This post highlights the work of Silicon Valley venture firm, Social Capital. Their goal is to create a GAAP-like standard for startup companies to use with the hope it helps to guide investors and entrepreneurs to better gauge the health of newer businesses.
Building a startup company from scratch can be an exciting journey. It offers the opportunity for an everyday man or woman to reach for the stars and accomplish their dream, provides solutions and advancement in our society, and/or achieve financial freedom for those involved. As one of my professors says, “the American Dream these days exists through startup culture”. For an investor, it provides the early opportunity to earn a killer ROI (return on investment). Can you imagine the possible ROI for early investors in Uber if — I mean, when it goes public?
However, both investors and entrepreneurs will agree that there are many uncertainties associated with early stage companies. Those that study public companies have the luxury of Generally Accepted Accounting Principles (GAAP) when analyzing business activity within the business cycle. My friends from my accounting class might hate me for admitting this after our recent midterm, but GAAP is useful and necessary because it provides standardization for investors so that they are able to make more educated investments, mitigating risk. Additionally, it helps us compare two companies side by side since they can be viewed on the same playing field. Unfortunately, using GAAP’s standardization does not make very much sense to use as a tool to study startups because of the lack of history of data and/or use of the data GAAP requires to be reported. In fact, there is no “generally accepted” standardization when looking at young companies. That can make it difficult to accurately determine the health of a startup.
When analyzing a startup, the early equity market is looking for product — market mix. Simply put, does the company have a good product in a growing market? If so, it is a good investment. But how does one measure this? Before Facebook revolutionarily started looking at MAU (monthly active users) and MRR (monthly recurring revenue) for example, some measured growth by page views for internet startups, which seems quite barbaric today. That’s like saying Kobe Bryant is a better scorer than Michael Jordan because he’s scored more points, but that’s failing to recognize His Air Highness (Jordan) played in less games than The Black Mamba (Bryant). Fortunately, no one uses page views to measure a successful web page anymore, but the example does serve to show the lack of sophistication in the metric tools used to look at companies on this level.
And so the idea of the entire project, known as 8 Ball, stems from these problems. The team at Social Capital realized that, in diligence, they were not seeing core product-market fit at a resolution they were comfortable with. 8 Ball focuses on determining how organic growth is in a company and what tangible value that growth brings.
Sprig is a small meal delivery service similar to Favor. Their entire marketing division included one intern at the time so it was hard for them to figure out why they were growing and where they should use their resources to foster more growth. Social Capital was able to use 8 Ball with Sprig to pinpoint Sprig’s growth. They concluded that focusing on how many meals it took to get customers hooked was the most important metric in predicting growth and used that data to assist Sprig’s marketing efforts. To illustrate, once customers were hooked, there was no use in marketing to those people or focusing on the people that have no idea what the product is because they were least affected by Sprig’s marketing when deciding to use/ignore the product. Social Capital showed Sprig that they needed to prioritize their marketing on those people that have used their product once or twice.
The Sprig example brought to light that startup companies know how to collect lots of data and the importance of collecting data, but have a hard time when asked to make sense of the vast amounts of raw data in a way that helps themselves make decisions, or when pitching their company to investors. Social Capital then thought to make 8 Ball an open source tool for anyone to use so that entrepreneurs can focus on making their ideas great and building their solutions while investors can spend more time on assisting those companies rather than teaching them how to comprehend their data.
Social Capital has already laid out their basic philosophy of accounting for growth, measuring cohort behavior, and how they visualize the depth of revenue/customer engagement . The goal now is to make those philosophies operational so that companies know as much as possible about themselves before they even go to a private equity/venture firm. The entire early equity process will be better because of this and the ultimate goal is that companies see the most value in Social Capital’smetrics so 8 Ball philosophies becomes the standard of measuring small business growth. Right now Social Capital has only released their software to analyze cohort LTV (lifetime value) from a perspective of engagement and revenue, but the framework is useful enough in understanding both incremental and cumulative revenue generation and can be used to understand any sort of behavior that customers exhibit when interacting with a business. It will answer questions like, “Do customers spend more early or later in their experience”. Try it out here.
In the future, Social Capital plans on releasing more versions of 8 Ball so that all that is required of business owners is submitting their complex data to be analyzed on an even deeper level with more metrics and simplified by Social Capital as they do today. Social Capital wants to make the models complex enough to best represent a business’ story, but open ended enough so that it can be used for any startup company to use. Best of all, it’s free for and based on Social Capital‘s vision, it should stay that way.
Whether the investment makes sense for Social Capital or the company looking for capital does not matter to CEO & founder, Chamath Palihapitya as long as success of that small business aids in a better society. That’s what I truly love about this company and its mission.
Check out Palihapitya’s recent project in Sri Lanka to make the entire country a wi-fi hotspot here.
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