https://www.bvp.com/atlas/cash-conversion-score/?utm_source=johngannonblogdotcom
Silicon Valley, and its many Twitter handles, celebrates financings as milestones. Unicorn valuations at 10-100x ARR multiples capture headlines while announcements of customers added and products launched often do not, leading to a flawed dynamic in which companies seek market validation by raising capital. The data, however, shows that CEOs are better served by only raising capital if and when that capital can generate a meaningful return, which often means not raising money.
Throughout Bessemer’s history of investing in cloud computing, we’ve recommended that companies track their business’ progress using the five C’s of cloud finance. Here at Bessemer, we also use these metrics as internal guideposts when evaluating the performance of prospective, later-stage investments. After months of analyzing the data from the portfolio companies we have funded, we’ve identified the Cash Conversion Score as a new metric that is a signal for future success.
Bessemer’s Cash Conversion Score equals a company’s current ARR divided by the total equity and debt capital raised to date net of current cash (i.e., equity and debt minus the cash on the balance sheet).
Within the Bessemer portfolio, a financing in a cloud company that had a Cash Conversion Score higher than 1.0x yielded an average internal rate of return (IRR) of 120%, which is 2x higher than the average IRR for a company with a CCS <1.0x.
With this new metric, we’ve developed another Good, Better, Best Framework.
This Good, Better, Best Framework for Cash Conversion Score holds regardless of company stage, from $5MM of ARR to $1 billion+. Currently, public cloud companies had a median Cash Conversion Score of 1.3x at ~$100MM of revenue. Of the approximately 50 public cloud companies, fewer than five had a Cash Conversion Score below 0.5x at that scale.
We realize that some might take this data to imply that raising incremental capital is bad, but that is not the takeaway at all. The median public cloud company raised $160MM to get to a ~$100MM revenue scale, with some companies having raised up to $750MM; it takes financing to build a market-leading company. Instead, the takeaway is that the great companies can use the capital raised to catalyze growth. They built their fantastic Cash Conversion Scores not by starving themselves of capital but rather through growing revenue alongside their capital base.
Great companies can use the capital raised to catalyze growth.
As the ratio of the ARR to total capital invested into a company, the Cash Conversion Score is effectively the return-on-investment of one dollar ever invested into a company. For both founders and investors, Cash Conversion Score is, therefore, a powerful proxy for returns. If a company has a CCS of 1.0x, one dollar of investment into the business yields one dollar of topline recurring revenue.
For example, assuming that the average cloud company gets a 10x revenue multiple, the one dollar of revenue multiplied by the 10x multiple equals $10 of enterprise value. Every dollar put into the company is getting a 10x return. Similarly, a company with a 0.1x CCS would only return the capital invested.