Investment Criteria: Fundraising Part 1
How to match metrics and investment requirements.
Entrepreneurship is a long, challenging climb. Like climbing, it’s important to mark your way as you go. Metrics give a standardized look into the performance of a company and allow both entrepreneurs and investors to gauge whether a potential partnership will be a good fit.
One of the first things entrepreneurs can do when looking for investors is to prepare the metrics needed to show the overall health and growth of their company. Most investors list their basic investment criteria on their website, so doing a quick preliminary search can cut down on calls with investors that aren’t a fit. Matching the investment criteria is critical to making sure the investor in question has the appropriate expertise in growing companies that are similar in size and industry.
Each investor will use a combination of general metrics and metrics that look a little different depending on the industry. We focus on technology companies and healthcare services companies, so we have listed the key criteria we examine for each below and why they are significant. To learn more about the definitions of these metrics and how they are calculated in more detail, hop over to Investopedia.
To start, every founder should know the three-core metrics of any business: revenue, EBITDA, and growth rate. But what do these mean in the context of investment criteria? Revenue range shows the size and relative maturity of the business. Is it a fund that looks to optimize mature organizations? Or is it one that helps build the infrastructure at earlier stages? EBITDA provides insight into the risk profile of the firm. Some require $5M+ EBITDA where there’s a safe cushion should there be any challenges scaling. Other firms and industries, like tech, can be okay with significant burn if it means the company can grow revenue quickly, as those businesses are valued on a multiple of recurring revenue. Finally, growth rate helps firms underwrite outcomes and estimate timing. Historical growth and momentum are both strong indicators of future potential.
Let’s take a deeper dive into some of the metrics we use every day that help us get to know a company.
Technology
Including software, tech-enabled services, & HCIT
Gross Margin
Gross margin provides insight into the efficiency of delivering goods and services. This helps investors understand the capital required to grow and scale a business. For example, companies with a higher margin can use the funds they raise to support sales and marketing, while lower margin businesses will likely have to continue to fund headcount and infrastructure to support the business as it grows.
ACV
ACV (Annual Contract Value) tells investors about your target market, the end client, and how many deals are required to propel the business forward. Does growing the business require landing 3-4 huge customers each year to grow, or hundreds of little ones? Investors will sometimes focus on Enterprise customers with large ACVs, or on SMBs (Small and Medium Businesses) where deal velocity is critical. Each has its pros and cons. With larger deals there are fewer data points in the funnel relative to small ACVs, which are likely to have many data points in the funnel to help project growth and incorporate any seasonality.
LTC/CAC
LTV (Lifetime Total Value) and CAC (Customer Acquisition Cost) also showcase a business’s efficiency. More specifically, they demonstrate how quickly it can grow versus spend on sales and marketing.
Rule of 40
The Rule of 40 measures the trade-off between profitability and growth, again exploring the efficiency of a company’s revenue growth rate when combined with their EBITDA. Some investors appreciate capital efficiency whereas others look for growth and winner-take-all markets where being first-to-market is critical.
GTM / Quarterly Bookings
A company’s go-to-market strategy can be validated by tracking quarterly bookings and can illuminate the strategy behind its momentum and growth rate. Past momentum is a strong predictor of future growth and understanding the current strategy will shine light on future marketing and sales strategies to employ.
Healthcare Services
Net Margin
Net margin demonstrates how efficiently a business is able to run. Investors also equate this with difficulty to scale as well. Said differently, how many resources are required to grow the business, and how will that affect investor and company projections in the coming years? In healthcare, margins that are too high can be seen as a negative. It could indicate future rate compression as well as prompt scrutiny surrounding billing practices and what the company is doing to keep its costs lower than others in the market.
Payor Mix
Payor mix shows diversification of revenue and stability in the payors. Medicare is a federal program and a relatively stable payor, but its rates are lower than commercial ones. Medicaid is determined at the state level and therefore is subject to greater variability and scrutiny. Commercial relationships can be attractive, especially if the company is in-network where rates have been agreed upon and payment terms are short. Out-of-network can be more challenging due to the ability to collect everything that’s billed and a longer payment term, but it typically has higher reimbursement than in-network. Finally, there is private pay where individual consumers are responsible for payment. It is the least consistent payor group. Investors look at payor mix to understand their comfort level with the payor and any concentration the practice might have.
Referral Sources
Referral sources demonstrate how a platform has attracted patients and grown historically. Investors think through additional referral streams and realistic market share for a particular geography to help underwrite growth potential and market saturation.
Regulatory Trends
Regulatory trends help investors understand rate increases, decreases, or stability, which prop up revenue and EBITDA. Healthcare is always under a watchful eye to ensure government and commercial payers aren’t overpaying for outcomes.
Expansion Opportunities
Investors want to understand where the company sees growth potential, and the opportunity and challenges for each. This could be through acquisitions, de novo locations, going in-network to attract patient volume or adding ancillary services.
This is Part 1 of our Fundraising Series. Go back to the series overview here.