Capital Chronicles #25

Hello there! Welcome to Capital Chronicles, saving you hours every week with ~2-3 minute summarised insights from the best venture builders, investors and capital allocators out there.

As subscriber #TBD, read on for the latest…

🛠️ On venture building…

High retention and positive net growth are critical to product success (Sequoia). Sustainable product growth hinges on achieving product-market fit and maintaining positive net growth, best measured by high retention rates and a quick ratio greater than one. If you have achieved “sustainable growth,” press your advantage by pursuing multiple acts to continue growth. If not, your next best course of action depends on which scenario is most applicable: “leaky bucket,” “death spiral,” or “end of life.”

Use Sequoia’s 2x2 product growth framework to determine the next best set of actions to drive sustainable product growth.

🧭 On venture investing…

We must rethink SaaS Metrics in the age of AI (Kellblog). AI is transforming SaaS pricing models by introducing new forms of value-based pricing, challenging the traditional definition of ARR, and materially impacting the key metrics used to value software companies. The proposed solution is to split ARR into baseline and variable components or use trailing product spend as a proxy for ARR. AI also requires thoroughly evaluating gross margins, which were previously often ignored in the software industry.

Update your definition of ARR for AI: either split it into baseline and variable components or rely on trailing product spend.

📖 Learning resource…

Simplified methods for calculating cap tables often lead to errors (Dave Lishego). Common shortcuts like the "effective pre-money method" lead to incorrect results due to oversimplification and faulty assumptions. Instead, frame the problem in terms of shares rather than dollars, calculating post-money shares by considering all components such as pre-money shares, equity investor shares, noteholder shares, and new options. This approach, though more algebraic, provides clearer logic and is less prone to misinterpretation.

Learn how to calculate cap tables correctly using the total outstanding shares method.

📊 Market insight…

Is AI going to kill software? No (Sapphire Ventures). Similar to Meritech’s analysis last week, Sapphire Ventures recognise the current cyclical (vs. structural) challenges for enterprise software and argue that AI will not kill software, underpinned by: (1) massive software TAM expansion; (2) AI-native products driving a new best-of-breed cycle; (3) Agentic systems displacing many legacy applications; (4) “Build” complementing “Buy”; (5) AI enabling much more efficient company building; (6) Pricing models evolving to better align with value created.

Gain insight into the core drivers underlying Sapphire Ventures’ AI-powered software investment thesis.

🎲Lucky dip essential reads…

• How to start your own VC Fund

• AI product and marketing growth strategy with Reforge

• What does it take for hardware startups to raise VC capital in 2024?

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Josh