In addition to the “highlights” that most venture capital firms discuss, and those that are most relevant to today's scrupulous funding environment, the forecasting feasibility and success of a startup goes beyond the total addressable market (TAM) and goes much deeper.
At the height of venture capital-backed growth, startups had to lock in just two key metrics to secure funding: TAM and revenue growth; the bigger the better. But the crisis of early 2022 brought another priority to the fore: sustainable growth.
It's complicated because it's not a single metric, it's more of a movement.
In many ways, sustainable growth is different by industry and product, but for the standard SaaS company, it is underpinned by one core concept: product scalability. In SaaS, scalability is measured through several metrics, including ARR (annual recurring revenue) per employee, R40 (Rule of 40) among others.
This is where you can recognize that there are exceptions to every rule. Just think of disruptive technologies where stock investors are still allowing astronomical amounts of cash to burn with no clear path to profitability. In any case, this article focuses on metrics and business environments that apply to most SaaS companies, not outliers.
Basic performance benchmarks for further financing
The scalability and unit economics of SaaS make the industry attractive to investors. risk capital. However, the “growth at all costs” mentality and the depletion of B2B marketing channels have tested investors' conviction that startups have what it takes to achieve profitability and success at scale.
Today we focus on metrics and business environments that apply to most SaaS companies, not outliers.
Gross and net margins are great metrics to track. Still, investors are now analyzing the fine print of these unit economics and ratios related to GTM (go-to-market) efficiency, an essential aspect of due diligence.
If you're looking to raise funds, it's important to know the metrics investors are evaluating. These are the essentials:
- ARR per employee: This provides a clear picture of business efficiency and the impact of each new employee, which becomes particularly important once the GTM team begins to scale. This is where automating specific tasks with AI can pay off. Success stories like Ramp, which reached over $100 million ARR with just 50 employees, show the possibilities and how high the bar is set for SaaS companies.
- R40: The Rule of 40 is a leading predictor of success and ability to grow. While many startups in any portfolio have seen a decline in growth velocity over the past 12 months, most have also seen an improvement in efficiency and margins. R40 is based on the idea that the highest performing startups have profit margins and growth rates (profit + growth) that add up to more than 40% and is a great way to visualize those profits.
- CAC and LTV/CAC recovery: Customer acquisition cost and lifetime value have long been reliable metrics for analyzing GTM efficiency. In 2023 alone, payback periods have lengthened significantly, putting pressure on working capital and finances. More efficient operations help reduce payback period and overall CAC while maintaining LTV.
- Customer Retention Rates and MRR (monthly recurring revenue) – are more crucial than ever as the cost of acquiring new customers has increased significantly. Not only are retention rates a great indicator of product-market fit, but strong customer retention is also vital to achieving strong unit economics due to the savings it generates within the GTM movement.
How VC priorities reflect a changing world
As capital becomes scarcer and increases less predictable, investors need to ensure that companies are growing sustainably and can deliver timely returns.
Traditionally, shareholder returns come from positive cash flow. Because venture capital investors look for longer-term returns, they only sometimes consider earnings per share or dividends (expected in public companies). Instead, they expect founders to demonstrate strong unit economics and the ability to continually reinvest in the business without significant outside capital coming in.
Companies that exhibit strong unit economics and reinvestment opportunities may have more influence in 2024 than before 2021 due to their impressive health: they burn fewer resources, have more breathing room, and have more mileage. In short, they are growing sustainably. SaaS companies with good metrics will naturally stand out from the crowd and, in turn, have more options and potential buyers. From now on, we will also see more companies looking for an exit and more distressed sales, giving leverage to those looking to acquire.
Internal financial discipline is also more critical than ever. It is a vital part of achieving better ARR efficiency. Interest rates remain high, requiring the cost of capital for founders to be a priority. Founders can generate a positive impact by improving profitability through greater internal efficiency, reducing infrastructure costs (premises, representation, overheads, etc.) and using artificial intelligence to improve productivity by automating repetitive tasks.
Increase funding through key metrics
SaaS is a strong industry. It has always been about increasing efficiency, which is why the field is resilient and has a good tailwind. To take advantage of this industry characteristic and raise funds in 2024, SaaS companies in all sub-industries must position their products as ways to save other companies time and money while increasing sales.
In addition to the efficiency and sustainable growth measures detailed above, dedicating time and energy to understanding the future of SaaS, feedback from SaaS business leaders has also been included to develop a holistic picture of what's to come. The summary is that Long-term success comes from strong metrics, disciplined leadership, and a laser focus on creating high-quality products for new and existing customers., instead of investing resources in new product lines that have not yet been tested.
The 2022 recession demonstrated that the SaaS industry is exceptionally flexible, agile and resilient. Signs of recovery are already appearing in the industry and, although growth has slowed, net margins have improved and companies are consuming less resources on average. Combine this with rising SaaS sales as well as the flow of venture capital deals and cautious optimism about SaaS fundraising may emerge.
