What are all the financial and non-financial benefits achieved? e.g. time savings, convenience, status, reducing negative emotions or risks, benefits achieved (financial and non-financial) achieved by the customers? What are all the costs incurred by the customer (purchase costs, costs to switch to your company, other adoption costs, ongoing costs)?
Provide a visualization of the potential user/customer interface of what will the customers/users will perceive in the MVP. Note that customer/user interfaces are evolving to include voice interaction, hand gestures, augmented reality, neural monitoring, etc.
Proof of Concept
The purpose of the proof of concept is to gain customer/user and domain expert feedback to validate specific critical assumptions of the MVP
The hardware or software prototype is only the hardware or software components of the MVP. The prototype’s purpose is to enable learning from customers/users and support demonstrations to customers/users.
This is the MVP, including onboarding, customer support, and exiting. The customer is not paying for the pilot. The two-fold purpose of the pilot is to identify any issues which prevent customer/user problems and needs being solved and to identify any issues which prevent the customer/user from being delighted. The pilot is providing specific feedback on the value the customers/users are achieving. The pilot helps determine what price should be charged.
This should really be called Minimum Viable Solution. A product or service with just enough features to have delighted early cash paying customers by enabling them to solve some urgent problems or needs, and to provide customer/user feedback for future development. The MVP includes the full solution, including onboarding, customer support, and exiting. What the customer does not see or interact with (i.e. all the behind the curtain resources and activities) will likely be inefficient, have manual components, technology that is temporary, etc.
Customers/users determine whether or not there is an MVP, NOT the startup team. If the MVP does not solve some core customer/user problems, needs, and meet expectations, there isn’t an MVP. The startup needs to learn from customers and users what needs to change to enable an MVP. It may take several attempts before there is an MVP.
Product market fit
The facts and analysis show that:
- There is a repeatable, scalable, and profitable business model.
- There are a large number of potential customers who believe their problems are urgent enough to buy your solution, and they can also afford your solution.
- The customers and users believe you have a better value proposition than the competitors.
You get to product/market fit by adding more features to the initial MVP until there are a large number of potential customers and users.
Marc Andreessen’s definition of product/market fit:
“The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers. Money from customers is piling up in your company checking account. You’re hiring sales and customer support staff as fast as you can.” From: On product/market fit for startups
New customer value achievement leading indicator (e.g. for Slack it was 2,000 team messages sent within 60 days).
New customer success metric (e.g. % of new customers achieving new customer value achievement indicator within 60-90 days).
NPS (Net Promoter Score) The single most important question is asking “Would you recommend our solution to others?” (Follow on questions could be “If so, why? If not, why not?”) This metric is known as NPS. What is your NPS? Above 0 is good. Above 50 is excellent. Above 70 is world class. How do you compare to your industry and competitors? What has been your NPS trend?
The Net Promoter Score concept was initially developed by Bain. The following is a link to the Bain website homepage for Net Promoter Score, which contains several short articles:
The following is a quick overview of using Net Promoter Scores:
Market Size Metrics
Market size = (The number people (or organizations) with an urgent problem or need that they are willing to spend money) times (the amount they are both willing and able to spend).
What is TAM (Total Addressable Market)?
- What would be the startup’s revenues with their future solution if 100% of the customers demanding a solution to their problem bought startup’s solution. This assumes all potential geographies, distribution channels and partners.
- Is the startup’s TAM large enough to launch and grow the startup? For example, the global smart phone TAM is huge, but the global TAM for smart phones that have a keyboard is tiny.
- The best way to calculate TAM is with a bottom up calculation, starting with a clear description of the target customer segments, its needs, and then considering the subset of customers who will actually provide revenue, and the revenue per customer. Recognize not everyone in every country will be able to afford the solution.
What is SAM (Serviceable Addressable Market)?
- This is the portion of the TAM that is within the reach the startup’s geographies, distribution channels, and partners, and your ability to deliver and support your solution. This still assumes 100% market share of those customers demanding a solution. SAM will change over time, as growth occurs in geography, the number of distribution channels and partners, and the volumes from each distribution channel and partner.
What is SOM (Serviceable Obtainable Market or Share of Market)?
- SOM will be lower than SAM for three reasons: there will be competitors, customers who are demanding a solution may not actually buy a solution, and there will be an adoption rate ranging from early innovators to laggards.
TAM, SAM, and SOM will vary at different points of the 5-year forecast. TAM, SAM, and SOM will also change as the startup validates assumptions by progressing through: initial assumptions, customers interviews, feedback from prototype in customers hands, feedback from initial revenue producing customers, feedback from MVP, customer feedback as solution capabilities are enhanced to provide value to a greater set of customers, etc.
Startups Financial Metrics
Free Cash Flow
Free cash flow = EBITDA, subtracting all cash commitment, subtracting non-cash items, subtracting increases in working capital
EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization)
EBITDA = (Capital expenses + Net Interest Expenses + taxes + non-cash items + increase in working capital)
Burn Rate and Runway
The monthly burn rate is the amount of cash the startup is losing each month. Burn rate = revenue – expenses.
Runway is the amount of time before you run out of cash. There are multiple runway scenarios e.g. revenue and expenses remain constant; forecast revenue vs forecast expenses, etc.. There may be multiple forecasts.
CAC (Customer Acquisition Cost) includes all the costs to acquire a new customer:
- Related compensation of the people.
- Overhead associated with the people.
- Technology to support CAC.
- Legal expenses associated with sales and marketing.
LTV (Life Time customer Value)
What is the lifetime customer profit, after customer acquisition? This will take into account churn.
A scalable business model is one in which LTV exceeds CAC.
Churn is the % of paying customers who leave each month. Your target should be at most 2% per month churn. 5% per months means you are in trouble. You must figure out and fix the churn problem if you hope to grow your company.
COGS (Cost of Goods Sold) What comprises cost of COGS? Everything required to meet the direct needs of current customers. E.g.
- Customer support people, and software.
- Technology e.g. software, cloud services, communications costs.
- Bug fix and minor enhancement to the software – after all you do need to retain current existing customers.
CAC is not part of COGS.
G&A (General and administration) What comprises G&A?
- Payroll administration.
- Recruiting administration.
- IT security.
- Corporate development e.g. M&A.
- CEO salary/benefits.
- Legal expenses (both in house and external), other than those associated with sales contracts.
All of the costs associated with discovering major changes to the business model and enhancing the solution.
Gross Profit Margin
(Revenue minus COGS) divided by revenue.
Let’s use QuickBooks to illustrate the concept of the financial metrics.
There is a GL line item for salaries.
Then then there is a class i.e. where do parts of the salary belong? (i.e. QuickBooks class)
- Cost of goods sold?
- R&D/Engineering/New Development?
Investment funds reporting metrics to their investors or limited partners
DPI (Distribution to Paid in capital): Cumulative distribution to investors /capital contributed by investors. Including management fees and expenses.
MOIC (Multiple On Invested Capital) Cumulative realized and unrealized value (an estimate) of the investment / capital invested by the fund.
TVPI (Total Value Paid In capital): Cumulative distribution to investors + unrealized value (an estimate) / capital contributed by investors. Including management fees and expenses.
Create definitions and metrics for your startup. This will help everyone (founders, employees, advisors, investors, etc.) have a common understanding about you actually mean when you use certain words.