In this episode of SaaS Open Mic, I’m speaking with Jess Bartos, an investor with Salesforce Ventures. We discuss the SaaS metrics that investors like Jess use to evaluate the potential of a company, no matter the market conditions.
If you’re looking to secure VC funding, you should understand your growth trajectory, net dollar retention, gross margin, rule of 40, and burn multiples.
Listen to the podcast or read the summary below.
Growth needs to endure at high rates
It’s no secret that VCs need to generate outsized returns. They need rapid growth in order to get to that magical place — return on investment. To be a good prospective investment opportunity, SaaS businesses need to be scaling quickly, and that growth needs to endure at a high rate for a long time.
[As investors,] we usually like to see getting from zero to one. From the time you launch your product to reaching a million of ARR in around 12 months or less. And then triple triple, double, double, double — where you triple for two more years and then double every year from that.
This is the growth trajectory of a best-in-class SaaS business on the path to a $100 million ARR that companies like Twilio and Hashi Corp have followed.
Naturally, growth will slow down as a company scales. However, investors will look at the ratio between this year’s growth and last year’s growth. Make sure that the slow-down is not too abrupt.
If last year you were growing at a hundred percent and this year you’re growing at 80%, then your growth duration is 0.8. And what you want to do is not deteriorate that. Don’t slow down too quickly.
Net Dollar Retention means you’re delivering on your promise
Net dollar retention (NDR) is essentially looking at your customer base a year ago, that same cohort of customers, how much you have churned, how much you have upsold or cross sold, and then what’s that percentage today.
For example, if you had $100 ARR at the beginning of the period, you churned $5, and you upsold $25, then your NDR is 120%.
We really like this metric because it encapsulates both the business’s ability to retain — so minimizing churn — but also their ability to upsell. That’s super important, not just winning new logos in B2B software, but adding additional products, expanding your platform, cross-selling, and increasing usage.
If your NDR is under 100%, you have a leaky bucket problem. On the other hand, NDR over 100%, indicates that the value of your product and your pricing are aligned with the success of your customers. It proves that you’re delivering on the promise.
Turn your gross margin into growth
Gross margin is your revenue, less the cost of goods sold. In SaaS, these costs are low, so healthy gross margins for a SaaS business can be around 70% to 80%.
I also like to look at gross margin because I think it’s the kind of telltale sign of any fake SaaS. So, technology businesses that are actually more of a service business as opposed to a software business, and you can really see that come across in gross margins.
Jess explains that having a high gross margin means that you’ll be able to invest more to grow faster. If you have 80% of your revenue left, you can spend it improving your product, and investing in sales and marketing.
Rule of 40 is the balance between growth and profitability
Rule of 40 is the sum of your EBITDA margin and your growth rate. If your EBITDA margin is 20% and your growth rate is 100%, your rule of 40 number is 120%. The rule of 40 measures the relationship, or balance, between a company’s growth and profitability.
Historically, valuation multiples for software companies have been correlated with how fast you’re growing. But actually, during the most recent market correction, these multiples started to be more correlated with how software businesses were doing on the rule of 40. (…) Both public markets and private investors are looking a lot more carefully at how efficiently you’re growing, and how much profitability or burn does it take to continue to grow at such a fast rate.
Burn multiples measure growth efficiency
Burn multiple is your cash burned, divided by your net ARR added in that same period.
Adding ARR is what you wanna be doing, and the burn is how you do it. This multiple shows the relationship between them.
This can be measured cumulatively over the life of your startup or it can be measured in a period. Jess recommends looking at this metric on a monthly or quarterly basis, in this cash-constrained environment. These numbers will give you confidence in how efficiently you’re growing.
If you are an early-stage company, over 3 is normal. But burn multiples should be coming down as you grow. Under 1 is fantastic because it means it takes less than a dollar for you to get another dollar of ARR, which is fantastic.
Use your SaaS metrics to tell a great story to your investors
As a last piece of advice, Jess reminds founders that it’s not just about numbers, but also about stories.
In the noise of all these numbers, use your numbers to tell a great story.
All these SaaS metrics, calculations, and figures, are at the core of telling a compelling story about your business, where it’s going, how you’re going to disrupt the market, and what is so exciting about it. Make sure to make investors part of that excitement.