"The Changing Landscape of Startup Valuations and the Evolution of Netflix"

Glasp

Glasp

Sep 09, 20234 min read

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"The Changing Landscape of Startup Valuations and the Evolution of Netflix"

Introduction:

In today's market, valuations of startups are no longer solely based on growth, but also on profitability. The traditional recipe for a premium valuation has shifted to include a balance of both growth and profitability. As startups raise funds to sustain their operations, the concepts of cash burn and cash runway become crucial. Additionally, Netflix's transformation from a content delivery provider to a network highlights the importance of commoditization and modularization in optimizing performance and capturing new value.

Understanding Cash Burn and Cash Runway:

Cash burn refers to the amount of money a company uses from its bank account to cover the shortfall from current operations. It is calculated by subtracting what the company spends from what it bills its customers. On the other hand, cash runway represents the number of months a company has until it runs out of cash. For venture-backed startups, a cash runway of at least 18 months is desirable, allowing them to focus on growth before needing to raise additional funds.

Key Metrics for Assessing Business Success:

When evaluating the future success of a business, several leading indicators can provide valuable insights. These include the CAC (customer acquisition cost) payback period, which measures the time it takes to recoup the cash spent on acquiring a customer. For startups, a payback period under 12 months is ideal. The LTV (lifetime value) to CAC ratio indicates the multiple of value obtained from a customer compared to the cost of acquiring them. Ratios above 5x are considered excellent.

Net retention measures how much a customer grows after they are acquired, while gross margin reveals the amount of money left for business investment after servicing existing customers. Finally, the burn multiple assesses the efficiency of the entire business by calculating how much cash is burned for each incremental unit of growth. These metrics provide a comprehensive understanding of a company's performance beyond just its go-to-market engine.

The Evolution of Startup Valuations:

In the past, startups raising significant funds often signaled potential success and attracted top talent. However, the shift towards valuations based on profitability has led to a more discerning market. This change benefits employees, as it reduces the likelihood of joining a mediocre business with a premium valuation. Employees should approach joining a startup as an investment decision and assess the long-term viability of the business using similar criteria as traditional investors.

Netflix's Transformation and the Conservation of Attractive Profits:

Netflix's success lies in its ability to commoditize time and connect content creators with consumers efficiently. By positioning itself as a marketplace for attention, Netflix follows the footsteps of market-makers like Uber and Airbnb in transforming industries. The shift towards "must-see" shows and events, even if they cater to a niche audience, highlights the importance of captivating content in today's media landscape.

The law of conservation of attractive profits suggests that when attractive profits disappear at one stage in the value chain, new opportunities for proprietary products emerge at adjacent stages. In the case of Netflix, the commoditization of time and distribution has allowed the company to integrate production and customer management. By modularizing and commoditizing various aspects of their service, companies like Netflix, Airbnb, and Uber have created new value and disrupted traditional industries.

Conclusion:

In the evolving landscape of startup valuations, profitability has become a significant factor alongside growth. Understanding the concepts of cash burn and cash runway is crucial for startups to sustain their operations and focus on growth opportunities. Evaluating key metrics such as CAC payback period, LTV to CAC ratio, net retention, gross margin, and burn multiple provides insights into a company's future success.

Furthermore, the transformation of Netflix into a network and its ability to commoditize time highlights the importance of modularization and commoditization in optimizing performance and capturing new value. Companies that can break up formerly integrated systems and modularize different aspects of their service have the potential to create the biggest breakthroughs in their respective industries.

Actionable Advice:

1. Startups should prioritize maintaining a cash runway of at least 18 months to allow ample time for growth and adaptability.

2. Focus on optimizing key metrics such as CAC payback period, LTV to CAC ratio, net retention, gross margin, and burn multiple to assess business success and efficiency.

3. Consider the long-term viability of a startup before joining, asking questions and evaluating the company's financial health and growth potential.

By considering these factors and embracing the changing landscape of valuations and business models, startups can position themselves for sustainable growth and success in today's market.

Resource:

  1. "Burning Bad: Cash burn, cash runway and valuation", https://www.mostlymetrics.com/p/burning-bad-3a1 (Glasp)
  2. "Netflix and the Conservation of Attractive Profits", https://stratechery.com/2015/netflix-and-the-conservation-of-attractive-profits/ (Glasp)

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