Category: SaaS

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?

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?

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?

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!

Recently I was talking to an investor that had competed to make a SaaS investment last quarter. The desired startup had just over $1 million in annual recurring revenue, a great management team, and a super hot market. After a competitive process, the final pre-money valuation: $60 million.

Why would a well-known venture firm pay 60x run-rate? Here are a few thoughts:

• Fund Size Dynamics – The larger the fund, the larger the checks. If the VC wants to lead the deal, and they usually put in ~$10 million, every investment is going to be in the tens of millions pre-money, whether the startup has $1M or $5M recurring.
• Deal Competition – The best way to raise capital is to create an auction process with multiple bidders. More competition from investors results in a higher valuation.
• Market – There are only so many untapped markets that are clearly large enough to support billion dollar exits. The more obvious the opportunity, the more the valuation goes up.
• Team – Certain founders and teams command a premium (e.g. repeat successful entrepreneurs as well as key prior employers). Ultimately, investors are betting on the team and place tremendous value on it.

While valuations have corrected in many areas, SaaS companies with certain dynamics are still commanding a large premium. Entrepreneurs would do well to understand the current market.

What else? What are some more thoughts on early stage SaaS startups still raising money at huge multiples?

One of the bigger challenges for SaaS startups that start to scale is the leaky bucket. Of course, a leaky bucket is one where whatever goes in the top comes out the bottom (not much of a bucket). With SaaS, leaky bucket is a reference to high churn rates such that it’s hard to fill up the bucket (grow the customer base) because existing customers are leaking out the bottom (churning or not renewing).

Four years ago, Josh James, founder of Omniture, which was acquired by Adobe for $1.8 billion, tweeted that before they sold Omniture, they’d sign 1,200 new customers and lose 800 customers every month, making it really hard, and costly, to grow:

A critical component of successful SaaS companies is low churn rates and high existing account expansion such that even if the company didn’t sign any new customers in a year, the business would still grow as the up-sells would be larger than the lost customers. Entrepreneurs would do well to ensure that they don’t have a leaky bucket.

What else? What are some more thoughts on the SaaS Leaky Bucket?