Which is the more important priority? Growth or churn? Churn or growth? Early-stage companies have limited resources to focus their efforts. On one hand, growth is important in order to raise a venture capital round. Growth shows demand for a product. On the other hand, churn is a huge source of friction and raises questions of product market fit.
Especially in the early stage, churn is the more important of the two priorities, and when founders ask me which to emphasize that the seed and series A, I’ll always respond churn.
Churn is a limiting factor on the business. Like fiction, at some scale, churn will prevent the business from growing. To maintain the subscription revenue from the existing customer base requires ever greater mountains of cash. A $20 million ARR business losing 50% of its customers every year will have to replace $10 million worth of customers each year to achieve 0% growth. Assuming 18 month payback, that’s $15M in sales and marketing spend. That means the business will be fundraising constantly.
Founder and early stage investors incentives are aligned to reduce churn as much as possible for five reasons. The first three are financial. First, there is additional fundraising risk at every turn because the sales and marketing costs are so high. The management team will be fundraising constantly. Second, each new round dilutes the existing shareholders, reducing the share of the company that is in employee hands, and reducing the return/multiple for investors. Third, the preference stack grows with each round. Preferred shares are typically paid their return first.
The fourth and fifth reasons are operational. Fourth, each churn customer erodes the brand equity of the business. At some point, there might be thousands of former customers who have used the product and are talking about why they have left. That’s a challenging marketing obstacle to overcome. Fifth, high-churn is an indicator of imperfect product market fit. Pushing the business to grow on a product that isn’t exactly what the market demands might lead to a situation where the company has raised millions of dollars and needs to pivot. Pivoting a mid-stage startup is incredibly challenging because the company has to continue to show growth while transforming its business. There is a tension between serving old customers and moving the business to a new product and model.
If instead, the startup focuses on achieving true product market early, the company will enjoy the benefits of a far more efficient sales model. Less capital required keeps more shares and company hands. Fewer churned customers implies a much healthier brand, further reducing acquisition costs. Last and most important, the business will have greater confidence in the direction it has chosen.
Published 2017-02-01 in Startups