In recent years, Software as a Service (SaaS) startups have been fed a steady diet of cheap money and concepts like “Grow at all costs” and “Winner takes all.”
This, in turn, was reflected in the way SaaS performance is measured, the way companies raise capital, how they spend their money, and how they are perceived by stakeholders, including investors.
But when the tap for cheap money was suddenly turned off, there was a belated realization by the broader market that, like all businesses, even SaaS startups must one day become profitable.
So how should founders measure and manage the performance of their SaaS startup in this ‘new’ climate?
At William Buck, the three main groups of metrics we look at are:
- Cash flow
- to grow
To get a true sense of how a SaaS startup is performing, each of these metrics needs to be analyzed individually and then considered as a whole.
A cliché but true saying is ‘cash is king’. This is especially true for SaaS startups and scale-ups that want to quickly acquire customers before they run out of money. The main challenge for the founders is the delay between the initial investment to acquire customers and the subsequent cash flow generated.
Founders will need to know how aggressively they can expand their business without overdoing it. Cash flow forecasts are required here. The main statistics are:
- Cash flow runway: how long does it take to run out of money? This figure represents a deadline to improve the cash inflow-to-cash outflow ratio and move the startup to the ‘next stage’ in terms of product development, customers and team capabilities.
- Gross cash burn rate: what is the company’s monthly expenses as a portion of its total cash reserves? This should be calculated each month and used to analyze the trend in cash flow expenditure.
- Net cash burn rate: What is the company’s net expenses after accounting for the inflow of revenue? By comparing the result of each month, you can see the volatility in the company’s cash flow and see if the cash flow trend is improving or deteriorating.
These stats, when considered together, tell a story about cash flow position.
SaaS startups are in a race against time to reach growth levels to make them attractive to investors and to fund the needed expansion without suffering from excessive dilution. The key metrics to analyze growth are:
- Customers Acquired: Simply the number of new customers who started using the company’s products in a month.
- Customer churn: How many customers did the company lose in the month as a percentage of users at the beginning of the month? A high churn rate indicates that customers are not satisfied with the offer once they have used it. Founders will have to determine why.
- Annual Recurring Revenue (ARR): What is the recurring revenue generated by the customer base? Once the king of all metrics for measuring SaaS companies, it still holds an important place in any startup conversation.
- ARR expansion/contraction: What level of ARR was generated in the month as existing customers changed their use of your products? As an extension of ARR, this metric can help founders determine subscription tier pricing and understand the value proposition from the customer’s perspective.
Ultimately, SaaS startups want low churn and a significant increase in ARR in each month, depending on…
Ultimately, the goal of analyzing cash flow and growth is to help the business reach a stage where it is profitable. While the stereotypical idea of a tech startup is a company that prioritizes growth over profitability, the current economic climate is now putting more emphasis on startups that can demonstrate a credible path to profitability.
To understand the factors that affect profitability, the key metrics to analyze are:
- Customer Acquisition Cost (CAC): On average, how much does the company spend acquiring each customer? Validates the effectiveness of the sales strategy and the return on investment that the company generates from its sales staff and marketing budget.
- Lifetime Customer Value (LTV): What is the amount of revenue generated by the average customer before churn? There are two ways a company can turn this to its advantage: by lowering the churn rate or by increasing revenue per customer through new offers or higher prices. Obviously, founders need to be aware of the direct correlation between pricing and customer churn.
- LTV to CAC Ratio: What is the expected total lifetime revenue of each customer compared to the cost of acquiring that customer? A higher ratio indicates a higher profitability for each customer. A ratio of less than 3:1 shows that a weak profit level is generated by each customer.
- CAC payback: Alternatively, the startup can look at how long it takes the average customer to generate the revenue needed to cover the cost of acquiring that customer. This is a function of revenue per customer and CAC and is the most effective metric to track for low turnover, high CAC startups with high LTV to CAC ratios, but long paybacks.
If a SaaS startup can get the profitability per customer in a strong position and grow the number of customers fast enough, then the company will be sustainable in its quest for scale.
The challenge with data
None of the above metrics can be calculated from a generic set of management accounts generated with accounting software. From the outset, SaaS startups should maintain separate records to produce these metrics. Every company is different and there is no one size fits all approach. Every startup must consider the relevance of data and inputs that are processed in the statistics.
Ultimately, these metrics need to be tailored to the company’s specific product and customer mix. It is important from the outset that the input to these KPIs is clearly defined and agreed upon.
It’s been said, ‘You can’t manage what you can’t measure’ – and we think this is especially true in difficult times like these, when founders have to work a lot harder to raise capital. As long as they take the time and effort it takes to capture the right data, interpret the meaning using these metrics and adjust their business accordingly, Australian startups have the best chance of sailing through these stormy seas and unleashing their full potential. to use.
If you would like more information about raising capital for your start-up and how we can help you manage your finances, please contact your William Buck advisor.