Almost four months ago I highlighted how the economic downturn was going to seriously hurt renewal rates for SaaS companies.
Unfortunately, it’s proving correct. Daily, big tech companies are announcing layoffs from Salesforce.com to Google to Microsoft. While the big brands make the headlines, for every major company that announces layoffs, there are hundreds of startups doing the same thing.
Startups often sell to other startups and tech companies.
Startups and tech companies are early adopters. When they do layoffs, through no fault of the SaaS vendor, the number of seats and/or usage volume goes down. This hurts the renewal rates. Lower renewal rates make it harder to grow as there’s a mountain to climb just to get back to the same size as the previous year, let alone grow fast.
Startup valuations are heavily dependent on the growth rate, especially using the Rule of 40 methodology. With growth rate down due to higher churn from layoffs and fewer new customers due to the slowing economy, the Rule of 40 score goes way down. A lower Rule of 40 score makes for a much lower valuation come fundraising time, which increases the chance of a down round or no round. It’s a vicious cycle.
For entrepreneurs, it’s a real balancing act. Here’s an opportunity to keep pushing hard to build out the platform and gain marketshare while everyone else is challenged. Only, push too hard without enough progress and the chance of not being able to raise another round on favorable terms dramatically increases.
For many entrepreneurs, the solution is to push hard while attaining some form of default alive. Becoming profitable or breakeven, so as to be default alive, results in tremendous flexibility — there’s no ticking clock requiring another funding round. Even if it’s too dramatic to immediately get to default alive, another variation is to have a plan in place, often involving cutting costs and team members, to make the change, if things don’t progress the desired way. More flexibility also provides an invaluable benefit — helping entrepreneurs sleep better at night.
It’s a tough time in startup land. For the entrepreneurs that can make it through the next 12-24 months in a position of strength, renewal rate improvements and stronger new customer growth will be the reward.