Burn vs. build: Putting your VC money to work

(Editor’s note: Clate Mask is co-author of the New York Times bestseller Conquer the Chaos and CEO of Infusionsoft. He submitted this column to VentureBeat.)

Raising a pile of cash is a huge blessing for entrepreneurs.  But it can also be a serious curse.

When entrepreneurs suddenly have a wealth of capital to grow their business, the decisions about how to invest that capital become difficult.  As an entrepreneur, it’s often hard to know whether you’re building value or just burning cash with your “investments.”  The line between burning and building becomes blurry because the success of those investments plays out over many months or years.  In the meantime, you’ve got to hit numbers and keep your investors happy.

A very interesting place where this burn vs. build dichotomy plays out is in the fast-growth, land-grab mode of customer acquisition.

VCs invest because the company has fast-growth potential.  In hot markets and a hot economy, the game accelerates and investors want to scoop up customers as fast as possible.  And, of course, management wants to grow, too.  But frequently, aggressive growth brings fulfillment problems and a host of management nightmares.  All too often, the result of aggressive customer acquisition is a cash bonfire.

So, how should management teams and investors work together to appropriately push aggressive customer growth and ensure they’re using that precious capital to build value instead of burn capital? Keep these three things in mind:

Focus on the numbers – Great management teams run the business by the numbers.  When it comes to decisions around customer acquisition investments, three numbers are critical: 1) Customer Acquisition Cost (CAC); 2) Churn; and 3) Lifetime Customer Value (LCV).  The entrepreneur and her management team must establish these critical metrics.  Ultimately, LCV should be measured as a multiple of the CAC.  The higher the multiple, the healthier the business and the more aggressively the company can invest in customer acquisition.

Know the acceptable numbers – It took me a while to realize how important it is that my investors and I are on the same page with respect to the appropriate LCV/CAC ratio.  The acceptable rate will vary by industry, but the board must come to an agreement on the targets and appropriateness of CAC, churn, LCV and the LCV/CAC ratio.  Doing so gives the management team the direction it needs and deserves.

Adjust for market conditions – This is where it gets fun.  The “acceptable numbers” always seem to be a moving target, depending on competition, availability of capital, company stage, etc.  I’m always amazed at how fluidly the market conditions change.  Sometimes a 2x LCV/CAC ratio is great; other times a 5x multiple is the target.  What’s important here is that the board and management agree what the acceptable numbers are and they are adjusting as necessary to help the company execute its strategy.

When entrepreneurs and their investors approach customer acquisition from this perspective, it becomes much easier to determine whether the company is burning or building.  At a minimum, the entrepreneurs and investors can approach their customer acquisition investment with eyes wide open, which improves communication at the board level and provides a big benefit to the management team that’s out executing to the board’s direction.