Quickly Evaluating a Potential SaaS Investment

Earlier this week a friend sent over an executive summary and financial model for a Software-as-a-Service (SaaS) startup and asked for my advice in evaluating it. While he hadn’t been an angel investor before, he was thinking about becoming one and this would be his first investment. After looking through the two PDFs, I told him that there’s nothing to evaluate other than whether or not he loves the market and the team. The startup had no revenue, no customers, and was working on building a prototype. It was simply an opportunity to bet on a market and team.

Now, if it did have an operating history, even a modest one, there would be a number of different metrics to analyze. Here are a few items to look at when quickly evaluating a potential SaaS investment:

  • Annual Recurring Revenue (ARR) – How much money would be generated if no customers were added and no customers left
  • 12 Month Growth Rate – How does the ARR from 12 months ago compare to the ARR today
  • Monthly Churn Rate – How many customers that started the month renewed for the next month and what has churn been for each of the last 12 months
  • Cost of Customer Acquisition – How much money is spent on sales and marketing relative to a new dollar of annual recurring revenue generated in each of the last two quarters

While there are a number of other metrics to analyze, these four quick items paint a clear picture of health and opportunity for a SaaS startup. SaaS is an amazing business model due to recurring cash flow, gross margins, and predictability of the business. And, potential investments can be quickly evaluated.

What else? What are some more thoughts on quickly evaluating a potential SaaS investment?

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