I am a big fan of turning the complex into something that is relatively simple to digest. I remember, in business school, every case study started with “ratio analysis” which the goal of coalescing the state of a particular company being analyzed into a handful of financial and operational ratios that would provide a bird’s eye view into the overall health of the company. Similarly, perhaps as I get older (and might argue, somewhat wiser), I have become big fan of certain core metrics when analyzing startups for investments. Some like LTV/CAC, Churn (or negative churn), and marketing efficiencies (Revenue/marketing $), I have written about in the past. But there is one particular metric in which I have become a big believer of late. I call it the MJ co-efficient. People ask, “why call it the MJ coefficient”. My response, “why not!” The title actually relates a lot to my own value system, as you shall see.
Often, especially in the Indian context, there has been a lot written about companies that are either unicorns or soonicorns, riding high on valuations (that, at one point in the not so distant past, were increasing by $100M/month) with hundreds of millions or even billions of dollars being invested, especially in the e-commerce domain. But a relatively small fund like Iron Pillar ($100Mish), can’t necessarily afford to invest in companies that are very capital intensive. Our model is to invest in companies that, either with the round being led by Iron Pillar, or one additional round post our investment, can get to sustained profitability. How, one might ask, could you ascertain whether a company is or is not capital intensive in the long run, or at least until you, as an investor, exit that company. Part of the answer lies in pro-forma analyses, looking at both domestic and global comps, and eventually going with some weighted average combination of analysis and gut feel to take a call. It is also important to get a fairly good understanding of the product-market fit, business model, and team’s execution capability in an interesting and large market.
But, the answer to above conundrum, in part, is the MJ Co-efficient (MJC), which is simply the ratio of Annualized Revenue Run rate ($ARR) divided by cumulative capital raised by the company ($R). Let’s drill into this a bit. ARR, of course, is a fairly reasonable measure of the company’s scale and how well/much are the customers willing to pay for the product or service (which, by the way, is a good proxy of where on the “cancer to vitamin drug” or “must have vs. nice-to-have” spectrum does the company reside). With ARR is embedded the notion of churn (or net negative churn, if the company is able to up-sell or cross-sell the go-forward customer base which exceeds revenue being lost by customers actually dropping off). In an ideal situation, a company has zero churn and significant net negative churn whereby existing customers continue to increase their spend because of the inherent value proposition of the company’s product or service. Customers, in that case, are essentially hooked and letting go of the product or service is simply not an option. In reality, there will and I would argue, should be, some churn (btw, it’s sometimes important to fire customers, especially if the unit economics with those customers simply don’t make sense and/or the customer is an outlier on the nuisance scale).
The denominator in the MJC is the total funding that the company has raised till date. The ratio, therefore, is a good indicator of capital efficiency (over the life cycle of the company). If the company has raised a ton of capital, but has virtually no revenue, the ratio is close to zero. If, on the other hand, the company has been extremely efficient with its spend, and at the same time has created a cult like following of their customers, MJC could be greater than 1. There are obvious exceptions to this metric. Certain domains or categories, like biotech, simply don’t lend themselves to this particular measurement as revenue stays close to zero, often until after an IPO. Similarly, others might argue that in the broader ecommerce domain, given the challenges of brand creation, customer acquisition and relatively thin gross margins, an MJC of 1 is virtually impossible, at least in the initial years, until the economies of scale can be leveraged.
I use the MJC more when evaluating enterprise SaaS companies. Having said that, there are relatively few truly capital efficient companies in the long run (i.e. those that don’t require at least $50-100M of funding over their lifetime before getting to cash flow positive with meaningful growth). Over my career, I have probably looked at thousands of plans and pro-forma financials. I can’t remember one company that actually hit their mid-long term targets. Predicting exactly how a company will scale is hard. But if I ask a typical tech entrepreneur if they can achieve $50M in revenue with $50M in total funding or $100M in revenue with less than $100M in total funding, the answer will be a vehement “Yes, of course. I can do it for less”. But I would encourage entrepreneurs to look at comps of established companies in your respective domains, and analyze how many, if any, of them got to the magical MJ co-efficient of 1, and when. There are examples. Zoho, for one, comes to mind where a bootstrapped company has gotten to phenomenal scale. But those are rare.
More recently, I have looked at companies that have shown a co-efficient of close to 1 post seed or series A level, which is fantastic, again from a capital efficiency standpoint. What that shows me, as an investor, is that the company not only can deploy capital efficiently, but that they have been able to use that capital to develop and sell their product effectively. At that point, if the company approaches me for funding, I know that they have the wherewithal to really grow their market share, and dial down their spend, for example, if need be to get to a point of sustenance during tough times. I might still pass on the investment for a variety of other reasons, but the likelihood that the company will run out of cash is minimized (because they have the ability to control their burn).
The MJC is a directional, not an absolute metric. In many markets, winners take all or most. In those cases, issues like significant marketing spends around brand and customer acquisition matter. Trying to simply stick to a MJC of 1 may lead to a situation where a company becomes a niche player or yields unintentionally to another player in the market.
Bottom line: It is crucial for a company to be able to control their destiny to the extent possible. Having the DNA of capital efficiency helps companies not only in the good times, but especially in the bad times. With that mindset, a company can survive during the downturn, and be wildly profitable when market conditions are positive. Again, the MJC is not an end-all be-all. To throw another metaphor in the mix, you also don’t want to be penny-wise, pound-foolish. Do what’s right for the business, and if it genuinely means spending more up front, either for R&D, branding, or refining the supply chain, so be it. MJC is simply a tool to measure efficiency as a company goes through its life cycle. Some may achieve that early in their life cycle and be able to show a product-market fit with relatively low revenue and smaller equity raise. Post that, they can raise larger rounds, go well below 1.0 on the MJC scale, but eventually come back above 1.0 once hitting the profitable growth trajectory. Other companies, depending on sectors, may only get to an MJC of 1.0 or greater well into their life cycle. Some, as I mentioned earlier, may never get there simply because it’s not revenue but other items such as IP that are the value creation driver. It’s important to keep the context of this tool in mind, and use it to measure your company against your competitors. But MJC can be a guide as entrepreneurs think about creating a culture of capital efficiency (something that’s important to me in my personal life) within their organization early. That can only benefit the company downstream, through good times and bad.