Before you make a decision to invest in a startup, one of the key indicators you should look at is traction. Having traction means that people are starting to use the product or service, and the business is showing signs of growth.
Traction refers to the momentum the startup has gained so far. Growth is powered by brand awareness and traction is one way to measure it. Traction indicates a real need on the market for the solution the company is offering. This is definitely a positive sign for investors because there is no longer just talk about an idea, but actual data supporting their claims.
Determining if a startup has traction
The specific key metrics used to measure traction can be different depending on the business. Which metrics to choose strongly depends on the phase the startup is in.
Startups who are just starting out, searching for a problem/solution fit and still setting their strategy and vision in place, are in the formation phase. Investing in these early stage startups is the riskiest but possibly will have the largest rewards.
If a startup has created a minimum viable product (MVP) and has begun looking for a product/market fit, the company has reached the validation phase. Once they’ve established that, the startup will start to scale and enter the growth phase.
Traction correlates with phases — the further the startup has come, the more traction it has.
For example, a startup raising a seed round, might not even have customers yet, so it wouldn’t make sense to look at the indicators related to it. Instead, engagement is what you should consider measuring.
In contrary, later stage startups most likely generate revenue, which is something you as an investor should have a look at.
Therefore, choose the key metrics that make the most sense for the particular startup you’re analysing.
What are some of the key metrics to consider?
There are a ton of different metrics out there that you can choose from. Finding the right ones can be a difficult task, which is why it’s a good idea to group them by categories.
Let’s divide the key metrics into three main categories:
Revenue can only come through paying Customers. Customers convert from traffic which is driven by Engagement. One is the cause for the other.
Engagement is the foundation of traction. It is especially important for startups in their early stages who don’t have any customers or revenue yet, so engagement becomes their main traction metric.
Engagement can be measured in various ways. People often associate engagement with social media metrics. But engagement is not just about likes and shares on Facebook, but also about the number of active users and their activity on the company’s website.
So don’t rely solely on the social media side of traction, but look even deeper. Below are a few examples of possible engagement metrics to consider using when assessing a startup’s traction.
Some metrics explained:
Bounce rate — The number of visitors who leave the website after viewing just one page.
Average number of pages per session — The more pages a visitor views during their visit to the website, the more engaging the website is.
Having paying customers is definitely a positive sign to look for in a company. It shows that there is an actual need out there for this product or service and people are willing to spend their money on it.
Traction, among other metrics, depends on the number of customers, so definitely have a closer look at that. Having just a few customers is not really a proof of traction, but having thousands can be.
The number of customers isn’t just the only metric to consider. Here is a list including some other key indicators you should look into. The metrics again depend on the type of business you’re looking into, because, for example, churn rate (defined below) is only applicable for subscription based businesses.
Some metrics explained:
Customer acquisition cost — The total cost of acquiring one customer. Takes into account for example marketing expenses, sales expenses, etc.
Customer lifetime value — All the value the startup will gain during the entire relationship with the customer.
Churn rate — The annual percentage rate at which customers stop subscribing to a service.
Having paying clients means the startup is generating revenue. It is an important metric to look at because it shows the startup is able to make money and sell their product, which is a prerequisite for profitability. Revenue is often referred to as the total income from sales but can also include other income like interest for example.
Here is a list of indicators to consider when analysing revenue.
Some metrics explained:
Monthly recurring revenue — A subscription business metric which counts the revenue which recurs every month.
EBITDA — Or earnings before interest, taxes, depreciation, and amortisation. It is used to assess the performance of a company to find out whether they have problems with profitability or cash flow. Keep in mind that EBITDA ignores changes in working capital (usually needed when growing a business), in capital expenditures (needed to replace assets that have broken down), in taxes, and in interest.
Traction, risk and potential returns
All in all, traction is something you can use to assess risk. A company that has little traction is much riskier to an investor than one which has noticeable traction. This also correlates to potential returns.
The higher the traction, the more likely an investor will generate a return on their investment.
On contrary, the possible gains could be higher when investing into an early stage startup with little traction. When there’s not much traction, the risk is higher, and the company is willing to give up more equity for the investment.
Ultimately, it is up to you as an investor to assess how much risk you are willing to take and how much traction a startup needs to show in order to be an attractive investment. Investing always involves risk, and you should never do it with money you cannot afford to lose. We’ll talk more about risk in a later post.
The Funderbeam Guide for New Investors
In case you missed the previous chapters in our series and want to know more, check them out here:
- Investing in Startups: 10 Checks Before Your First Deal
- 1) The Problem — Analysing Your First Investment
- 2) The Solution — Does It Solve The Problem And Can We Make Money Doing So?
- 3) The Market — Who Is Going to Buy The Solution?
- 4) The Competition — How Does the Startup Stand Out from the Crowd?
- 5) The Team — Who Are the People Behind the Scenes?
- More coming soon!
Funderbeam consists of three parts:
- Free data intelligence on investors and startups
- Tools for startups to raise funds and for investors to co-invest
- A marketplace for investors to buy and sell their investments
Our vision is to provide everyone in the world with equal opportunities, whether you are building a company, or looking to fund the next big thing. What if the next Silicon Valley is not a place, but a platform?
LEARN MORE ON FUNDERBEAM.COM, OR WATCH THE VIDEO BELOW: