The three quality signals that predict compounding better than growth metrics
Two companies both grew revenue 100% last year. Same market, same traction, similar teams.
One sold for $400M three years later. The other burned through two more funding rounds and sold assets in a fire sale.
The difference wasn’t in their growth rates. It was in three quality signals visible in month six.
Why this matters
Investors optimize for the wrong metrics. Revenue growth gets all the attention in pitch decks and board meetings. But growth rate alone tells you almost nothing about whether a company will compound or collapse.
The companies that compound value over 5-10 years have something else. Three specific quality signals that appear early and predict sustainability better than any growth metric.
Miss these signals and you’ll overpay for temporary momentum. Catch them early and you’ll spot compounders while everyone else chases growth.
The research and pattern
Kahneman showed that humans are terrible at distinguishing signal from noise. We grab onto vivid, recent data and ignore underlying patterns.
In investing, growth is vivid. It’s what founders pitch and what makes headlines. Quality is subtle. It shows up in places most investors don’t look.
Here’s what I’ve observed across hundreds of deals: most due diligence focuses almost entirely on growth metrics, market size, and competitive positioning. Quality assessment gets a fraction of the attention.
But the companies that deliver exceptional exits share common quality characteristics that were visible early. These quality signals are completely independent of growth rate. You can have explosive growth with terrible quality (these companies flame out). You can have moderate growth with exceptional quality (these become compounders).
Take Zoom versus many video conferencing competitors in the mid-2010s. Zoom wasn’t the fastest growing initially. But they had something competitors lacked: net revenue retention above 140% in enterprise accounts. Customers who bought Zoom expanded their usage dramatically over time. Competitors saw customers plateau or churn.
That quality signal was visible years before Zoom’s IPO. It predicted the outcome better than growth rate ever could.
The pattern repeats across markets. Quality signals appear early. Most investors ignore them because they’re chasing growth. The investors who catch quality signals early find the compounders.
The framework
Here are the three quality signals that matter more than growth rate:
Signal 1: Revenue retention expansion
What to measure: Net revenue retention among cohorts that have been customers for 12+ months.
What it reveals: Whether you’re solving a getting-bigger problem or a getting-solved problem. Getting-bigger problems compound because customers need you more over time. Getting-solved problems plateau because customers eventually max out their usage.
Red flag threshold: NRR below 110% after the 12-month mark means you’re fighting gravity. Quality companies maintain 120-130% NRR in mature cohorts. Best-in-class exceed 140%.
Signal 2: Gross margin trajectory under growth
What to measure: Gross margin in your fastest-growing customer segment versus your mature segment.
What it reveals: Whether scaling makes you more or less efficient. Quality businesses improve unit economics as they grow. Mediocre businesses see margin compression under growth because they’re buying revenue.
Red flag threshold: If gross margins in your growth segment trail your mature segment by more than 5 points, you’re subsidizing growth. Quality compounders show flat or improving margins across cohorts.
Signal 3: Organic attachment rate
What to measure: Percentage of new customers who came through referral, word-of-mouth, or product-led growth versus paid acquisition.
What it reveals: Whether customers love you enough to tell others. This is the only moat that compounds automatically. Paid acquisition scales linearly with spend. Organic attachment scales exponentially with quality.
Red flag threshold: Below 30% organic in a mature business means you’re renting customers, not earning them. Quality businesses hit 50%+ organic within 36 months.
Application to your situation
Most investors I work with are sitting on companies optimizing for the wrong thing. They’re pushing growth targets when they should be fixing quality fundamentals.
Here’s how to apply this framework to your portfolio company or deal:
Pull the last six months of cohort data. Calculate net revenue retention for customers who’ve been with you 12+ months. If it’s below 110%, stop chasing new customers and figure out why existing customers aren’t expanding. The fix is usually in product roadmap, not sales strategy.
Segment your gross margins by customer acquisition vintage. If margins are compressing in newer cohorts, you have a pricing problem or a cost structure problem. Quality companies fix this before scaling. Mediocre companies hope scale will solve it (it won’t).
Track where your last 50 customers came from. If fewer than 30% came through organic channels, you don’t have product-market fit. You have distribution-market fit. That’s fine for an exit in 18 months. It’s terrible for building a compounder.
I’ve seen portfolio companies run this analysis and discover they’re growing fast but retention is collapsing. They pause new customer acquisition, fix the product, and come back with strong retention metrics. Growth rate drops temporarily. Exit quality improves dramatically.
Key takeaway
Growth gets the pitch deck. Quality gets the exit.
Working on a deal and want to know which quality signals show up (or don’t)? Reply with the deck and I’ll share what I see in 60 seconds.