David Cummings on Startups

Scaling a B2B SaaS Startup is Expensive

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David Cummings

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Software-as-a-Service (SaaS) is an amazing model with great recurring revenue, high gross margins, and strong industry growth. That said, scaling a SaaS startup is expensive. Very expensive.

Once you’ve crossed the desert and reached profitability, you can control you own destiny, especially if profitable, however modest, is true profitability paying market wages, and not just ramen profitable. Now, break-even or slightly profitable is great, but scaling the business and staying ahead of the market requires significantly more investment. The real challenge is when the law of large numbers kicks in based on the size of the customer base and the renewal rate. In order to grow, the number of new customers signed monthly has to keep growing because the number of customers leaving keeps growing.

Scaling a SaaS business is expensive because the primary expense of the business is people, and people need to be hired and trained in advance of customer acquisition. With the SaaS model, customers don’t pay a large sum of money up-front, rather they pay monthly or quarterly, often with an annual contract. The lifetime value of the customer is great but payment is spread out over years, with a decent chunk of the first year’s revenue going towards sales and marketing costs for customer acquisition, leaving little left over to staff up engineering, support, services, and back-office functions.

To recap: first year customer revenue almost all goes to sales and marketing, payments are spread out over years, and people are the largest expense, which need to be hired and trained in advance of delivering value. To scale a SaaS startup, sales has to get out in front of churn, which is always growing on an absolute basis assuming the the churn percentage stays constant and the business is growing. Along with significant investment in sales and marketing, all other core aspects of the business need investment in advance of customer growth.

What else? What are some other reasons scaling a B2B SaaS startup is expensive?

Comments

4 responses to “Scaling a B2B SaaS Startup is Expensive”

  1. blueschoolhouse Avatar
    blueschoolhouse

    All the more impressive that you guys have pulled this off without outside capital. If the financial model is pretty reliable you might have access to (non-dilutive) capital to step on the gas (debt financing).

    Reply
  2. swagner2 (@swagner2) Avatar
    swagner2 (@swagner2)

    I think your own experience is interesting as an outlier.

    SaaS Capital [Btw: Pardot customer] wrote a contrarian view in “The Cost of Capital for SaaS.” In it they stress the impact that focusing on profitability over growth will severely hinder the business’s valuation and ability to raise capital.

    To quote their paper: “The practical ramification of slower growth for a private SaaS company can be stark: companies get lumped into a lower tier of valuation multiples, they cannot easily raise additional capital and they will have difficulty executing a successful private sale.”

    The examples they give are similar to Salesforce.com’s spending on sales and marketing at over 100% of revenue in the first five years.

    They conclude with: The SaaS valuation landscape has changed dramatically over the last 24 months in both the public and private markets. It seems almost overnight the market has gone from “survival mode” to “growth mode”. The costs associated with standing still are now evident in the widening valuation gap between the market leaders and the market laggards. The most significant issue facing today’s SaaS companies is finding cost effective methods to finance and accelerate revenue growth to drive increases in valuation and create liquidity options.

    Dave what are your thoughts on how to sustain this without raising capital?

    Reply
    1. David Cummings Avatar
      David Cummings

      Great comment and question. SaaS businesses can get decent lines of credit from banks that understand the model (e.g. Silicon Valley Bank) and use that to hire people ahead of revenue growth.

      Reply
  3. Franco Arda Avatar
    Franco Arda

    Great post though I disagree with “primary expense is people.”

    It all depends on the platform. If it’s self-serving (i.e. no onboarding sales needed), I’d say advertising is the highest costs.

    Reply

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