Why VCs Can't Fund Your Startup

[@servescape]

Why not require every customer to sign 3-year agreements? That's what we did. Sure we grow slower but there's no leaks. What is the increased valuation opportunity of a company that can successfully sign up 3 year agreements?

[@ConradAtHeadline]

Yes, it's great that you can get customers to sign 3-year contracts. But one thing to think about is to consider how many more customers you might have acquired if you only required 1-year contracts? The logic is that the sales cycle for a 3-year contract is probably longer than for a 1-year contract or pay-as-you-go model. Therefore, requiring 3-year contracts is likely artificially hampering growth (although it's anyone's guess unless there's data to support it). Another consideration is that annual contracts (even 1-year) can raise concerns from VCs if there isn't much data on what happens to users after the first year. How much evidence is there to show how many of those users renew at the same or higher contract values, or worse, drop off entirely? I've seen many young companies with numerous 1-year contracts, but very few of these contracts reached their 1-year anniversary date for renewal. This presents a risk. In such cases, I typically look for proxy behaviors to see if users are still actively using your website throughout their 12-month term (and even increasing their usage). This can help alleviate some of the risk. A company with 12 monthly payments gives me 12 solid data points indicating that the customer is sticking with the company and gaining value. A 1-year contract only provides one data point, making it a riskier proposition for investing. The valuation will reflect that risk.

[@ConradAtHeadline]

When I mentioned that there are investors who invest in companies with slower ARR growth but excellent retention (to explain why retention can attract investors), my point wasn't to suggest that we, as VCs, can be content with slow ARR. We have an expected return profile within a given fund life, and with slow ARR growth, we're unlikely to achieve the necessary return in time. However, VCs can typically analyze the reasons behind slow ARR growth. We can sometimes pattern-match and identify growth levers that aren't being fully utilized. For example, if you didn't have enough money for running ads, but the customers you're acquiring via ads are retaining exceptionally well, that slow ARR growth can be explained and somewhat de-risked from an investment perspective. On the other hand, if a VC determines that the slow ARR growth is due to you addressing a small niche market, it's unlikely that you can accelerate ARR growth significantly. In such cases, the VC will likely pass on the deal.

[@servescape]

​@@ConradAtHeadlineinteresting. Thanks for sharing these thoughts.