· The enterprise value of a SaaS company at IPO can be predicted almost entirely with just two metrics: 1) the annual recurring revenue in the most recent quarter, and 2) the yoy growth rate of that ARR from the year-ago period
· The relationship between revenue growth and the EV / ARR multiple can be plotted cleanly on a line of best fit that explains an IPO’s price to within 2 turns (i.e. if the plot predicts a 10x EV / ARR, the actual price would be within 8–12x)
· In order to go public, you should have ARR of at least $100 million, and a revenue growth rate of 25% or more. In 2018, 26 SaaS companies went public, with a median ARR of $228 million. 23 of those IPOs has growth rates over 25% yoy
Software-as-a-Service (“SaaS”) companies are characterized by what we finance practitioners like to call “recurring revenues” … they recognize revenue for services that are contractually committed over a period of time, and the revenue repeats consistently in future periods if a customer is happy with the service.
In a well-run SaaS business, a happy customer will stick around for a long time, and the profit that can be made from that customer will increase considerably. (On the other hand if a customer is unhappy, they will churn quickly, and the business will likely lose money on the investment that they made to acquire that customer.)
There are three keys to success to managing a SaaS business:
- Acquiring the customer
- Retaining the customer
- Monetizing the customer
Acquiring the customer is managed by optimizing your “cost of acquisition” (“COA”) or the “cost of acquiring a customer” (“CAC”), and by understanding the relationship of CAC to the “lifetime value of a customer” (“LTV”) or “months to recover CAC.” A well-run SaaS company will have a 3:1 LTV:CAC ratio or better, and will recover your CAC inside of a year.
Retaining the customer is a function of the “product market” fit, the strength of the value delivered relative to other competing alternatives, and the costs associated with switching. “Churn” / “attrition” … the percentage of customers who stop using your product or service … is a good way to measure this, along with it’s glass-half-full counterpart: “retention.” A well-run enterprise SaaS company will get this below 3% per month for paying customers.