Thursday, June 25, 2015

By the time you're at $2-3M in ARR, you need a VP of Sales who's done it before

For most SaaS startups, the VP of Sales (along with the VP of Marketing) is one of the most crucial hires they need to make. Unless you have a no/low touch sales model and you're growing virally (a.k.a. you're successfully hunting flies or mice), someone needs to build a scalable sales organization, whether it's an inside sales team (a.k.a. hunting rabbits or deer) or a field sales team (a.k.a. hunting elephants).

It's also one of the toughest hires. Jason M. Lemkin gave an epic talk about the subject at our 3rd annual SaaS Founder Meetup, last year in San Francisco. Jason also wrote extensively about the topic on SaaStr. If you haven't read his articles yet, make sure you read all of them.

As Jason explained in this post, one of the things that makes hiring the right VP of Sales so hard is the timing. If you try to hire your "Mr. Make it Repeatable" or your "Ms. Go Big" VP of Sales too early, say at $500k in ARR, you'll almost certainly not get a great one. The reason is that a great one will most likely not leave his or her current position at a successful, fast-growing, well-funded SaaS company, which pays him or her hundreds of thousands of dollars in salary and bonus/commission per year, to join your tiny little startup.

Starting to look for your VP of Sales too late is equally dangerous, though. If you want to grow roughly in line with the T2D3 formula, which most venture-funded SaaS startups should shoot for, you need to hire a lot of sales people in year 3. An exception are SaaS startups with a no/low-touch sales model and viral growth (see above) and potentially companies which have a massively negative net MRR churn rate and therefore don't have to acquire as many new customers. If you're fortunate to be in one of these categories, you may not need a big sales team, but most SaaS companies aren't.

That's why I think most SaaS companies that don't have sales management experience in the founder team need to start looking for a VP of Sales by the time they're at around $1.5-2M in ARR so that by the time they're at around $2-3M, they've recruited a VP of Sales who can take them to $10M and beyond. My thinking becomes clearer if you take a look at this model, which calculates how many sales people you need to get from, say, $1M in ARR to $10M. Note that a big and productive sales team may be necessary to achieve that goal, but it's obviously not sufficient. You also need a great product, great marketing, etc. – otherwise your sales team won't have enough warm leads and closing them will be too hard.

(click for a larger version)

Click here to download the Excel sheet.

Here's how the model works:

  • Enter your current ARR in cell D10. You can of course also enter your ARR target for a future date, depending on what you want to calculate. In the template, I'm assuming that you're at or close to the end of year 1 and want to work out your hiring plan for year 2 and year 3.
  • Enter the monthly growth rate that you're targeting for year 2 and year 3 in cells D11 and D12, respectively. Note that this should be your "net MRR/ARR growth rate", which takes into account all MRR movements like churn, expansion or contraction. The sample data that I've put in reflects the T2D3 formula (grow to $1M in ARR in year 1, triple in year 2 and triple again in year 3).
  • Input your monthly net MRR churn rate (i.e. [churn MRR plus contraction MRR] minus [expansion MRR plus reactivation MRR]) in cell D13.

Using these inputs, the spreadsheet will calculate the new ARR from new customers that you have to acquire in order to meet your growth targets. See row 25.

Now ... how many sales people do you need to achieve these target numbers? This depends on the following inputs:

  • Your AEs' quota, i.e. how much new ARR you expect each AE to bring per month. The model assumes that your AEs will on average meet their quota. In reality, some of your sales people won't meet their quota and some will exceed it, so this number really is just the average which you expect to achieve.
  • Ramp-up time, i.e. the time it takes your AEs to reach full productivity. The model assumes that they're 100% productive in month 4. For months 1-3, you can enter different percentages in cells G10-12.
  • The size of your sales support team. In cells K10-14 you can enter how many Sales Directors, SDRs and SDR Directors you expect you'll need in proportion to the number of AEs.

The sample numbers that I'm using in the template are broadly in line with the results of this benchmarking survey. As you can see in the spreadsheet and in the chart, based on these assumptions your total sales headcount increases from 2 to 9 in year 2 and from 9 to 30 in year 3. So in year 3 you'll have to hire and train 21 new sales people (plus replacements for people that leave or are let go). 

Without a VP of Sales who has built and scaled a sales team before, that's tough. 


PS: As you can see in the chart below, there's a 1:1 correlation (approximately) between ARR and sales headcount. That's OK in the $1-10M ARR stage, but in the longer term the best SaaS companies manage to grow revenues faster than sales spendings, primarily by focusing on account expansions to achieve an ever-increasing negative MRR churn rate and by continuously getting up sales efficiency.

(click for a larger version)


Tuesday, June 16, 2015

Why we politely ask for a deck first

When founders reach out to us to pitch us for an investment, they usually have a fundraising deck which they’re happy to send over. But every so often it also happens that a founder wants to set up a call or a meeting before sending over any material. In these cases I usually ask the founder if he or she could send us a deck first, with a view to have a call or meeting as a potential second step. But every time I do this, it makes me feel uncomfortable because I don’t want to come across as impolite, arrogant or unapproachable. In this post I’d like to give some background on how we work, which will hopefully make it easier to understand our behavior in the scenario I described above.

I have understanding for founders who want to walk us through their story and vision rather than sending over some slides. A startup is a founder’s baby which they often have a deeply emotional relationship with, and it’s understandable that when they pitch it, they want to leave the best possible first impression. It’s also understandable that founders want to get to know us first and learn more about us before sending us confidential information. What’s more, most founders are very smart people who are great to talk to. For all these reasons, I wish we could talk to all founders who reach out to us.

But it’s impossible. In the last 90 days we’ve logged 987 potential investments in our Zendesk (which we use for deal-flow management). Even with three Associates and one Intern, we can’t talk to all of these startups. If we did, we wouldn’t have enough time to dive in deeply into sectors, do due diligences, spend time with our portfolio companies and do many other things which are important for our business.

This is why using the pitch deck as the first filter is so important for us. When we go through a deck, a couple of minutes are usually enough to determine if we want to learn more. There are plenty of reasons why a company may not be the right fit for us (and Point Nine not the right partner for the company): It may be too early-stage or too late-stage. It may be a sector we’ve looked at before and aren’t excited about or it may be an area which we don’t have any expertise in. Or it may be in a field that’s too close to one of our existing portfolio companies. Most of the time when we pass quickly after having seen a deck, it doesn’t say anything about the quality of the startup and only means that the company is outside of our investment focus.

Obviously our process isn’t perfect. Not taking a closer look at each incoming request means we will miss great companies (and grow our anti-portfolio). But the same is true for any other approach.

A few closing comments:

  • I know that most other VCs feel the same about this, so if you want to raise money, spending time on producing a great pitch deck is time well spent. I also think that creating a deck is a great exercise because it helps you think through each area of your business systematically.
  • Michael wrote a great post about “What should be in my fundraising slides”.
  • Don’t ask for NDAs.
  • Don't send your pitch deck to dozens of VCs. Do your research to find out which 5-10 firms look like the best fit for you and start with those.
  • You don’t have to include everything in your “teaser” deck. I would recommend to include KPIs in the deck, since these are crucial for the investor to determine if you’re at the right stage, but it’s perfectly fine to leave out sensitive information like details on your product roadmap.

Wednesday, June 03, 2015

Announcing Point Nine Capital III

Today we’ve announced Point Nine Capital III, our new €55M fund. Investors in PNC III include institutional investors like Horsley Bridge Partners, Sapphire Ventures, Flossbach von Storch and Vintage Investment Partners as well as a number of highly successful Internet entrepreneurs. To our existing LPs: Thank you for your continued trust! To the new ones: Welcome on board!

When we raised PNC II, our goal was to build a leading independent European early-stage venture capital firm. While it’s still very early days for us, we think we’ve made good progress towards that goal in the last years.

PNC II was based on a couple of ideas and principles:

Live Berlin, think world
We saw a strong need for a Berlin-based seed VC because Berlin was starting to become a great startup destination, yet there was not a single VC that was headquartered in the city. At the same time, we didn’t want to limit ourselves to investing only in Berlin (or only in Germany for that matter) because we saw great startups being founded all over Europe (and elsewhere). Before PNC II we had already invested in Berlin-based companies like DaWanda, Delivery Hero and Mister Spex as well as in companies from Denmark (Zendesk), the UK (FreeAgent, Geckoboard, Server Density), Canada (Clio, Unbounce), the US (StyleSeat, Couchsurfing,...) and even New Zealand (Vend) and Japan (Gengo), so we were already used to this approach.

Focus on early-stage investments in SaaS, marketplaces and eCommerce
While we wanted to be pretty agnostic with respect to geography, we were going to be pretty focused when it comes to stage and industry. We’d only do early-stage investments (seed and early Series A) and would focus on three categories: SaaS, marketplaces and eCommerce.

Be “The Angel VC”
Both Pawel and I had a background as angel investors, and just because we raised a fund we didn’t want to give up our angel investor mentality. We wanted to combine a founder-friendly, no-nonsense, value-add approach with the ability to make bigger investments and do more follow-on financing.

Think long-term and give before you take
VC investing is an incredibly relationship-driven business. To be successful, you constantly need other people’s help and goodwill. What that means is that if you’re a newcomer, you should try to “give” as much as you can to as many people as you can in order to build long-lasting relationships.

Small is beautiful
Our original goal for PNC II was to raise €30M. We ended up raising a little more (~ €40M), but it was still a typical micro VC size. One reason for becoming a micro VC was, of course, that we wouldn’t have been able to raise a €100-200M fund, so it was an easy decision. :-) But we also felt that a €30-40M fund was the right size for a European seed fund: Big enough to invest needle-moving amounts in startups and have capacity for follow-ons, but not a size at which you need multiple unicorns just to survive, as my friend Jason M. Lemkin put it. (Not that we have anything against unicorns, but you know what I mean.)

Three years later

Three years later we feel encouraged by the early results of our strategy. Many PNC II portfolio companies have raised large follow-on financings from great investors like Accel, Acton, Balderton, Bessemer, Emergence, General Catalyst, Matrix, MHS, Storm, Valar and others. In many cases, valuation has gone up significantly since our initial investment, in a few cases as much as 10-20x and more. Again, it’s still very early and it will take another five years or so to see if we’ve done a good job with PNC II, but we’re super excited that so many of our portfolio companies are on a great track. We’re also extremely grateful for the appreciation that we’re getting for our work – from portfolio founders, other investors, our LPs and the bigger startup community.

Finally, we’re also extremely happy with the team that we’ve been able to build. Assessing an ever-increasing number of investment opportunities and managing a portfolio of around 50 companies wouldn’t be possible without the fantastic work of our Associates or our Operations Team. Thanks guys, you’re awesome. :)

So, we’re happy with our strategy, and we’re going to continue it with PNC III. We’ll continue to invest heavily in Berlin but will also continue to invest all over Europe and beyond. We’ll keep our “Angel VC” tagline, and we’ll continue to do our best to be a “good VC”. We’ll stick to early-stage, and while PNC III is a little bigger than PNC II, we’re not leaving micro VC territory.

In terms of sectors, we’ll stay focused on SaaS and marketplaces, although we’ll also keep exploring new areas like bitcoin, IoT or drones (interestingly, the investments which we’ve made in these new areas so far all fall under SaaS or marketplaces from a business model perspective). The one area which we got somewhat less excited about in the last years is eCommerce, mainly because it requires so much capital and because the margins are usually small. There are (very) notable exceptions, of course – Westwing is one of the best-performing companies of PNC I, and if Stefan Smalla ever starts another eCommerce company we’ll invest in it again in a heartbeat.

Copy & paste?

So a lot of things are going to stay the same, which explains why, when we told our partners at Horsley Bridge about our plans for the new fund, Kathryn said, with her inimitable wit: “Sounds like copy & paste”. That’s true, but I should point out that other things have changed and will continue to change rapidly. Some of the “pattern matching” that we’ve used to pick great companies 3-7 years ago doesn’t work any more because what used to be innovative a couple of years ago is table stakes today. Many of tomorrow’s unicorns might and probably will be based on technologies which barely exist today. Add all the changes that are happening in the funding ecosystem, and it’s clear that while we’ll stick to our core values, we’ll have to keep re-inventing ourselves to stay relevant. So don’t worry about us getting slow and saturated. We’ll stay hungry and foolish.




Friday, May 08, 2015

A closer look at the 6 things to pre-empt 90% of Due Diligence

Since last week's post about 6-7 things to pre-empt 90% of Due Diligence was liked/shared/retweeted quite a bit, I'd like to follow up with some additional details on what exactly SaaS Series A/B investors will look for when you supply them with the data and material that I've mentioned. In my post I suggested that you should prepare a key metrics spreadsheet, a chart with your MRR movements, a cohort analysis, a financial plan, an analysis of your customer acquisition channels and, if you're selling to bigger customers, information about your sales pipeline and details about your largest customers. Let's go through these items one by one and try to anticipate some of the questions potential investors will think about.

As a caveat, I'm going to mention some benchmark numbers but it's very important to note that none of these numbers can be viewed in isolation. There is not one number which will determine if investors want to invest. It's always about many puzzle pieces which together form a picture of the strength of your company.

Key metrics spreadsheet


  • What's your visitor-to-signup conversion rate? Typically this metric is in the 1-5% range. If you're significantly below that, that doesn't have to be a red flag – there can be good reasons for a lower rate – but it may raise questions.
  • What's your signup-to-paying conversion rate? In my experience, most good SaaS companies convert 5-20% of their trial signups into paying customers (but again, there can be exceptions).
  • What's your lead velocity? Are you getting more and more new trials/leads every month?
  • What's your account churn rate and more importantly your MRR churn rate? The best SaaS companies have an account churn rate of less than 1.5% per month and a negative MRR churn rate (which doesn't mean that you can't have a great company with somewhat higher churn or that you have to be at negative MRR churn at the time of your Series A/B).
  • How fast and how consistently have you been growing MRR? Have you been adding an ever-increasing amount of net new MRR month over month?
  • How has your ARPA developed? Have you been able to increase it?
  • Are you able to sell annual plans?
  • How long did it take you to get to $1M ARR? The best SaaS companies get there within 12-15 months after launch (but again, lots of exceptions ... there are companies that start slowly and skyrocket later).
  • How much have you been spending on customer acquisition? As a rule of thumb, most SaaS companies should target a CAC payback time of 6-12 months, although in some cases there can be good reasons to spend significantly more.
  • What are your CoGS and what's your Gross Profit Margin? As a pre Series A startup you're probably not great at tracking/attributing CoGS ... which I think is OK.

MRR movements

  • How much MRR have you been gaining by acquiring new customers? Have you been able to add MRR by expanding existing accounts as well? 
  • How much MRR have you been losing due to churn or downgrades?
  • Mamoon Hamid of Social+Capital has coined the term "Quick Ratio" for the ratio between added MRR and lost MRR, and he's looking for companies with a Quick Ratio of > 4. If your Quick Ratio is significantly below that, is it trending in the right direction?

Cohort analysis

  • How does your account and MRR retention look like for some of your older customer cohorts? Do you have low or even negative MRR churn?
  • Taking a "vertical" look at the cohort analysis, are you getting better and better over time, i.e. do your younger cohorts look better than older ones?
  • What's your estimated CLTV based on this cohort data?
  • How does usage activity look like on a cohort basis? Is there a lot of "hidden churn" (customers who got inactive and are likely to cancel soon)?

Financial plan

  • Is your plan both ambitious and realistic? Most investors are looking for T2D3 type growth, i.e. once you've reached around $1M in ARR you should try to grow 3x y/y for two years.
  • Is your plan a coherent continuation of your historic/present numbers, both methodically and with respect to your key assumptions? Projecting a sudden, drastic improvement of your key drivers is understandably much harder to sell to investors.
  • Are your key assumptions plausible, and what's the impact of somewhat more pessimistic assumptions?
  • Did you sanity check the outcome of your model? If the result of your model is that you'll be a money printing machine within two years, that's usually a sign that you're underestimating future costs. :)

Customer acquisition channels

  • How did your customers find you? Organic, paid, both? Ideally you have strong organic growth (which is strong proof of product/market fit) as well as some success with paid customer acquisition channels (which can be scaled more easily).
  • How does your conversion funnel look like for different sources of traffic? What are your costs per lead and per customer for different marketing channels?
  • How close are you to building a (somewhat) predictable and repeatable sales and marketing machine? Do you have a sense for the scalability of your customer acquisition channels

Sales pipeline

  • How does your current pipeline look like? Do your short-term targets look realistic based on your "in closing" pipeline? Does your overall pipeline support your mid-term targets?
  • How has your pipeline developed? Has it become stronger and stronger over time?
  • Are you starting to get a handle on closing probabilities and closing timelines?

In the original post I said as a bonus tip that if you're an enterprise SaaS company, you should put together some additional information about your largest customers. Here's another bonus tip: Include information about your NPS (which is hopefully very high) and how it has developed over time.

Ideally, all these puzzle pieces together, along with the size and attractiveness of the opportunity you're going after and the strength of you and your team, will form the picture of a SaaS startup which has clear product/market fit, enthusiastic customers, strong initial traction, continuously improving metrics and which is on its way to building a repeatable, scalable and profitable customer acquisition engine.


Friday, May 01, 2015

6 things to pre-empt 90% of Due Diligence

The founder of a portfolio company recently asked me what kind of numbers and other material he'll need when he goes into his next round of fundraising. He wanted to make sure that when he starts talking to new potential investors, he'll have answers ready to most of the questions he'll be asked.

That was a great question. By putting together a comprehensive set of data you can pre-empt 90% of the questions which investors will ask you when they assess a potential investment. This has a number of important advantages:

  • It saves you time because you'll have to answer fewer individual questions and requests in a piecemeal fashion.
  • It can speed up the fundraising process dramatically if investors get almost everything they need at once (or almost immediately upon request).
  • It makes you look better, because it shows that you're on top of things.
  • Almost all of the numbers (good) investors ask for are things that you should be highly interested in anyway, since they are important for understanding and running your business.

What kind of numbers you should prepare of course depends on the industry and stage you're in. I'm going to assume that you're a SaaS company and that you're going for a Series A or a Series B round. In this case, the following things will help you pre-empt a lot of DD questions:

1) A spreadsheet with your key metrics, since launch, on a monthly basis. It should include funnel metrics (visitors, signups, conversions etc.) as well as key financial metrics (MRR, CoGS, CACs etc.). If you haven't seen it yet, I put together a template for a KPI dashboard some time ago, which should serve as a good start.

You are probably tracking most of these numbers already anyway, so you can use a copy of your internal dashboard, but make sure that it's clean, comprehensible and that you're using the right terms.  If your dashboard contains any ambiguous metrics, add footnotes with precise definitions to make sure that an outsider understands exactly what he's looking at.

2) A chart with your MRR movements, since launch, on a monthly basis. That is, a chart that shows your new MRR, expansion MRR, contraction MRR, churn MRR and reactivation MRR for each month since launch.

MRR movements in ChartMogul
If you have a very wide range of customer size, consider breaking down the MRR movement analysis by your customer segments, because in that case the aggregate numbers across all customers may not tell the full story. So if you're selling to both SMBs and bigger enterprises, consider showing one MRR movement chart for the SMB customer segment and another one for the enterprise customer segment.

Make sure to provide the raw data along with these charts (and any other charts you provide) to allow the viewer to do his or her own calculations.

3) A cohort analysis, showing each monthly customer cohort since launch and how the cohort’s MRR has developed over time. I created a template for that, too. If you're selling to both SMBs and enterprise customers, you should again consider doing a separate analysis for each of the two segments.

Also consider adding a cohort analysis which is based on an activity metric. Think about what your key usage indicator is, then run a cohort analysis that shows the development of that number over time.

4) A financial plan for the next three years. The plan should follow the same logic as your historic KPI dashboard and should be relatively simple. Don't hard-code many numbers and make it easy to understand which assumptions the model is based on. Here are a few additional tips, and here's a template for a financial plan I built some time ago.

5) An overview of your customer acquisition channels. That is, a breakdown of your website visitors, leads and customers by source and data about your customer acquisition costs. 

Try to add some data points or estimates on the scalability of your customer acquisition channels. I know this is very hard and sometimes impossible, especially for inbound marketing driven companies, but some projections are probably better than having none at all.

6) If you're selling bigger deals, detailed information about your current sales pipeline. This should include a list of all qualified opportunities, and for each opportunity the potential deal size (in terms of MRR or ARR), pipeline stage and, if you have enough historic data to make a solid guess, closing probability and timeline. If you're a low-touch sales, high-velocity, low ARPA SaaS company you can leave this out.

Bonus tip: If you're an enterprise SaaS company, put together some additional information about your largest customers. Think of it as a little case study, with some information about how the customer found you, how the sales process looked like and how the account has developed over time.

What do you think? Does this capture most of the data Series A/B investors want to know?

[Update 5/8/2015]: I wrote a follow-up post with some additional details on what exactly SaaS Series A/B investors will look for when you supply them with the data and material mentioned above.]


Friday, April 24, 2015

Key Revenue Metrics for SaaS companies

Thanks to Nick Franklin for reviewing a draft of this post!

When I talk to SaaS startups and take a look at their metrics, it still happens quite often that some of the numbers aren’t quite clear to me and it takes some time to clarify things. I’m not referring to sophisticated reports or analyses but to the much more mundane question of what exactly people mean when they use a term like “revenues”.

It’s maybe not surprising that there’s sometimes confusion, given that there are several different ways to express revenues of a SaaS company and even more ways to label them: revenues, sales, turnover, MRR, CMRR, ARR, cash inflow, cash-in, billings, bookings, GAAP revenues, income and so on. That said, I believe most SaaS companies can focus on a small number of revenue metrics which aren’t overly complicated.

If everyone in the SaaS world can agree on the same nomenclature, I think that will make communication between founders and investors more efficient and will save all of us some time. So let’s take a look at the most important revenue metrics in SaaS.


MRR

Monthly Recurring Revenue (MRR) is, as the name suggests, revenue that you anticipate to recur on a monthly basis. If you’re selling monthly subscriptions, MRR is simply the price paid each month for the subscription. If your customers are paying you for more than one month upfront, you simply divide the amount you received by the number of months in the subscription period.

Say you’ve acquired two new customers. Customer A has signed up for a monthly subscription at $100 per month and Customer B has signed up for an annual subscription of $1100 per year. In this scenario, customer A increases your MRR by $100 whereas customer B increases your MRR by $91.67 ($1100/12).

This simple metric is the most important metric a subscription business needs to calculate, which is why ChartMogul (which for disclosure we’re an investor in) is highly centered on MRR. If you focus completely on MRR and calculate it correctly you’re in pretty good shape, so feel free to stop here and ignore the rest of this post. :-)


ARR

Annual Recurring Revenue (ARR) follows exactly the same concept. The only difference is that it measures your annually recurring revenue as opposed to your monthly recurring revenue, so your ARR is 12x your MRR.

Since both metrics are interchangeable, it doesn’t matter if you’re tracking MRR or ARR. I personally prefer MRR, but I can’t tell you why. Probably just out of habit.


Cash inflow

Cash inflow or “Cash In” is the amount of money that you’ve received in your bank account. In the example above, it’s $100 for customer A and $1100 for customer B. A related term from the accounting world is “Accounts Receivable” and refers to cash that is legally owed to you but which you haven’t received yet. Since SaaS companies are typically paid upfront, at least for a month of subscription if not a year, you usually don’t have to worry too much about this and can focus on cash inflow.


Revenues

Revenue means MRR plus any non-recurring revenue such as implementation fees, setup fees or charges for professional services. Let’s say you’re charging a customer $1000 for a data migration project that takes one month to complete, plus another $3000 for onboarding consulting in the customer’s first three months. In that case, the customer will increase your revenue by $2000 in the first month ($1000 for the data migration and $1000 for consulting) and another $1000 in month two and three each. But since these revenues aren’t recurring, don’t include them in your MRR.

Note that this definition of “revenues” is what I believe is usually the right way to look at revenues at the management and board level whereas the numbers which your accountant will produce for your financial statements will likely look slightly different. The reasons are a couple of subtleties in the way software revenues are recognized based on US GAAP and other accounting standards, which brings me to...


US GAAP Revenues

Since I’m not an accountant and don’t even have an MBA we’re now entering territory which I’m not very familiar with, so proceed at your own risk. :) US GAAP Revenues means revenues in accordance with the “Generally Accepted Accounting Principles” adopted by the SEC. Your US GAAP revenues will usually be close to your revenues based on the definition I outlined above, but there can be some differences. For example, US GAAP revenue is typically calculated using a daily recognition model as opposed to the more practical monthly model. That means that if a customer signs up for a subscription at $100 per month on January 15th, according to US GAAP you should only recognize $50 of those $100 in January, despite the fact that that customer is adding $100 to your January MRR. Another difference is that as I’ve learned when doing some research for this article, apparently you may have to recognize things like implementation fees over the subscription period as opposed to the period in which the implementation service is being provided.

This topic is a science of its own, and if you’re interested you can read this 150 page manual from Deloitte about software revenue recognition, but the good news is that you don’t have to worry too much about it. Find a good accountant who understands SaaS and let him figure it out.


Bookings

I’ve seen several definitions of the term “bookings”. Broadly speaking, bookings are the total dollar value of all new contracts signed, but it’s not clear if the number should be annualized for contracts that are larger than one year, nor if non-recurring revenues should be included. Even worse, if your contracts have different subscription periods (e.g. one month and one year), the bookings number can be very ambiguous and misleading. I would therefore recommend to not use this metric and largely agree with the Bessemer Cloud Computing Law #2 which famously stated that “booking is for suckers”.


Billings

The term “billings” refers to the amount that you have invoiced and that is due for payment soon. If your ARPA is low and most customers pay you via credit card and/or your bigger customers usually pay you on or about the time of subscription or renewal, this metric isn’t important. If you agree on longer terms of payments with your customers, it can become important for cash flow planning purposes.


Committed MRR

Committed MRR or CMRR is a projection of your MRR in the next month or future months based on your current MRR, adjusted by guaranteed expansion MRR and anticipated churn MRR. SaaS companies sometimes have customers that start with a low price but have already agreed to a price increase in the future. CMRR is a great way to track and show this type of guaranteed expansion MRR. If you adopt the CMRR metric to show guaranteed expansion MRR, make sure that you also take into account “guaranteed churn” in order to make it consistent. That is, subtract MRR which you expect to lose from customers that you expect to stop using your software in the near future.


Closing thoughts

I believe that most SaaS companies do well by focusing on MRR and Cash Inflow plus, depending on the nature of the business, revenues and CMRR. The only thing I’d add is that if you’re selling annual subscriptions but you don’t get the full payment upfront (or similarly, if you’re for example selling 2-year-subscriptions but get only one year upfront), you should monitor your MRR broken down by contract length. That’s because there’s obviously value in selling longer subscriptions vs. shorter ones but that difference won’t show up in your MRR nor in your Cash Inflow in these cases. If you think there are any other revenue metrics that I’ve missed, please let me know.

Finally, I’m well aware that while all of these metrics are easy to understand conceptually, there are still a lot of devils in the details. The purpose of this post is to come to a common understanding of the key revenue metrics – how to deal with some of the many special cases that you’ll inevitably see (discounts, refunds, currency fluctuations, metered charges, etc) might be the topic of another post.



Tuesday, March 31, 2015

Hyper-growth in SaaS

Following his well-received guest post about cohort analysis, here comes another guest post from my colleague Nicolas. Enjoy!

Status Quo


From an investor’s perspective, SaaS companies have a lot to love: High gross margins, predictable (recurring) revenues and capital efficient operations. On the flip side, most of them follow a common thread when it comes to growth. It might be too much to label it the ‘long, slow SaaS ramp of death’, but their revenues tend to develop slower than those for consumers plays. How come? In contrast to B2C companies like Uber, Delivery Hero or Homejoy for which it was critical to get the unit economics right, scaling distribution is usually the toughest challenge for a SaaS startup after it has found product / market fit. And this is understood by the markets.

If you are looking at the assumptions for frameworks like ‘T2D3’ and growth projections as outlined by Christoph recently, SaaS companies are typically expected to scale to $100m in revenues before approaching an IPO. You can also see this growth pattern in reality, here is a telling graph of the median SaaS revenue level pre-IPO that I borrowed from Tom Tunguz:



There is no question that growing to $100M in revenues in 7-9 years is an impressive achievement and doesn’t sound like a long, slow ramp of … anything. But if you compare that with Spotify’s estimated revenue of $1B in 2014, some 9 years after founding, you quickly see that there has been a significant difference in scale of successful consumer and enterprise businesses. This holds true for other consumer focused internet companies as well. As you can see, all but one member of this cohort have reached or are on track to reach $1B in year 6 (at the latest!):



At this point I want to stress that clearly all revenues are not equal and due to high margins, customer lock-in and predictability, $1 in SaaS revenue is really something else than say $1 in e-commerce revenue. But it’s fair to say that historically IPO prospects in the B2B field could not match the explosive revenue growth of successful B2C companies.

SaaS Growth in 2015


Something is changing though. Look at these growth curves:


(taken from this great presentation by Mamoon Hamid and slightly edited)

You guessed right, they are all SaaS businesses. And while you could argue that the revenue growth curves of Company B and C still roughly follow the slope of a long, slow SaaS ramp of death to an IPO and come in around the median we saw at the beginning of this post ($2.5M-4.5M ARR after two years and $8M-12M after three), Company A is on steroids! It’s Slack (and B and C are Yammer and Box respectively).

And while that is pretty wild, I couldn’t even fit Zenefits on there properly, because with $20M ARR in under two years and a goal of $100M after three, it’s literally off the charts. Admittedly, I can't say for sure that this reported 'ARR' is net revenues or what exactly their COGS structure looks like, but either way their pace is incredible.

Are we starting to see SaaS companies taking shortcuts and adopting consumer growth curves? Let’s quickly take a look at these two examples and see what they did differently.


Case 1: Slack


You are probably using Slack, but if not just have a look at the twitter love they get. Yes, looks like they are the hottest thing on the block since KoolAid. Although I am personally not 100% sold on all design choices, the way it handles integrations and plays nice on all platforms is quite impressive. I am sure that word of mouth and referrals are the key traffic drivers for them.

Second, it’s free. At least until you hit 10k messages. And by then it is likely that you are already locked-in. So are you going to become a paid customer? What if you commit to Slack now, but your team slowly drops off and you pay for these users anyway? Fear not as Slack will only charge you for monthly active users! Pretty clever, huh?

In summary:

  • A very good, consumerised product with native connectivity 
  • ‘Risk-free’ freemium business model

  • Bottom up growth dynamics boosted by WOM

  • A large bankroll ($180M in financing)



Case 2: Zenefits


How much are you paying for your HR software right now? How about $0, plus you can manage benefits through the platform with a few clicks? Hard to deny that value proposition (although we believe that this is not one-size-fits-all and best of breed solutions like our portfolio company Humanity will win large parts of the market).

So they ‘just’ had to push that value proposition into the market. And with push, I mean push real good, as according to LinkedIn, there are over 100+ people in sales roles at Zenefits. And that’s a company in its second year! Compare that to Atlassian or Zendesk, which didn’t have a proper salesforce until they reached thousands of customers.

In summary:

  • Freemium again, yet this time with a different spin

  • Aggressive outbound distribution
  • A large bankroll ($84M in financing)


Conclusion


So what does this mean? It’s a bit too early to predict how these two specific stories play out, but this much seems to be true:

  • It’s possible to scale SaaS companies faster than ever before
 in 2015
  • Consumerization of the enterprise is happening on the product and business model level
  • Freemium is a valid strategy in enterprise SaaS 

  • Nobody, not even suits, like large upfront commitments

  • Investors are willing to make large bets early in a company’s lifetime if it adopts consumer growth curves


It’s important to note that both cases here are horizontal SaaS solutions that are attacking broad markets. I haven’t seen a vertically focused cloud company scaling this fast, but who knows what the rest of 2015 holds. I’m curious to see how this new playbook for hyper-growth in SaaS develops.



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