Building a SaaS technology business and maximising it's potential for investment or sale is a challenging journey. In this article, Quake's financial director Dave Duggan explores the metrics that matter and why keeping focus on your numbers can dramatically change your valuation prospects.
Applying SaaS metrics to your business
The right SaaS metrics, calculated the right way, at the right time, can equip business leaders with objective insight and guidance. Not dissimilar to flying an aircraft, they provide you with a suite of primary instruments (the metrics), which deliver critical data from which you can make immediate changes to your control inputs. Whilst the business equivalent of control inputs are not so clear or straightforward (being strategic or operational adjustments), metrics can be the catalyst for confident decision making.
Having said this, unlike other financial metrics which are well standardised, calculation criteria can often be open to debate. Each business model is unique, which makes it imperative to take a step back, and ask yourself two key questions:
1) Is the metric applicable to your business at its current stage?
2) Which financial components are required to correctly calculate the metric?
Cherry picking figures which deliver best in class metrics can be tempting, however if they do not reflect the operating model, this can be a recipe for disaster. True performance will be masked, and you may be storing up problems which become harder to unravel at a later date. As a sense check, metrics that do not reflect underlying P&L performance can sometimes be a red flag, though this is not always the case.
How to use your numbers effectively
Once the above has been considered, and you’ve calculated your desired metrics, there are two key uses of the outputs:
1) Actionable insights for running your business:
The metrics should be telling you something, by helping to guide investment, efficiency gains, or further analysis. This is especially important at the growth stage, to help establish if your unit economics are scalable.
2) An honest appraisal of your business:
Lenders, VCs, and potential acquirers will perform their own financial due diligence. They will drill into your numbers and assumptions, and challenge you on their findings. Bear this in mind when discussing figures externally, as you don’t want to be caught out and jeopardise your hard earned term sheet.
As an example, let’s pick a metric which is not SaaS specific, but has a significant influence on many of them - Gross Margin.
As we all know, Gross Margin = Revenue less Cost of Sales, expressed as a percentage of revenue. The question is, for a SaaS business, what should be included in your cost of sales? Obviously hosting charges, but it should also reflect all the costs attributable to delivering and supporting your product. On which basis, your delivery team (if you have one), and elements of your customer success and technical support teams need capturing, to provide you with a ‘fully loaded’ Gross Margin (in addition to all the peripheral costs of employment, such as local taxes). All of a sudden, your Gross Margin might look nothing like the highly automated unicorn you read about, which has a 20x valuation, and has formed the basis of many valuation assumptions.
Gross Margin is also a critical component to customer acquisition cost payback calculations, and as we have seen, the payback period will vary significantly depending on how you calculate Gross Margin.
It’s also worth noting that metrics shouldn't just be historical. Ideally, your forecasts should also incorporate them, highlighting areas where efficiency gains or investment may be required, allowing you to adjust strategy and hiring plans with greater confidence.
What key metrics are important?
Some of the key metrics we like to understand at Quake are as follows:
- Customer Acquisition Cost (CAC) per £1 new ARR
- Customer Acquisition Cost (CAC) payback period - critical in early stages, especially when bootstrapping
- Churn (£ and logo), stratified by vintage and customer segment
- Net Retention, stratified by vintage and customer segment
- Gross Margin (helps establish scalability, and as mentioned, influences payback calculations)
- ARR growth rate
Whilst the above list is non exhaustive, they cover the key areas of efficiency, scalability, and product stickiness. Benchmarking is useful, and there are an array of useful resources online, albeit reiterating the theme of this article, everything needs to be considered against the context of your business model, and lifecycle stage.
In summary, it helps to have a baseline understanding of your key SaaS metrics, as they are a true reflection of your operating model. Even if you’re not financially minded or despise spreadsheets, a little time spent trying out some calculations can provide you with some of the most objective insight you’ll ever have of your business.
Have fun!