One of the responsibilities of a good venture capitalist is to have a good understanding of what the future holds. Between shifting markets, developing technologies, and disruptive entrepreneurs, the details of the future prove to be a bit of a moving target. Venture capitalists do their best to understand what may happen in the future but have to admit that no one truly has a crystal ball.
When evaluating a company, you must do your best to create potential answers for the elements that are unknown. Ask yourself: What are the narratives that convey the value the startup offers and why it will ultimately be successful? This is especially difficult for early-stage companies with limited data and performance metrics. However, there’s one metric that may provide you with a snapshot of a startup’s customer experience: churn.
Churn, which is essentially the inverse of retention rate, displays the rate at which a startup is losing customers. High churn rates indicate that there may be something wrong with the physical product or service and that user growth may merely be a result of an effective marketing strategy. Plus, high churn adversely affects the growth that you’ve worked so hard for. Running a startup with high churn is like trying to ice skate uphill. Low churn rates often translate to a long customer lifespan, a wonderful customer experience, and most importantly a high likelihood for gaining cheerleader customers.
You may be wondering what I mean by cheerleaders — allow me to explain. Folks in marketing will often categorize different types of customers in a multitude of ways, but there is one type that is typically the most coveted: cheerleaders. These customers will be active advocates of your company to all of the people in their own network without any incentives from the company like a referral system. These cheerleaders create somewhat of a network effect where they strongly encourage their friends to use the product too. They create an infrastructure for the most powerful type of advertising: word of mouth.
Here’s a great example of a cheerleader I think we can all relate to.
Low churn rates and a high number of cheerleaders are two excellent metrics that create a narrative of a valuable customer experience, which typically equates to an extended customer lifecycle and high lifetime value.
So, does low churn singlehandedly give a VC the green light to invest in an early stage startup? Absolutely not! It’s like getting the corners done in a 1000 piece puzzle. However, it’s a great way to get a read on how the product is being received by the customers when there is limited information available.
When facing a significant amount of uncertainty, I often think back to some advice from my high school physics teacher: Use everything you know to figure out what you don’t know.
In VC, we can equate this to finding these crystal ball metrics for early-stage startups that will give us hints about what the future of the startup may look like.