The $15 Million SaaS Revenue Plateau

One of the challenges for SaaS startups that hit the growth stage is stalling revenue right around $15 million. After finding product/market fit and a repeatable customer acquisition model, things look great. Only, the $15 million recurring revenue milestone turns into a plateau, and not another simple number on the way towards serious scale ($100+ million). What gives?

Here are a few reasons why SaaS startups stall at $15 million in revenue:

  • Leaky Bucket – As the customer base grows, the number of customers that churn each month grows as well. Eventually the amount of new revenue signed will equal the amount of revenue lost unless the renewal rates are high and the customer expansion rate is strong.
  • Lead Velocity – Often, when starting to scale, there are a small number of lead sources that provide the bulk of the leads. Only, as the business grows, the lead volume from these sources don’t scale resulting in growth challenges.
  • Market Size – While entrepreneurs talk about the amount of money spent in a market, the reality is that a much, much smaller percentage is spent on new software each year in that market. Most markets are smaller than what people think.
  • Internal Challenges – Organizational health is much harder than it appears. Once the organization passes 150 employees (Dunbar’s number) things get even more complicated internally, and that affects growth.

SaaS startups in the growth stage often hit a $15 million revenue plateau and don’t recover. Recognize the impending challenges and work to minimize them.

What else? What are some more thoughts on why certain SaaS startups stall at $15 million in revenue?

Funding Dynamics for Modest Growth SaaS Startups

Continuing with the discussion around SaaS funding valuations and forward multiples, I was talking with a growth equity investor out of the Northeast yesterday and the topic of valuations came up. Now, growth equity typically targets startups with $10 – $25 million in annual recurring revenue and makes a sizable investment ($10+ million). For this particular firm, they focus on SaaS startups with modest growth between 10% and 30% where they believe the companies can continue to grow for a number of years, but are often overlooked by the larger funds because they don’t have a high growth rate (e.g. 60%+ growth per year).

Here’s how they think about these investments:

  • Growth rate still drives valuation with typical valuation range being 3 – 5x current annual recurring revenue (but usually closer to 3 – 4x)
  • Return expectations are targeted at 3x cash on cash in 3 – 5 years (imagine buying in at 4x run rate, the company doubles in size over a few years, and a buyer comes along that pays a higher multiple)
  • Forward multiples are less relevant as there’s not as much competition among investors driving valuations up
  • Metrics like gross margins and renewal rates, as well as the management team and market size, also play an important role in valuation

Entrepreneurs looking to raise institutional capital at a large multiple need to have a great growth rate to go with it. Otherwise, the valuations are a much lower multiple of a run rate.

What else? What are some more thoughts on funding dynamics for modest growth SaaS startups?

SaaS Funding Valuations Based on a Forward Multiple

Continuing with last week’s post on 3 Quick Ideas When Thinking about SaaS Valuations, there’s another common way to determine a SaaS valuation for funding purposes based on a multiple of what the revenue or run-rate will be in 12 months. This approach is known as a “forward multiple”, and because the valuation is based on an expected amount in the future, it effectively takes into account the current growth rate, which is one of the largest, if not the largest, drivers of valuation, everything else being constant.

Long term, SaaS companies will likely trade at 4-6x revenue based on strong recurring revenue, great gross margins, and excellent economies of scale. As a simple example, if a SaaS company was put into harvest mode, it could generate 60-80% profit margins and get an EBITDA multiple of 6 – 10x, resulting in the same value as 4-6x revenue.

So, if a startup is doubling year over year, and expects to double again next year, a funding valuation could be 4-6x the expected run-rate in twelve months. If a startup is at $5 million today, and will clearly be at $10 million in 12 months, asking for a pre-money valuation of $40 – $60 million might get funded, assuming a great team and market. Investors would be willing to “pay up” for a fast-growing startup as they believe it’ll continuing growing fast and has the opportunity to be a large, meaningful business.

For entrepreneurs raising money, use the idea of a forward multiple when discussing valuation.

What else? What are some more thoughts on SaaS funding valuations based on a forward multiple?

3 Quick Ideas When Thinking about SaaS Valuations

With ServiceMax’s great exit to GE, it’s clear that SaaS valuations for high growth market leaders continue to be strong. When thinking about SaaS valuations, here are three quick ideas to keep in mind:

  1. Rule of 40% – Growth plus profitability should be 40% or greater. Meaning, if the company isn’t profitable, it should be growing revenue at a rate of 40% or higher. If the company has 20% profit margins, it should be growing at least 20%. If no growth, it should have 40% profit margins.
  2. Growth Rate Multiplier – A simplistic formula to quantify how growth rate translates into valuations is as follows: (2 * Annual Recurring Revenue) + (Annual Recurring Revenue * (1 + (2.5 * Growth Rate))). A no growth SaaS company would be 3x ARR. A $1M ARR company with a 200% growth rate would be $8M (hot startups command much higher multiples).
  3. Type of Equity – Not all equity is the same. As an example, equity with cumulative dividends and participating preferred rights makes the effective valuation much lower than the stated valuation. When reading about valuations online, know that different terms can make for different valuations.

A variety of factors contribute to valuation with growth rate and scale being two of the biggest drivers.

What else? What are some other ideas when thinking about SaaS valuations?

Customer Churn is Always Higher in the Early Days

At Pardot, in late 2012 at the time of acquisition, our monthly customer churn was 1.4% (meaning, we lost 1.4% of all our customers every month). Why do I still remember that number over four years later? Well, because it was seared into my mind by being one of the top five questions asked by investors. And, we pitched over 35 VCs through the years, making it a popular topic of conversation.

Now, in some SaaS businesses, 1.4% monthly churn isn’t that good, but we were a month-to-month solution for small-to-medium businesses (SMB). In that market, with that type of no-contract situation, that was considered a great churn rate. Only, it wasn’t always that way. In fact, most startups have high customer churn in the early days and then get better with time.

Here are a few reasons why customer churn is higher initially:

  • Customer Consistency – Early on, the ideal customer profile isn’t well defined as the goal is to get early adopter customers in the door and to work towards product/market fit. Inevitably, bad-fit customers get signed and contribute to a higher churn rate.
  • Contracts – Many startups, like Pardot, start with little or no contract, as a way to remove friction to adoption. While it is customer-friendly is some regards, it makes for customers that sign when it’s really a short-term paid trial in their mind, makes for more volatility when customers hit hard times and leave with no notice, etc. Contracts, at least annual deals, help minimize some of the churn potential in the first few months after the sale.
  • Product Maturity – Software products always have bugs. Always. Early on, products aren’t very mature and will have more bugs resulting in greater potential for customers to have a bad experience that increases the risk of churn.

Entrepreneurs would do well to work towards a low a churn rate and keep in mind that it’s always higher in the early days.

What else? What are some more reasons why customer churn is higher early in the life of a startup?

Metrics to Track by Startup Stage

Recently an entrepreneur asked what metrics they should track at their stage startup. Being in the seed stage, I recommended keeping it simple by tracking the 9 Simple Weekly Metrics for Seed Stage SaaS Startups, with cash on hand, burn rate, and monthly recurring revenue being the most important. As the startup grows, the number of metrics tracked should grow as well.

Here are the weekly metrics to track by stage:

Match the metrics to the stage and add more operational rigor as the startup grows.

What else? What are some more thoughts on metrics to track by startup stage?

Quick Notes on ServiceMax’s $915 Million Exit to GE

GE announced their acquisition of ServiceMax for $915 million earlier today. ServiceMax is a SaaS company focused on field service workers. Imagine having a number of employees that work in the field (e.g. fixing and servicing products) — ServiceMax provides the management platform. From their site:

ServiceMax’s mission is to empower every field service technician in the world to deliver flawless field service and every organization to unleash the untapped growth potential of service.

Here are a few quick notes on ServiceMax:

  • Founded in 2007 (~9 years to exit)
  • Raised $204 million (source)
  • 469 employees on LinkedIn (source)
  • Revenue guess based on $200k/year/employee – $94 million
  • Built 100% on Force.com (source)
  • 400+ customers (source)

Congratulations to Dave Yarnold and team on building a great business!