Cockroach

What does cockroach mean?

Cockroach (a capital-saving, resilient company) refers to a young company that, with low cash use, a flexible cost structure and early revenue, can also withstand longer periods without new funding. If necessary, it adapts its business model instead of shutting down. The term, also used as cockroach startup, is borrowed from the insect, which is regarded as particularly undemanding and resilient.

The term was coined in the US venture capital market, that is, the market for equity capital in young growth companies. It is used as the counter-image to the unicorn, a non-listed company that quickly reaches a valuation of at least USD 1 billion with high capital input. It refers to a style of management, not a legal form or a contractual term. In Germany it is encountered mainly in conversations with investors, in advisory board meetings and in phases in which venture capital is scarce and capital efficiency is weighted more heavily than pure growth.

Characteristics of a cockroach company

Typical is a combination of financial and organisational characteristics:

• Low cash outflow: The net burn, that is, the monthly net outflow of liquid funds, is low in relation to the funds available. The reach of the funds (runway) is correspondingly long.
• Flexible costs: A large part of the costs can be adjusted at short notice, for example through freelancers, infrastructure that can be cancelled monthly or performance-based sales compensation.
• Early revenue: The company generates income early, in part from project or service business alongside the actual product.
• Adaptability: Target group, pricing model or product focus are changed when the data suggest it. Such a pivot follows from insights, not from impatience.
• Orientation towards viability: Planning aims to reach break-even with the funds available. The company is or thereby becomes default alive.

Opportunities and risks of the cockroach approach

The advantages lie in independence. A company with a long runway does not have to close financing under time pressure, can compare offers and keeps more shares because it needs less capital. In addition, it gains time to find a viable market instead of having to keep a direction because the funds for a change of direction are lacking. When venture capital becomes scarcer, such companies depend less on the state of the financing market.

The risks lie in growth. In markets with network effects or high switching costs, a better-funded competitor can occupy market share before a capital-saving company reaches the necessary size. Project and service revenue that initially finances product development can tie up capacity and permanently turn the company into a service provider. Finally, there is the danger that a company persists for years without growing notably. For investors, capital is then tied up without a sale or follow-on financing in sight.

How investors assess a cockroach company

In the review, investors distinguish whether low cash use is an expression of discipline or of a lack of growth opportunities. What is decisive is what the company achieves with the funds deployed. Three metrics provide insight. The burn multiple measures cash use per euro of newly gained annual recurring revenue. The contribution margin per customer is revenue less directly attributable costs, and the payback period is the time until customer acquisition costs are recovered. Together they show whether an additional euro of capital would lead to profitable growth. Sound unit economics, that is, positive profitability per customer, turn a frugal company into an attractive candidate for growth financing.

Venture capital funds need holdings whose value multiplies in order to meet their return targets. A company permanently oriented towards frugality therefore does not suit every investor. For family offices, business angels with a longer investment horizon or strategic investors, by contrast, it can be well suited. In a company sale, capital efficiency also has an effect: a company that has reached break-even appeals not only to strategic buyers but also to financial investors. If the product does not find a viable market, an acqui-hire is sometimes left as a way out, in which an acquirer takes over mainly the team.

Practical example: cockroach course after an aborted Series A

A software company for route planning for mid-sized freight forwarders has prepared a Series A, the first larger funding round with professional investors. Discussions do not reach a conclusion because of a weak market phase. The company has EUR 1.44 million in liquid funds with a net burn of EUR 180,000 per month, so the runway is eight months.

• Paid advertising is replaced by sales through industry partners against performance-based commission: EUR 45,000 less outflow per month.
• Contracts with freelance developers are not renewed, planned hires suspended: EUR 25,000 less.
• Infrastructure is switched to cheaper tariffs: EUR 10,000 less.
• The team takes on paid integration projects at existing customers, which also improve the product: EUR 60,000 additional inflow per month.
• New net burn: 180,000 minus 45,000 minus 25,000 minus 10,000 minus 60,000 = EUR 40,000 per month.
• Because of notice periods and the ramp-up of the projects, this takes effect gradually. In the four months of transition, EUR 180,000, 120,000, 80,000 and 60,000 flow out, together EUR 440,000.
• The remaining EUR 1.44 million minus EUR 0.44 million = EUR 1.0 million lasts, at the new net burn, 1,000,000 divided by 40,000 = 25 months, so 29 months in total instead of 8.
• Growth in recurring revenue slows noticeably but remains positive.

At 25 months, the runway is above the 12 to 18 months that should be available at the start of a funding process. The company can therefore approach follow-on financing again without time pressure. In the new round, however, it has to explain how it wants to switch from the frugal course back to growth and what effect additional capital would have on sales and revenue. The cost measures demonstrate the management's ability to steer; the growth potential has to be demonstrated by the unit economics.

Distinctions: cockroach, camel, zebra and bootstrapping

• Camel: describes a company that grows in a balanced way between growth and efficiency and survives lean periods. The terms are close to each other; cockroach places more emphasis on adaptability and change of direction.
• Zebra: stands for a company that combines profitability with social benefit. The focus is on the company's purpose, not on resilience.
• Bootstrapping: financing from own funds and revenue without external investors. A cockroach company can very well be venture-backed.

Common mistakes

• Frugality without direction. Cost reductions extend the runway but do not replace a plan for how the company becomes viable or grows again.
• Service displaces product. Project revenue that was originally meant to finance development determines the team's priorities after some time.
• Frequent changes of direction. Anyone who changes the business model before a direction has been sufficiently tested gains no insights but uses up time.
• Survival as the goal. A company that exists for years without growing ties up capital and the founders' working capacity and loses appeal for investors and buyers.
• Cost measures not explained. If cuts are not explained in reporting, investors read them as a sign of crisis instead of a deliberate decision.

Frequently asked questions

What does cockroach mean in German?

Literally Schabe or Kakerlake. There is no fixed German term for the corporate image; what is meant is a capital-saving, resilient young company that can keep operating even without new financing.

Is the term cockroach meant disparagingly?

No. Among investors it is generally used appreciatively and describes capital discipline and resilience. In a company's external presentation it is nevertheless unusual because of the image.

When does a cockroach approach make sense?

Above all in phases in which venture capital is scarce, and in markets in which size brings no decisive advantage. In markets with strong network effects, an overly frugal course can lead to competitors with more capital occupying the market.

What is the difference between a cockroach and a unicorn?

The handling of capital. A unicorn quickly reaches a valuation of at least USD 1 billion with high capital input and high start-up losses. A cockroach company keeps cash use low, grows more slowly and in return stays less dependent on the next funding round.

Can a cockroach company grow strongly later?

Yes. Capital-saving companies can use the time gained to find a viable market and then raise growth capital. The capital discipline from the frugal phase is then an argument in the review.

The Roemer Capital view

When companies we accompany through a funding round have a frugal phase behind them, we make this phase part of the Equity Story. We show the cost measures with figures, their effect on the runway and the development of the unit economics during this time.

We put the emphasis of the presentation on what comes afterwards: how much capital the company needs for which growth step and by what investors can measure success. Capital discipline alone does not justify an investment for a growth investor. Combined with a reliable financial model, it becomes an argument for valuation and terms.