Pre-Paid SaaS Contracts are Free Working Capital for Startups

Software-as-a-Service (SaaS) as a business model has a number of advantages including alignment of value between customer and vendor, strong cash flows, high gross margins, and great economies of scale. As with any growing startup, one of the most limiting factors is cash — the faster the business grows, the more cash it eats. Another benefit of SaaS that should be mentioned more often is that of pre-paid contracts.

With pre-paid contracts, like Salesforce.com requires, payments are made in advance of service being rendered. These contracts are often pre-paid quarterly or pre-paid annually with a discount (e.g. pay for the full year and get 10% off). For the startup this results in free working capital to grow the business. Yes, there’s an unearned income liability and an obligation to fulfill the service, but with the money in the bank, many startups use it to grow the business even faster than if they didn’t have pre-payments.

There’s another secondary benefit of pre-paid SaaS contracts: potential profits in the bank aren’t taxed until revenue is recognized and profit earned. Say it is December 31st and the startup’s bank account has $100,000 more than it started the year. Normally, if that’s profit it would be taxed around 30% leaving only $70,000 left to invest and grow the business. Well, with accrual accounting and $100,000 of unearned income due to pre-paid contracts, that money isn’t taxed until the revenue is recognized resulting in more capital to grow the business on January 1st.

Pre-paid SaaS contracts provide free working capital for startups and should be considered when thinking through business ideas (e.g. can we get customers to pre-pay us to help fund the business?).

What else? What are your thoughts on pre-paid SaaS contracts as free working capital for startups?

SaaS Leaky Bucket Number

Software-as-a-Service (SaaS) has a number of important metrics for the business model with one of the most important being customer renewal rates / customer churn. Josh James, the co-founder of Omniture, which was bought by Adobe for $1.8 billion a couple years ago, sent this tweet out last week:

@dharmesh @sawickipedia yes annual. If monthly is 10% then run
My first business lost 800 customers per month. New 1,200. Net 400. Scary.—
Josh James (@joshjames) January 04, 2012

The idea that they’d sign up 1,200 customers per month and have 800 customers leave per month drives home the need to closely watch customer renewals. The ratio of new customers to lost customers is critical and now has a formal name:

Leaky Bucket Number = New Customers Per Month / Customers Lost Per Month

Note that it doesn’t take into account the average revenue per new customer vs the average revenue per customer that leaves as well as customer upgrades or downgrades. Generally, it’s a good metric to monitor because it’s easier for people to understand we signed 29 customers and lost 11 customers because it continues to keep the number of lost customers top-of-mind. And, it’s especially important for this number to be greater than one otherwise the startup is losing more customers than it’s adding.

What else? What do you think of the SaaS leaky bucket number?

Assessing Customer Renewal Rates and Churn Trends

Image via Wikipedia

Customer renewals rates are one of the key tenets for Software-as-a-Service (SaaS) startups. It’s important to track relevant details as to why a customer leaves so that these can be analyzed and addressed.

Here are some common categories for SaaS companies to track in order to assess customer churn trends:

• Budget
• Product functionality
• Usefulness
• Personnel change
• Project needs

Another general question I like to track is whether or not the item was within our control. The idea is that some things, like budget, are outside our control, but product functionality is within our control. Another area to look at when assessing customer renewal rates is to look at the sales reps that brought in the account to see if certain reps are signing clients that aren’t good fits, and thus have higher churn rates. A third exercise is to do SaaS cohort analysis and look at renewal rates of groups of customers from defined time periods (e.g. how do customers signed in Q1 2011 compare to customers signed in Q4 2010).

What else? What other ways do you assess customer renewal rates and churn trends?