By Tomy Han, Principal
“When you can measure what you are speaking about, and express it in numbers, you know something about it; but when you cannot measure it, when you cannot express it in numbers, your knowledge is of a meagre and unsatisfactory kind.” – Lord Kelvin
SaaS companies are a unique breed.
While most enterprises can rely on large, upfront transactions to drive revenues, SaaS companies rely on monthly or annual recurring revenues that can only make up for high customer acquisition costs over a longer period of time. The resulting delay in profitability in sales and marketing spending has made SaaS metrics both traditionally difficult to assess and of the utmost importance due to the need for long-term forecasting.
Every quarter at Volition Capital, our financial team sends a CFO form to our portfolio companies requesting specific financial information. Over the years, as our understanding of SaaS companies has evolved, so too have the financial metrics that we request.
Below is an up-to-date list of the most important SaaS metrics that we use to evaluate startup success and value in 2020. We recommend that startups not only collect these metrics but leverage them to create a library of data to aid in benchmarking. Only then can you define strategies for increased success, whether you are looking for investors or well on your way to acquisition/IPO.
Customer Acquisition Cost (CAC) Payback
The CAC Payback metric provides insight into a SaaS company’s go-to-market capabilities by showing how quickly a company can recoup its initial S&M cost on a per-customer basis. As stated earlier, SaaS companies generally have high customer acquisition costs that take a long time to recoup. CAC Payback indicates the number of months it takes for capital to be returned with each new customer. The shorter the payback period, the more efficient the acquisition methods are. The calculation is simple:
(S&M spend / # of customers acquired)
(Average Revenue per account * Gross Margin %) / 12
The higher the number, the longer it will take to recoup the initial investment in acquiring a customer. The longer it takes to recoup those dollars, the longer it takes to be able to reinvest the cash back into the business, creating a multiplier effect on the value of a dollar. The ideal target should be less than twelve months, though these figures could be skewed if the company is not yet operating at scale. In short, this metric can help forecast time to profitability on a per customer basis.
Customer Lifetime Value (CLTV) / CAC Ratio
This metric takes CAC into context by showing how much value overall the company is deriving from its spending on sales and marketing over the projected lifetime of a customer. The higher the ratio, the greater the value of dollars created for every dollar of S&M spend. But how much higher?
Generally, we like to see companies with a ratio of 5x+. This means for every dollar of S&M spend, you can expect to make five dollars over the course of your average customer’s engagement with your company.
Average Revenue per Account (ARPA) * Gross Margin % * Expected Lifetime
(S&M spend / # of customers acquired)
SaaS Magic Number
As you consider your S&M spend, the SaaS Magic Number is an alternative to the CLTV / CAC Ratio. The SaaS Magic Number is used to benchmark sales efficiency, aiding companies in identifying when to continue to invest in S&M and when to evaluate.
The Magic Number asks the question: For every dollar in S&M spend, how many dollars of revenue did the company generate? It goes beyond just calculating value as the CLTV / CAC Ratio does; it provides insight into market saturation and sales team effectiveness by comparing past and present revenue and expenditure.
(Current Quarter Revenue – Past Quarter Revenue)*4
Past Quarter S&M Expense
Ultimately, a score greater than 75% indicates a company can grow fast and efficiently and should continue to invest in S&M. Below is a table that describes how a company should approach different scores.
SaaS Magic Number Targets
Not ready to invest in S&M
50% – 75%
Invest in S&M
This is a classically important metric. The SaaS cash efficiency ratio measures how quickly a company is burning cash. The ratio provides insight into how long companies can keep burning cash after factoring in net new Annual Recurring Revenue (ARR).
If the ratio is low, say, under 1x, it means a company might need to raise another round of capital, or, in extreme cases, reconsider their business model. To calculate this figure, you simply divide your ARR by your cash burn, which is defined as the amount of outflow quarterly for operations.
Net New ARR
Gross Revenue Retention (GRR)
GRR measures annual revenue retained from a customer base, not including expansion revenue or price increases. High retention indicates a company is keeping and renewing its customers, which is arguably the most important element for SaaS businesses.
(Starting ARR – Churned ARR)
Gross retention is always on a scale of 0-100%. High GRR is indicative of a sustainable revenue stream and future growth, as well as the maturity of the product, product market fit, and customer satisfaction. Generally, we look for enterprises with 90%+ GRR and SMBs with 75%+ GRR.
Net Revenue Retention (NRR)
This metric is a more complete picture of GRR. Like GRR, it captures the negative impact of lost customers, but it also captures the positive impact of price changes, cross-sells, up-sells, and growth in usage.
Starting ARR + (upsell – churn)
SaaS Quick Ratio
This is our final metric, and it can be used to measure growth efficiency. It factors in additions to revenue from new and existing customers and lost revenue from churned and existing customers. This metric is somewhat similar to NRR, though it calculates on a monthly rather than annual basis and includes new customer growth as well.
New MRR + Expansion MRR
Churn MRR + Reduction MRR
Low quick ratio indicates the company has difficulty driving new revenue growth, while high quick ratio shows steady growth. Our target SaaS Quick Ratio is greater than 4.
Conclusion: The Kelvin Scale
Like Lord Kelvin, we believe in measuring success. We evaluate all our portfolio companies and potential investments using these metrics, and we think they provide a good contextual framework. As a founder or team member of a startup, consider tracking yourself against these metrics to better understand your own success.
That said, metrics are only as good as the team that produces them, and we go to great lengths to balance our quantitative evaluation of companies against the less tangible elements of the team that makes them up. When we say grow with Volition, we also mean personal and professional growth. We invest in people as much as we invest in companies, and we want to become your partners.
If you really want to scale, you need to trust in yourself, your product, your partners, and your team even as you use metrics to guide your decision making: this is the path to SaaS success.
Photo credit: James Glover