Measuring SaaS Churn Rates 2.0

Dave Kellog published a new post recently titled A Fresh Look at How to Measure SaaS Churn Rates in which he introduces several new concepts related to SaaS churn. On the surface, SaaS churn seems pretty straightforward — take the number of customers that were up for renewal at the start of the time period, take the number that left during the time period, and divide the second into the first — but it’s much more nuanced than that. What about logo vs revenue churn, by cohort, by product, by account, or by any of a number of other measures? It gets more complicated, quickly.

Here are a few notes from the article:

  • Leaky Bucket Equation: Starting ARR + new ARR – churn ARR = ending ARR
  • Tracking it as churn is more common that tracking it as renewals
  • Shrinkage (anything that shrinks ARR) and expansion (anything that expands ARR) need to be factored in
  • Two most important churn rates: logos (by customer count) and ARR (by recurring revenue)
  • 5 churn rate formulas:
    • Simple churn = net churn / starting period ARR * 4
    • Logo churn = number of discontinuing logos / number of ATR+ logos.
    • Retention = current ARR [time cohort] / time-ago ARR [time cohort]
    • Net churn = account-level churn / ATR+
    • Gross churn = shrinkage / ATR+

Want to better understand churn in the context of SaaS? Head over to A Fresh Look at How to Measure SaaS Churn Rates and take a deep dive.

What else? What are some other good resources on SaaS churn?

Venture Debt as Safety Net

Lately, several entrepreneurs have asked me about venture debt. Venture debt is bank-provided debt for startups that have raised money from venture capitalists or have a few million in annual recurring revenue. At Pardot, we didn’t raise any venture capital but we did use a $3M line of credit from SVB. Only, I’m not seeing entrepreneurs sign up for venture debt to actually use, like we did at Pardot.

Today, entrepreneurs are signing up for venture debt as a safety net. The idea is to have the money available in the event things don’t go according to plan, but not to be used as part of the plan. Here are a few thoughts on venture debt as safety net:

  • Entrepreneurs are optimistic at their core, but they also know that things don’t always work out like the plan. Having a financial back up option provides some peace of mind.
  • Venture debt has a price (legal fees, closing costs, etc.) but the actual debt doesn’t have to be drawn down making it much cheaper than expected to have access to the capital
  • Signing up for venture debt requires more ongoing financial rigor with the bank, but that financial rigor is a good thing in that there’s another set of eyes reviewing the business operations (e.g. someone at the bank that reviews a number of these types of businesses)

Entrepreneurs that have the scale or funding should actively evaluate venture debt as a safety net. The costs are relatively low and the value is high.

What else? What are some more thoughts on venture debt as safety net?

The 3-Step Startup Marketing Framework

Hiten Shah has a great post up titled The 3-Step Startup Marketing Framework where he outlines the process he used to help grow popular startup Kissmetrics. Here are the three steps:

  1. Identify your target customer by understanding:
    • What your product does
    • The problem your product solves
    • Who wants this problem solved
  2. To find out where your target audience hangs out:
    • Create a master list of potential places
    • Establish criteria for ideal marketing channels
    • Vet your list according to those criteria
  3. To engage with your customer
    • Identify your method of engagement
    • Expand as far as this method allows
    • Confine your reach only to the target audience
    • Aim to deliver a high amount of value

Go read The 3-Step Startup Marketing Framework and follow his process.

What else? What are some more thoughts on this startup marketing framework?

Pros and Cons of Being a Solo Founder

Continuing with this week’s theme of co-founders (see here, here, and here), there’s another topic to address: solo founders. While a pair of co-founders is the more common success story, major companies like Amazon.com were founded by a solo entrepreneur. I’ve founded a number of startups both with co-founders and as a solo founder and have a few thoughts on it.

Here are some pros and cons of being a solo founder:

Pros

  • Simple – There’s no recruiting another founder to join the team. It’s just you starting out with no dependencies.
  • Cheap – Work on your startup during the day and drive Uber at night to pay the bills. It’s only your expenses.
  • Style – Whatever your style is, you get to keep doing it. You make the rules, the hours, the whatever — it’s just you.
  • Equity – The startup is 100% yours. You get to personally debate the whole “all of a grape vs a slice of a watermelon” regarding your strategy to raise money or bootstrap and the potential outcomes.

Cons

  • Lonely – Having a co-founder means having a companion that’s there with you 24/7 focused on making the startup successful. Going solo can get lonely.
  • Speed – Small, high quality teams move much faster than an individual. There’s a ton to do and never enough time.
  • Debates – Decisions are often better when two committed people work to come up with the best solution. As an individual, there’s often a single perspective (advisors and mentors can help here).

Some of these cons can be solved by raising money and hiring people. Only, it’s a chicken and egg problem in that you need traction to raise money. And, to get traction you need people. Also, most investors want to see at least two founders as it fits their pattern recognition.

Being any type of founder isn’t easy, and being a solo founder is especially hard. Consider the pros and cons and make the best decision for you.

What else? What are some more pros and cons of being a solo founder?

Characteristics to Look for in a Co-Founder

Continuing with the recent co-founder posts on equity and the high cost of a third co-cofounder, there’s another important topic: characteristics to look for in a co-founder. I’ve seen many co-founder relationships come apart after starting a company due to lack of compatibility and alignment. Basically, there wasn’t enough understanding and relationship building before getting married.

Here are a few characteristics to look for in a co-founder:

  • Owner Mentality – Is the co-founder willing to forgo salary to keep the lights on? Will they put their house up as guarantee on a business loan?
  • Commitment – Do they understand just how hard it is to be successful? Are they willing to grind it out for years to see some level of modest success?
  • Skills – Do they have exceptional skills that are complementary? Are these skills hard to come by or highly valued? How relevant and proven are the skills?
  • Values – Do they share the same core values? How about personal, family, and life values?
  • Personality Fit – How well do you get along? How confident are you in spending thousands of hours working together?

A co-founder is a big decision. Entrepreneurs would do well to outline the characteristics of the ideal co-founder and then compare those against the person(s) they have in mind.

What else? What are some more thoughts on the characteristics of of a co-founder?

The High Cost of a Third Co-Founder

Continuing with yesterday’s post on Co-Founder Equity Ideas, there’s another point that needs to be made: adding a third co-founder can be one of the most “expensive” things a founder does, assuming equally split equity. Think about the standard scenario where there are two co-founders, each with 50% of the company. Now, introduce a third, equal co-founder where each has 33% of the company. The original two founders would have 33% less — that’s a huge amount of dilution.

Here are a few thoughts on a third co-founder:

  • Two co-founders is almost always better than three, especially when there isn’t a clear division of responsibilities, as it’s easier to make decisions and get everyone on the same page
  • Adding a third co-founder with equal equity results in substantial dilution for the first two co-founders
  • Consider adding the third co-founder down the road once the startup has made more progress and the co-founder can be brought on at a different equity level (they could be an advisor in the interim)
  • If the startup raises money, there’s often the ability to pay more salary and less co-founder-level equity, such that the dilution from the investment is better overall for the original founders

Think about the great tech success stories like Apple, Amazon, and Google — there’s rarely more than two co-founders. Know that having a third co-founder is rare and brings with it a high cost.

What else? What are some more thoughts on the high cost of a third co-founder?

Co-Founder Equity Ideas

Recently an entrepreneur was asking me for ideas on setting up an equity arrangement with his co-founder for their new startup. Over the years I’ve seen a variety of arrangements, both good and bad. Here are some of the key ideas:

  • Require Vesting – Yes, everyone is in this and fully committed. Only, things can, and do, change. Have a vesting period (typically four years) with a one year cliff and full acceleration on change of control. And, when raising money, expect investors to ask for founder vesting (some amount recognized for time served and some amount remaining).
  • Don’t Delay the Ownership Conversation – Co-founders are so excited, and focused, on their idea that they wait too long to have the ownership and equity splits conversation. Have the conversation right away and make sure everyone is bought in.
  • Do Equal Ownership Splits or Value-Based Splits – Equal equity ownership is the most common approach I see (e.g. two founders each with 50% of the company). Another approach I see is one based on some form of value the founders bring to the table (e.g. if one is more senior or has been working on the idea before bringing on the other, then there’s an unequal split).
  • Have a Buy/Sell – One more critical item is having a buy/sell agreement that outlines to potentially buy out a co-founder if he or she leaves. A simple buy/sell formula or plan is recommended.
  • Document the Commitment – Write down what each person will be doing, how much time they’ll be spending, and any other expectations to earn their equity. I’ve seen several examples where a co-founder ended up not being a co-founder and instead was more of an advisor or consultant.

Choosing a co-founder is often one of the most important decisions an entrepreneur makes. Document the relationship and follow these best practices.

What else? What are some more co-founder equity ideas?