We evaluate a lot of SaaS companies. And, we evaluated our own SaaS company for years. But how we evaluate growth-stage companies at the top level is specifically designed to help everyone quickly focus on strengths and weaknesses to make improvements that accelerate growth. In Beacon9, that SaaS business evaluation is the first part of our consultative process, but the methodology is just as applicable to DIY, so I thought I’d share some of that today.
Please note that this evaluation is designed to identify rather than fix. It’s about finding things that can be investigated further to leverage or improve. And, it’s important to note that this is not a technology evaluation, it’s a business evaluation.
SaaS Business Evaluation Framework
There’s a set of key metrics that define a SaaS business. Different people put varying levels of importance on these metrics, define their ranges differently, and sprinkle in their secondary numbers. But ultimately, there’s a pretty small set of kingpin numbers that tell the story.
In my experience, that story is told in the relationship between and among the metrics. At Beacon9, we produce a snapshot analysis (shown below) that gives us our key metrics. More importantly, it puts them together in a way that helps us see the relationships between the numbers and get some insight into potential strengths and weaknesses driving overall performance.
It doesn’t take any especially hard-to-come-by data to see your SaaS business through these metrics. And, the truth is, if you don’t have the data that is required, you’ve already had a huge learning moment. Your marching orders are to have a machine behind the business that allows you to monitor and extract key business data. So let’s assume that you have access to the numbers behind a snapshot like this.
Behind the SaaS Evaluation Snapshot
There are ten worksheets bubbling up into our snapshot. These worksheets are the numbers that describe the addressable market; revenue and churn; sales and marketing; customers; R&D; culture; P&L; and balance sheet. Then there are a couple more that are qualitative.
Within each worksheet, we also have sub-metric analyses that illustrate performance, despite the fact that those don’t rise to the snapshot level. Sales and marketing are especially fertile for sub-metrics that help identify opportunities.
Bare minimum inputs are revenue (split by type); customer and revenue churn; sales expense; marketing expense; new contract value (split by revenue type); headcount; and P&L COGS and EBITDA.
SaaS Evaluation Periods
I like to look at quarters. And in most cases, I like to have enough of a history that I can see trends. So you’ll see that this particular snapshot covers seven quarters. It’s up to you how much context you want or need, and how granular that should be. The closer you are to the startup stage, the more likely you’ll want to see things monthly. Even in growth stage, you’ll likely switch to monthly once you dig deeper beyond the top-level evaluation.
About the SaaS Business Evaluation Snapshot
Market and Scale
We like to understand scale because it provides a frame of reference for stage and our expectations of the other metrics. Then we like market penetration over time because it shows how the business is performing relative to market size. Are you growing faster or slower than the rising tide?
Revenue and Mix
Revenue growth over time shows growth, trends, and momentum. It’s also an easy way to see lumpiness which goes to predictability (and executional risk/valuation). The reason we look at recurring revenue versus all revenue is to easily see how the highest value portion of the business is performing and to understand if or how the mix is evolving. Again, trends over time are important here.
CAC and Sales Efficiency
With our four CAC and sales efficiency metrics we’re getting into understanding what it costs to create a new dollar in recurring revenue. These metrics reveal a lot about sales and marketing efficiency and ultimately the capital efficiency of the business. Combined with COGS, we also begin to see maturity through the lens of CAC recoupment against MRR margin. Sales efficiency says a lot about growth capital readiness and the evolution of that number over time provides insights into predictability and market fit.
ARPU and Revenue per Head
We look at two average revenue unit numbers. Since we don’t bubble customer count up into our snapshot, we rely on ARPU (and ACV) to understand customer scale and related risk. The reason we have MRR and all ARPU is to again provide insight into revenue mix and how that mix may or may not be changing over time. Are you trending towards proportionally more recurring revenue or less?
We like revenue per head to get a quick idea of the fundamental productivity of the company. If there’s any kind of revenue-per-head flag, we can then look to COGS by department and EBITDA to get more specific. There are a lot of ways a SaaS company can be over- or underbuilt.
Customer and revenue churn speak volumes about market fit and customer success. Norms vary based on space and scale, but churn tells us a lot. We look at both customer and gross and net revenue churn to relate back ARPU and to get a peek into expansion/contraction (in the net metric). We’re looking for differences between the three churn metrics and trends over time.
LTV and LTV/CAC
Lifetime value is a function of churn and ARPU and pulls a lot together when looked at relative to CAC. LTV and sales efficiency (SaaS magic number) are sort of the SaaS metrics dream team in terms of illustrating growth potential and executional risk.
Calculate your LTV and LTV/CAC ratio using our LTV calculator.
New Contract Value
ACV can be revealing when looked at in relation to sales efficiency or CAC. It’s also directly related to CAC recoupment, which links back to capital efficiency and growth potential. Contract size ties back to expectations around the sales cycle, sales strategy and sales tactics.
SaaS Business Evaluation Quick Checks
Revenue concentration is in here as a check that there aren’t too many eggs in one basket. It’s an axis that isn’t captured anywhere else and a box that should be checked. High revenue concentration means high risk and an opportunity to mitigate that risk to improve the company’s position.
COGS shows how efficient you are above the line and which way that percentage is trending. The expectation is that more mature companies are more stable and efficient than less mature ones, so the growth-stage trend should be consistent or declining COGS.
EBITDA makes it into the snapshot to have a quick idea of profit/loss and how that trend is evolving.
And finally, the rule of number is another quick check that summarizes growth and profit (and the tradeoff between them).
We can extrapolate a lot from COGS, EBITDA, and rule-of number. For example, if you have nice, low COGS, but are burning cash while growing well, you have a lot of expense (probably in sales, marketing, and development).
What’s the Black Column?
We set targets for many of the values in our SaaS business evaluation snapshot to make it easier to spot trends or outliers. The yellow boxes are conditionally formatted based upon the values set in the black column for each row. Targets vary based on stage, space, scale and other factors. Despite the fact that they can be evaluated on many of the same metrics, no two SaaS companies are alike.
I Used to Have A Tracker Very Much Like this Snapshot
Once you get your SaaS business evaluation set up for your own company, it’s not hard to maintain. And once you have a series of periods in your tracker, you can begin to see patterns and use those patterns to initiate adjustments. I used something very similar to this when I was a SaaS CEO. Each month it would get updated with fresh data that would help illustrate performance and identify opportunities. I then used it for planning to set goals and track against them. All in all, the SaaS business evaluation is an objective, market-aligned way to evaluate and identify business strengths and weaknesses on an ongoing basis.