Klear, Inc.
2021 Fillmore Street
San Francisco, CA 94115
You could probably tell from my last post that I love to ski. I started when I was 4 and it is one of my very favorite things to do. It has been an activity that has delivered some of the greatest memories for my family of six, cemented my best adult friendships and is among the most rejuvenating psychical activities I know of. I grew up skiing in New England where it was cold and icy and my kids grew up skiing in California where it is warm and sticky. So far, this ski season is one for the ages across the Western US and not in a good way. This Saturday I went for a hike in the mountains of Marin and throughout the hills and the neighborhoods, the cherry blossoms were in full bloom on January 31st. Powder or Sierra cement, ice or sun, there has typically been a predictable period of “winter” in Northern California where we prayed for and were often rewarded with snow. This was something different. I hope mother nature is simply off-cycle, and a miracle March is in the offing.
The Cycles We’re Born Into — and the Ones We Learn
Some cycles we’re born into, some we teach our children and some we only learn as we acquire the wisdom that comes with experience. Some are as short as a breath and some are as long as the 100 year Long Cycle Ray Dalio writes about to explain current geopolitics. Many cycles are interdependent and compound or cancel each other out.
There are two cycles that are mission critical to young companies and they’re extremely interdependent and critically important to successful scale, but I almost never hear founding teams talking about them together. My career has led me to become obsessive about the velocity of money. Whether it is trading, payments, funding, or sales, it is something that I believe is clinically overlooked and fundamentally important to building companies.
If you’ve ever seen the edge of the cliff as a founder, pulled out of a nosedive or funded a miraculous payroll to keep the company on track, you’ve experienced the importance. If you’ve ever grown a company 10X+ while maintaining control, you know that this skillset was part of the secret sauce. If you’ve ever delivered superior investor returns then you must understand this metric. Let’s make it really simple by talking about two dependent cycles inside of any scaling company: Burns and Turns.
Burn Cycles: The Clock Every Startup Watches
Our customers build rockets, land things on the moon and deploy satellites into orbit and their definition of a burn cycle is different than the one we’re discussing here, but as scaling companies, they have both!
When founders and boards talk about runway, they also talk about burn and burn is typically measured in cycles - usually months - and is comprised primarily of relatively predictable opex expenses like payroll, rent, infrastructure (SaaS and cloud services) and sales and marketing spend.
The curve is is a downward slope that hopefully looks more like a green circle than a double black diamond.
The Runway Problem: When the Bank Account Gets Closer to Zero
With each cycle the company gets closer to “cash out” or, more practically, to an empty bank account . . . unless there is revenue (more importantly AR converting to actual cash) coming in the other end to extend the runway.
That is a burn cycle.
Let’s now talk about a Turn Cycle in a similar context.
Companies that build put money into inputs, turn those inputs into products, sell those products (or services) for more than it cost to make them (pretty please!) and get their invested capital (cash) plus a bit more back.
This is a turn of capital.
Success comes from getting more out of your turns than you lose in your burns.
Every company has a velocity of money, in fact economies have a velocity of money. The velocity of money is very closely correlated to the health of a company or an economy.
Generally, faster = better.
Turn Cycles and the Cash Conversion Cycle
At Klear we talk a lot about CCC — the cash conversion cycle — and everyone thinks we’re boring. It’s ok, I know. My friends tell me the truth. I’m going to talk about it again now, but if I didn’t warn you, you might not even notice. Let’s look at turns in the context of a backlog.
For example, say you make drone engines in the US. Let’s also say (hypothetically of course) that the US government bans foreign made drone engines and you suddenly have a massive backlog of orders that isn’t going away any time soon. Let’s also say that you calculated your WCR — working capital requirement before the backlog (if you did this calc at all you’re better than most.) Finally let’s say you recently did a raise and aren’t prepped to do another one and your VCs aren’t capitalized to simply write another check.
Your ability to consume the backlog is going to be driven by your velocity of money which is going to be determined by the number of turns per dollar you can achieve.
When you invest in inputs, the money is “trapped” in that from of capital until you deliver, invoice and collect.
If that is 120 days you can achieve 3 turns per year.
Let’s say you’re selling your drones at a 50% margin and you have $5M to allocate to a production cycle and that capital will be reinvested in the next cycle while the margin you earn will go toward other expenses.
Even this level of clarity and discipline is fairly rare but let's continue . . .
A Simple Example of Capital Turns
$5M x 150% = $7.5M per turn in sales orders that you can fill.
$7.5M x 3 = $22.5M in revenue you can capture with that working capital and that turn cycle. (Again, margin is going to running the rest of the business.)
Let’s say a production run is split 50/50 with 60 days in manufacturing and 60 days from commercial terms. If you could liquidate the invoices you could cut the cycle in half, reinvest the capital, double the velocity and do 6 turns. Technically this doesn’t change CCC academically but it does change your velocity when moving through a backlog.
$7.5M x 6 = $45M!
Why Capital Velocity Beats Traditional Financing
At 50% margins you’ve generated $22.5M in gross margins, that is gross margin equal to total revenue in the previous capital constrained scenario and is achieved simply by increasing velocity of capital.
Yeah, but how much does it cost to liquidate the invoices? It honestly doesn’t matter.
With 100% certainty it cost LESS than selling equity before you close that revenue. Mathematically it could cost 100X more to fund this with equity. When done well, it can be tremendously efficient.
What if you could also leverage the accounts receivable financing program to fund the acquisition of inputs to truly shorten the CCC and increase velocity of money? What if you could leverage some of that additional margin to increase the size of a turn?
“Wait, can’t I just use bank debt or a line of credit?”
Let’s do that math real quick. Bank debt is usually based on the balance sheet, venture debt is based on the equity balance. Neither will scale into your backlog.
Comparing Capital Velocity vs Debt
If you had $5M in cash, let’s say you could raise $3M in debt - might be ambitious but let’s go with it.
That’s $8M X 150% (from before) = $12M
$12M X 3 turns = $36M
Better than $22.5 but not as good as the $45M achieved through capital velocity. Not to mention that we didn’t factor in the burns and their impact on debt as the runway gets closer to the end. There is a better way, and capital velocity is the strategy.
When Capital Stops Being the Constraint
Now that the capital constraint is solved more, you may run into a capacity constraint that isn’t capital but production related.
This is VICTORY.
You’ve consumed a bunch of the backlog, created a happy customer, captured a bunch of revenue and established the baseline metrics required to capitalize an increase in production capacity.
This is execution in action! Bravo!
This is a bankable business model.
The Next Step: Capital Structure and WACC
As you scale the business by controlling and accelerating the velocity of money, more options will become available to you.
Equity will be raised at higher valuation with less dilution and other types of financing will become accessible due to scaling execution and demonstrable financial discipline.
We’ll examine this in further detail in the next installment when we look at WACC and The Capital Stack.