PG’s essay The Fatal Pinch is about startups that have:
- Raised money and now have high burns.
- Have not met existing investors’ expectations.
- Need to raise more, but can’t because they’re seen as failures.
PG gives you advice toward getting out of the fatal pinch.
Let me help you avoid it altogether by understanding investor expectations.
VC is about grabbing future cash flows.
- Real winners in a VC portfolio yield returns above 20% IRR.
- The easiest way to model a startup’s cash flows is as perpetuities.
- This is because your revenue should be roughly monotonously increasing.
Present Value of a Perpetuity = Dividend / Required Rate of Return
- Dividend = Present Value * Required Rate
Startups don’t pay dividends, but if you consider:
- the dividend as new revenue generated after an upcoming round
- and the present value to be the money invested during an upcoming round
Then you can use this simple test to see if you should raise your upcoming round:
- Will X in cash enable us to increase revenue by at least 20% of X?
- If yes, raise.
- If no, you’re setting yourself up for a fatal pinch.
Btw, the 20% IRR use here is a low cutoff for success.
- The IRR of unicorns is closer to 40%.
Someone told you “it’s about long term cash flows, not short term revenue”.
- Don’t let seed stage dynamics set your expectations for later rounds.
- Institutional VC holding periods just aren’t that long.
Someone told you “we need to focus on month-over-month growth in”.
- All startup metrics worth considering are just proxies for cash flow.
- Even a good cash flow proxy becomes a vanity metric if you fixate on it.