Measure Your Success & Tell Your Story Using SaaS Metrics

Please welcome founder and CEO of Insight Squared, Fred Shilmover, to introduce our next session.

Good afternoon, everybody. Um, my name is Fred Shilmover. I'm CEO and founder of Insight Squared, and I have the honor of introducing David Spitz today. Uh, so for 13 years, David has been managing director and head of, uh, the software and SaaS practice at Pacific Crest, uh, which is the tech arm of, uh, KeyBank Private Market. And really as active as anyone in the space. David has been personally involved in many of the premier SaaS IPOs, including Salesforce.com, SuccessFactors, Workday, ServiceNow, Viva, Zendesk, and last year Twilio and Blackline. He also sold Salesforce.com their first sort of major acquisition, a company called Intranet, And I had the privilege of working for John Samorjai, uh, for a time. Um, and I know he would tell you it's been one of their most successful, one of their best acquisitions, bringing to the company, uh, executive Alex Dayan and, uh, the beginning of the Service Cloud. Uh, you may also recognize David, uh, and Pacific Crest from the annual SaaS survey that they do. And if you don't read that or haven't read that, I highly recommend it. It helped me understand sort of the underpinnings of SaaS business economics and also what it takes to be successful. David's going to talk to you about SaaS metrics to better run your business. It's a topic that is near and dear to the heart of InsightSquared and myself. Without further ado, I'd like to welcome David Spitz.

Thank you. Hi. Is this working? Can you hear me? OK. Big group, really bright lights. So I am going to start with something a little whimsical, but I think everybody uses this term in this industry, the so-called leaky bucket. This is basically SaaS for dummies. I mean, this is the way a SaaS business works. And so I think the best way to think about this relative to this nice picture here is just to think about the fact that if you're a company that aspires to grow at 50% and you have a normal amount of churn— and we're going to talk about what's a normal amount of churn— You probably really need to be thinking about growing something like 70%. And a lot of people will focus on, well, how do we make our churn lower? And that's crucial, of course. But regardless, it's just a natural part of life that you're going to have to deal with a leaky bucket. Hopefully you can repair it and you can do all the customer success things that I heard about earlier today. But ultimately, this is the way you need to think about your business. And the way I guarantee you every investor will think about your business. And so maybe just to look at it in terms of like Salesforce.com, this is a business that is on the verge of— it's about an $8 billion run rate. And they literally— let's assume they don't disclose their churn, but they're probably losing on the order— it would be normal to think— and I'm not talking about the net churn now. I'm just talking about the amount that they'll lose by virtue of people getting acquired or leaving or what have you, they're going to lose $800 million next year of their business, of their ARR. And so that's huge. And I think all of the things you do with respect to metrics relate to dealing with these issues, the CAC and the churn and the LTV that results. And we're going to spend today some time talking about that. I think it's probably the most topical. I know there are a lot of sessions around this. We've done a lot of work in this. And churn and LTV and those underlying unit-level economics do— they are destiny. They do determine how your business is run. But I think a lot of people do it wrong. A lot of people basically believe their own BS. And a lot of people will use the convenient metrics. And that's fine if you're pitching, you know, someone to invest in your company. But ultimately, it will come home to roost, whether it's in terms of how to how to repair things that are broken or just how to improve everything. And so ultimately you need to make sure you're doing it correctly. There's no one correct way, but there are definitely many wrong ways to do it. But the next thing I'm going to do in this discussion is encourage people to think beyond the unit-level economics and think about the real economics. So I'm going to sound a little bit like a banker there, but The more time I've spent with the very high-quality companies, the more I've analyzed, and my team has analyzed, what makes these companies work, and what makes some companies great, and some other companies not as great, is the underlying economics. And those two do meet eventually. And if you're $8 billion, of course they've met already. But even if you're $20, $40, $50 million in ARR, they will start to meet, and you better have some good answers as to why you're either burning a lot of cash still, or what that means relative to how fast you're growing. And so we'll spend some time there. And then finally, we'll spend at the end, we'll actually look at how companies are valued in the public markets, companies in the sector, because it does set the stage for how you're going to be valued if you're doing your B round, or ultimately if you're going public or selling your business. So ask the basic question, what constitutes good or acceptable churn? There's no one answer to that question. But it does help to start just by looking at what's out there. And we've got profiled here a number of public companies. At the time that they went public, what was the number that they relayed in their S-1, in their prospectus. And what you can see is these numbers are all over the frickin' map. But to make matters even worse, they're defined— every company defines it differently. And so you see— we'll come back to this chart. But this is the, again, whimsical apples and oranges, and lots of different kinds of apples and oranges, and even a rotten tomato in there. I won't say who I'm thinking is a rotten tomato, but we've worked on many of the prospectuses for those companies that you saw on the previous chart, and some not. But look, if you're selling your business in an IPO, you want to put the best light on it. And you do have license to look at the business in a way that makes sense, but also puts it in its best possible light. And that's what people do. But you'll see. That, you know, for example, ServiceNow is one of the lower numbers on this page, but there's an asterisk next to it. There aren't a lot of asterisks on this page, so this is just one example. It's one I think many of you are familiar with, that the notion that we call gross churn versus net churn or net dollar retention. In the case of ServiceNow, their numbers are so good that they're able to actually just put the gross retention, as some people call it. But basically the 4% from 96 to 100, that's what they lose without the benefit of the upsells. Whereas some other companies on here, most of them in fact, if you look at Cvent, which is no longer public, that's a net number. So their gross churn isn't 3%, it's significantly higher because there's a lot of upsells. You know, you see a Veeva and a Twilio, arguably some of the, you know, they are the biggest numbers on the page. Of course, they're over 100%, so they include the upsells. It's hard to navigate that. We actually have a document. Well, these are some— I've got a great team and they put together a really in-depth review of how people do these calculations for the purposes of their S-1. These are the only people that actually have to write them down in a way that the SEC reviews, and if you lie, you've got issues. They are real, but each one is very different. And some are conveniently defined, honestly. And so you can define it in such a way that you get the benefit of, for example, if you started a deal in the middle of one year and you record the GAAP revenue from that year versus the GAAP revenue from the next year, you get sort of an immediate uplift. Is that really land and expand? No, it's not. It's just timing. And so what I would encourage you to do strongly, because in order to get this right, you really need to understand what the starting points are. You should go and download this document if you're into this geeky stuff. This presentation is available, I think, through the Saastr app or something like that. So I encourage you to do that and sort of understand that. But I'm going to hit a few high-level topics here with respect to that. Churn is so critical when you think about lifetime value because it's Typically a very small number, hopefully. And it sits in the denominator of the calculation of lifetime value. And so it is such a critical number. So kind of working from the bottom up on this page, most public companies tend to report net dollar retention. Why? Well, it looks the best. That's certainly the cynical view. But it's a valid number to be looking at. But if you're looking internally to try to figure out what's really going on in your business, you should be looking at gross churn. And in fact, if you're actually calculating LTV, in most cases— LTV, by the way, is lifetime value. Sorry about that. In most cases, you should be using that gross churn number for that LTV calculation, in my opinion. Not always, but usually. And then finally, If you're really trying to figure out what's going wrong or what's going right with your business, you should be looking at something I call non-renewal rates. If you're consistently booking 2 or 3-year deals, your churn can look a lot lower than actually your customer success, customer happiness is. And so you may have 30% non-renewal rates, but people only get to renew every 3 years. It's going to look like you only have 10% gross churn, but really you've got something else, and that's not as good. The folks that are doing this well internally should be looking at all 3 of these metrics and some others. By the way, if you're selling stock to a sophisticated SaaS investor, a venture capitalist, or somebody who really gets to look on the inside, They're not gonna just take your net dollar retention number. They are gonna wanna understand these other two numbers and the derivatives thereof. And then just to kind of— Fred had talked earlier about our SaaS survey. I think some of you are familiar with it. I've interspersed a few pages here of the results of that survey. Again, you can find this online. It's a pretty thick document. It's definitely not something to go through in a setting like this in detail, but I threw in a few This is about 300 companies that responded and we asked anonymously, got responses, "What's your net dollar retention?" We defined it. Over the entire group, that number is about 102%, meaning the expansions and upsells are actually more than balancing out the gross churn that the average company has, or the median company has. Just to give you some context. But my point as well on this is you really need to be careful. So the number of times I'll go in and meet with a company that will tell me— they'll go calculate this LTV calculation. So a lot of people And I'm sorry to go through this so quickly, but our time is limited. A lot of people will tell you LTV to CAC. That's, yeah, I'm losing a lot of money, but it's worth it because my lifetime value of a customer, that is the value of the customer over time based on the churn and based on the margins that I receive from those customers over time, that's a multiple, a large multiple of my customer acquisition costs. CAC is customer acquisition cost. Acquisition costs. David Skok, who's been a partner of ours for some time, he republishes our survey. He's thrown out the notion that a 3x LTV to CAC is kind of like the breakpoint where a business starts to be really interesting. That's debatable. I think that is a good number to start with. But my first key thing that people trip up on is they'll often compare LTV and CAC on an apples and oranges basis. And I don't want to get buried in the details, but for most companies that do upsells, uh, and do expansions, there is a cost to that. And, um, as a result, um, you can't get the benefit of those upsells and those expansions if you're not also penalizing yourself by not looking at the net churn, but looking at the gross churn. I'm a big believer that in most cases, and every company's a little bit different, and I don't want to get too buried in the, in the weeds here, but in most cases you need to look at gross churn. So if you're losing 10% of your base every year before counting the upsells, that should be a starting point for thinking about what churn number you're gonna put in that LTV calculation, that lifetime value calculation. But it goes on from there. So The other thing people do is they're very formulaic. And so they'll look, they'll say, "All right, this is what I spent on sales and marketing last quarter, and I'm gonna say that's what led to my increase in ARR, my increase in my subscription rate in the following quarter." And they're gonna look at that quarter also and say, "Here's how much I lost of the base." So I had this many non-renewals and My churn in that quarter, or even if I average it over the last 4 quarters, my churn, and again I like to use gross churn, was 5%. So I'm gonna plug that number into the LTV calculation. I'm gonna come up with LTV/CAC of 8. 8 times. 8 is a huge number, by the way. If you truly have 8 times LTV to CAC, it's a dynamite business. The issue is this point on the bottom of the slide here, which is does 5% churn? Even if it's averaged over the last year, does that really mean you're going to have a 20-year life? How many products have a 20-year life? Not many. Not many. And so my point on this front, and again, if you're trying to really be honest with yourselves and be forthright with potential investors, is you should probably come up with a number for churn, gross churn, that you think really reflects longer term what's going on with your business. And so it would be pretty rare that you'd actually say 20-year life on these things. So I'll get off my high horse, but I think it's also really important. Even though I am saying use the gross churn and don't get caught up in the land and expand, in terms of the calculation. I am a big believer, and I think the data really does support, that if you're doing things right and you're doing things in a way that's really economic, earlier on than most companies do, you're thinking about the upsells and you're thinking about the expansions because they're a heck of a lot cheaper. This is the CAC ratio, as, as a lot of people call it. This is basically how much does it cost to get a new dollar of ARR in terms of sales and marketing, customer acquisition costs. And these are the median numbers that we got from our survey, but $1.13 is the median for just new ARR from a new customer. So just banging down a new door versus upselling at $0.27, expansions at $0.20. So it's like one-fifth of the cost. And so it is extremely meaningful and you should be looking really carefully at that. Okay. So we're going to switch gears here. This is sort of the part 2 of the discussion. And this is kind of new. I haven't really gone through this before, but there are a lot— there are a lot more people who are getting focused on, for understandable reasons, just how much capital does it take to get to a certain level. We've talked some about that on a high level. But what we've done with this presentation is really looked at— so there's the standard metrics, and we use this in our survey. There's something that we call and others call the CAC ratio, which is what I was just talking about. How much does it cost to acquire a new dollar of ARR? It's not how much does it cost to acquire a customer, which some people talk about as CAC, but to us this is a little bit more economic. It's in dollar terms. The one that's easier to understand that's directly related to this, this CAC ratio, it's kind of the inverse, but you have to stick the gross margin in and then multiply times 12. This is the CAC payback period. So if you get a new customer, forget about churn, but you get a new customer or a new dollar of ARR, how much does it cost you? And how much does it cost you in terms of how quickly can you pay it back with the gross margin from the new ARR that's earned. I'll get to that in a minute. I didn't say that very clearly, but it's basically how long till the dollars that flow in from a new customer, how long does it take to pay it back, pay back the cost to acquire that customer? And the last one, this is probably the most important one in many ways at the end of the day, which is how much your business model factoring in factoring in your entire cost structure and factoring in how people pay you. Some people get billed, you know, were able to bill customers upfront, others are not. But ultimately, how much capital does it take to get certain growth in your ARR, to get to a certain level of ARR? That's at the end of the day what's really going to matter because that's what's going to force you back to the market to raise more money, get dilution. And all those things ultimately matter. And as I mentioned early on, those unit-level economics, they are destiny in that they will determine ultimately in a big way how this burn is working. But at the end of the day, if the two aren't meeting, you're probably not doing something— you're not thinking about something in the right way. And so we're going to look at that third one in some detail. But before we do, I just thought I would hit the CAC payback period because it's Again, it's the one that's easiest to think about. This is on a gross margin basis. Some people will talk about it on a revenue basis. That's fine, but a business that has 60% gross margins should be thought about in a different way than a company that has 90% gross margins. There are both, and there are great businesses on both fronts, but you really should ultimately be thinking about the margins involved. The median from our data, and we didn't ask people this question directly, by the way. We used to do that. We iterate each year. In the most recent survey that came out in September, October timeframe, we actually asked the components and got 18 months. But you can see there's a fairly wide spread. Okay, so this is what's kind of new, and this is probably a little hard to see and a little hard to follow, but this is NetSuite. What we did is we posited that you can go look at a company that's gone public. If they haven't gone through too many machinations, too much M&A or too much— you know, a lot of companies now will sell, you know, founder stock before. But if you just look at it when it's fairly pure, and NetSuite from what we can tell was pretty pure going in. There was a lot of money that went into the company historically, but you can look on the balance sheet You can look at the, basically the money. You can see how much money, how much capital has gone into the business. And you can double-check that with, there's services like PitchBook that will look at the financings. And so, and then you should subtract the cash that's still on the balance sheet. Because you haven't burned that capital yet. Obviously if there's debt you need to account for that too. But when NetSuite went public, they had gone through, they had burned $160 million of capital, and they were at a run rate. We just took the last quarter and annualized it. Their subscription run rate was $100 million. You have the orange line, I think that's orange, basically tracking the cumulative capital. You can see they were fairly breakeven free cash flow-wise. That's not always the case, by the way. Fairly breakeven from a free cash flow basis, which is what in investors, public market investors care most about, more than like EBITDA or something like that. And then you can see the trajectory of the ARR on the top line, the blue line, versus the capital consumed. And they turned cash flow positive a few years later, and then in a more major way. And of course, we know what happened, you know, 9 months into 2016. They got bought for $9+ billion enterprise value. They had a very solid business. But I think this is a really good way to think about that notion of capital burn versus ARR. I'm not saying you should stack up against NetSuite. Not everybody has an Uncle Larry, right? But nonetheless, there are companies that will burn through more money or less money. And so here, and this is a somewhat random group, obviously some really well-known companies. People who filed S-1s. And we did the same exercise for these businesses. And basically went through where they were at the time of the IPO. After the IPO, it's a little tougher to go through the exercise if they've done a lot of M&A and things like that. But anyway, still doable. And you can see like Workday, they were at a cumulative burn. So they had burned $160 million and achieved $169. $1 million. And then the last column just basically says how much capital cumulative net, because some of these turn positive, did you burn for that size. I would caution you not to compare that right column. They're not all apples to apples. People were at different points in time. And it's a company like Castlight, it's almost unfair because they just happened to go public really early. They were a pretty big burner. And so it's not unfair in that sense. But, you know, there are companies that clearly have, you know, overperformed versus their peers. ServiceNow and Veeva are some of the best from an economic perspective at the time that they went public, some of the best companies. They were both very cash flow positive. ServiceNow actually had turned somewhat negative around their IPO because they kind of revamped their operations, as I remember. But literally, You know, and it's in the footnotes. Those companies had been generating cash for some time. And they were each at $160 and $135 million in ARR. So it's pretty incredible. But this is a good guidepost. And that graph that we had on the previous page, you know, you could draw the same thing, including post-IPO, to kind of get a sense of where you are. We asked this question, by the way, in our survey. It's all self-reported, and so the results aren't— I don't think they're as reliable as what we did for the public companies when they were going public. But you can see here, again, this is the median company self-reported. To get to $5 million in ARR took $8 million median of capital burned, and it took 3 years, and so on. We do $5, $10, $20, $40 million in ARR. That's just the median. So anyway, they're not completely out of line with the previous companies. So all right. So the last piece of this, and I'm going through this faster than I thought I would, but I'll have time for questions if people have them. There's a lot of interest in this rule of 40, and actually somebody said to me the other day, "No, that's kind of— I don't hear that as much anymore." So we still hear it, but, you know, we're— probably a few steps removed. And it really doesn't start to apply until you get to some size. So I don't know what size that would be. It's somewhat arbitrary, but call it at least, I would say, $10 million in ARR and probably more like $30 or $40 million. So I imagine a lot of people, this is a distant benchmark to hit. But the concept, the underlying concept is prescient. It's pretty valid. And that's the notion— because the public markets are, as we'll see in a minute, are focused on growth and profitability as measured by free cash flow over time, or at least that it's demonstrable profitability. And there are some companies that are growing really fast and losing a fair amount of money, but they're still rewarded for it. And so it's the notion that you should add your growth rate plus your margin. And think of margin in this case as free cash flow. In most cases, sometimes you don't have that data. But what we did here on this page is basically looked at a bunch of SaaS public companies and plotted on the x-axis, we plotted the revenue growth, and on the y-axis we plotted the margin. And, and then we drew the line, the diagonal line, which is the Rule of 40 line. So people The ones above and to the right are doing better when they add their growth. So you look at Twilio. They are losing money. They're losing less than they were, but their free cash flow margin is in the -5% to -10% range. But they're growing 60%, 65%. And so they're well above or nicely above the Rule of 40. And you can see which companies sit above and which companies sit below. I mean, if you're below, it's bad, but it's something that investors are going to take note of. We did the same for the private companies in the survey. And here, again, it's self-reported. You have to take it with a grain of kosher salt, as I like to say.

But—

and there's a little bit of Tableau in this. So the size of the ball relates to how big the company is. And you can see there's one on the top right that looks Pretty amazing. I wish I knew who it was. It's anonymous, so I don't. I get a lot of investors who call me, "Can you just send me your data?" I don't have it. I really don't have it. So, and you see the ones in red are below. And obviously small balls, that's not a big deal. It's not like you need to be above the Rule of 40 when you're still a young company. But it does matter over time, as we'll see here in a second. But I thought it was interesting to note, so if you look, There's no way you can read this, but we looked at, my team looked at, all right, how many of these companies that are above that line, above that Rule of 40, again, somewhat arbitrary line, how many of them, what percentage of them are above? So about 40%, turns out, of the SaaS universe of public companies are above the Rule of 40 line. However, if you look at market cap, and you've got companies like ServiceNow and Veeva and Salesforce, close to 80% of the market cap is above the Rule of 40 line. So that's really interesting, right? If you look at our private company universe, we don't ask people how they were valued, so we don't have that. But we do have the fact that about 1 in 4 is above, and the other 3 in 4 are not. Now, they're younger companies. It's not necessarily a bad thing. It's just, it is. So the last piece of this, this discussion just relates to, well, I wonder if Rule of 40, or said better, growth, this quantity of growth plus margin, I wonder if that's somehow a determinant of valuation, maybe more so than growth. And it turns out, I mean, this moves every day, of course, it does tend to be a better indicator of value. It's not scientific here, but We actually plotted growth plus margin on the x-axis. And on the y-axis, we put the multiple, just the enterprise value to revenue multiple. That's what most people will look at as kind of what the value is. And it's on a projected revenue basis, because that's how the public market thinks. And it looks pretty good. I mean, it's the— again, for the geeks in the room, it's the The R squared is 0.64, so the correlation is— that's pretty good. We've looked at this over time just to see, and sometimes we'll see this at 80%. So it flips around. We even have the formula. It's about 10 times that quantity of growth plus margin plus 2. I'm not saying that's how you should value your company, especially in the earlier days, but it's interesting. It does, if you just look at it on the surface, it does tend to make you think, well, I got to look at both of these things really carefully. And the trap that you may fall into if you do that, you should not lose sight of the fact that when you do this next year, like you do the same exercise the next year, the multiple that you'll be working with will be multiplied times your size, your revenue. So don't lose sight of the fact that revenue growth is a heck of a lot more important than profitability. A heck of a lot more important, because you will make a lot more money if you get bigger in terms of the valuation that you will have. But this notion of how you're going to be valued is going to be crucially linked. So my advice to people would be, yeah, this is important, but step on the gas as long as you can, you know, back it up that it makes sense. You don't want to lose oodles of money in the process. So my closing thoughts, and this is not anything I didn't already say. This is tell them what you told them. But I still believe that the SaaS metrics rule, like the churn, the CAC, the LTV. But be careful. Don't believe your own bullshit. A lot of people do. Number 2, yeah, the unit-level economics. As I said in the first bullet, they do matter. But the thing that's going to bring the investors to the table, or in your case, not bring too many investors to the table where you get lots of dilution, focus on the long game of capital consumption for growth. It really is the most important thing at the end of the day, even if the SaaS metrics will determine how you stack up. Don't wait to focus on that. And then finally, the public markets do focus on this notion of growth and profitability. 12 months ago, they were maybe too far on that, but don't be fooled. As I was just saying a few minutes ago, high growth is much more important than generating free cash flow in the current period. So that's all I've got. I'm happy to take some questions. I have a minute left. If there's a question. And if not, I got one back there. I don't know if I can hear you. Is there a mic in the room? [Speaker:AUDIENCE] Yeah, SaaS is more consumer-oriented. Something more like Netflix or Spotify or— [Speaker:JASON M. LEMKIN] I'm having trouble hearing you, unfortunately. It's probably my ears. [Speaker:AUDIENCE] Enterprise versus consumer. [Speaker:JASON M. LEMKIN] Enterprise versus consumer? Yeah. So basically, one of the biggest determinants— and I assume you're asking relative to to churn. And you know, consumer— anything that costs less is gonna have more churn, virtually. So that's why smaller customers tend to churn more. And of course, the ultimate small customer is a consumer. So you're gonna have churn. And I had this debate with Jason M. Lemkin about some of this stuff. But if your customer acquisition cost is sufficient efficiently low, that may be fine to have higher churn. And so I don't think you live and die necessarily by the churn. If you have really good land and expand in the consumer model, and your customer acquisition cost because of a freemium model or something like that is attractive, that can be great. So I guess I'm out of time. Thank you very much. This has been fun.