Hello There.
I hope you had a good Diwali. I went to my in-laws’ and was mostly treated like a prince. I think I am still in a Food Coma. Damadji was treated with royal levels of deference and was not even allowed to get his fat rump off the couch. I’ll enjoy it while it lasts…
Shortly before Diwali, I met up with a few B-school friends for drinks. I had seen at least two people only after 13 years. Both had lost their hair. I still retain some, so on the relative scale, I am doing much, much better.
A chance remark by someone in that reunion of sorts got me thinking about SaaS Metrics. The topic was the subterfuge some companies employed to make things appear rosier than they are. I immediately went back to my days as an IB intern at Credit Suisse and a MD asking me to use PEG ratio instead of PE ratio to make the chart appear more, er, sexy? The client threw out the deck claiming shenanigans, I was shouted at in the meeting for the “fuckup”1.
Anyway, I have spent the last couple of weeks thinking about the metrics that really matter. Strip vanity - look at the most essential building blocks.
Another reason for writing this is to streamline my deal flow a little. I am going to describe what I like to see on these axes before I decide to spend more time on making an investment decision on any SaaS opportunity. So if you aren’t where I would like you to be (on most of these metrics), please note that I will be happy to be someone to give you ideas or feedback but my purse-strings are very likely to remain firmly shut. Also, if you give me your metrics formatted like this - I am much more likely to come back to you very quickly with a yes/no decision.
Feedback is welcomed.
Broad Strokes
Here is a quick mental map of the structure that I was finally satisfied with. Sure, there is a lot of stuff that I have left out but from my (highly limited and likely misguided) experience, these are the key metrics that would reliably give you a very good sense of what’s going on, and what needs working on. Also, full credit to the Wife for using her ex-consultant chops and MECE-ing the crap out of this with me.
Broadly, I am looking at 6 key areas, divided into 3 main buckets:
Revenue and Retention
Unit Economics, Margins and Burn Efficiency
Engagement
Let’s look at these in detail in the following sections.
1. Revenues and Retention
So, the very first challenge is to get someone to pay for your beautifully elegant, next-best-thing-since-sliced-bread offering. That is the biggest proof of market fit IMO - that someone you don’t know (or heck, even someone you do know), is willing to pay for your products.
MRR and ARR: the first question any VC will ask you. This is your monthly or annual recurring revenue (depending upon what frequency you are billing folks at). It is important to discount one-time or windfall revenues from this figure. Typically, crossing $500k in ARR is usually a very good sign for an aspiring SaaS Unicorn. I would also encourage looking at various breakups for ARR - to get more granular insights into the health of the business. As an example, for most of the companies I see, I usually want them to break-up their ARR into new accounts, up-selling in existing accounts, scaled down accounts and churn. Each of these slices gives deeply meaningful insights and allows for pinpointing areas where we are doing well (or not).
Growth Rates: Simply put, treat your ARR as an IRR number calculated monthly. If you were at $500K a year ago and you are at $5mn today, you are tracking a compounded monthly growth rate of ~20% - not shabby by any stretch. Anything below 10% tends to make me very uncomfortable.
Customer Concentration and Associated Risk: While a diversified customer base is a good to have (and its lack by no means a dealbreaker), it is an important factor that impacts your ability to control your destiny. If you have 2-3 very large accounts that forms a majority of your revenues, I am now also exposed to their performance, and hence their ability to keep paying for your services. So, this is one of those x-factor type deals - and something that I have to look at de-novo for each company. For example, being a provider of network management tools to Dell EMC (far more central to their business) is much more attractive than being a provider of HR tools to Dell EMC (likely to be replaced by a cheaper option in times of stress). I can be, and have been wrong on this one before.
Retention: Acquiring customers is one thing, keeping them is quite another. This is where your VC will ask for cohorts of your customers and see how many have stayed with you. It also is an important measure of your value and the value of the ecosystem you are creating. Typically, I will ask for value and account cohorts. You may not keep all your customers, but the ideal state is where even when you are losing customers, you are able to grow your value from what you have kept to higher than original. Let’s say last month, you acquired 5 customers for an ARR of $100 each for a total 12 month contract value of $500. Now, if 13 months later, you have lost two customers but you have renewed the remaining 3 contracts at $200 each, you are now tracking an FTM revenue of $600 from this cohort. Works for me. However, I am going to ask some really hard questions about why you lost your two customers. Not everything is under your control but I would like to know exactly what happened.
2. Unit Economics, Margins and Burn Efficiency
I have lumped these three because to my mind, these are like 3 enmeshed gears that turn together. The real question I am trying to answer is on the sustainability2 of your business and if turns into a virtuous cycle without blowing up too much of investor capital.
Customer Acquisition Cost (CAC): Self Explanatory - how do you compare with peers, where are you spending it, how has it moved in the last few months. Oh, BTW, I don’t just look at Facebook and Google spends as CAC. I would typically look at CAC as your entire Sales and Marketing spend (including, but not limited to flights, cabs, hotel stays, events, kiosks, dinners, drinks, other miscellaneous entertainment3) over the last 6 months by the customers acquired. Sure, adjustments in the denominator to adjust for lag are welcome but the numerator has to be necessarily wide.
Return on Incremental Marketing Capital (or spend) - RoIMC: Fancy name, but what it means is the ratio of new sales ARR to Sales and Marketing spend. Ideally, you have signed up more revenue than what you spent acquiring it. If this is not the case, it is usually a hard pass for me (barring very early companies where this is more of a capex/investment than an expense. Hence the word capital and not expense above)
FTM to CAC ratio: Another expression of RoIMC - but more focused on payback. Can I recover what I spent acquiring the customer in the first period itself. For me to be interested, the answer has to be yes. I am not fussed about the period (mostly) but I am concerned if the acquisition cost cannot be recovered in the first contract. If you can sign a 5 year contract, sure, more power to you. Another related lens is of contribution - i.e. Contract Gross Profit v/s CAC. You don’t really want to spend too much acquiring an account that doesn’t make you enough money.
Margins: Gross Margin (Sales less COGS) and LTV (Gross Profit less CAC). I like gross margins in excess of 65-70% and LTVs of 2-3x CAC. Anything less typically signifies a company that will have serious issues scaling because it has people doing what software should be doing.
Burn Efficiency: Ratio of Burn over a period to Net New Revenue (ARR/MRR, whatever is relevant) in that period. Lower is better. If it is less than 2, I will be very interested. If it’s around 1, I will probably write you a cheque on the spot.
3. Engagement
So, this one has been done to death elsewhere on the internet so I am not going to expand too much on this. There are other, far smarter people who have written much more about this and much better than I can. Now, DAUs and MAUs come with some significant caveats - it has to be right and sensible for your business. A tax SaaS company may have abysmal DAUs/MAUs but will likely have solid end of quarter numbers. Social media type companies will probably be able to make sense of HAUs (hourly active). Really valuable products like WorkDay, Dropbox etc don’t necessarily get used daily. However, your DAU/MAUs have to make sense in terms of where you product fits.
I would also like to make a case for looking at paid and free users separately. If your paid engagement is falling, it’s typically a sign of changing behaviour or an emerging problem. In either case, likely a 5 alarm fire that the founder should be digging into hard.
I hope this was useful, and in case I am missing something or if my way of looking at it is wrong / underbaked - please do let me know.
As always, I look forward to hearing from you. If you liked this post, pls feel free to share this or subscribe to this newsletter using the links below. I try to write a 1000-2000 word essay once a week.
Now, the one great thing about the MD in question is that he knows what is a performance and what isn’t. So, after this meeting he proceeds to take me to Morton’s Steakhouse at the Marina Oriental and buys me some very expensive wine (which I did not know how to appreciate at the time) and an exquisite steak (which I sent back and asked for it to be well-done because I thought it wasn’t cooked; yes, the 21 year old me was a philistine) as rewards for taking one for the team. That deal directly led to the fall of the Thai government at the time but that’s a story for another time after I have been plied liberally with the Oban 21.
Let’s take a fintech example. If I were trying to acquire customers for a wallet, simplest way for me to grow fast is to say hey - if you load 100$ in your wallet, I will give you another $20 as an incentive to join. Not only will I grow like crazy, but I am also very likely to achieve Unicorn Status because I will be hitting the market for my next fundraise every 6 months and increasing my valuation each time. The problem is that I cannot possibly sustain this. More importantly, the customer will spend the $20 I gave them and very likely disappear to the next company offering such a great deal. Such a construct is usually a very hard pass for me.
Inside joke for i-bankers.