Below is the ‘Tip of the Week’ transcript from the Podcast Ep36: SaaS Startup Investing (Mamoon Hamid)
On today’s show we talked about a lot of different SaaS metrics and I wanted to take this week’s tip to define each, review how they work and talk about the preferred level for these metrics. And remember that this only includes those that we reviewed today. There are limitless other metrics that one can evaluate but we covered a lot of critical ones, so that’s what I’ll review.
First, we’ll start with…
1. MRR: Monthly Recurring Revenue. Simple enough. In a business where use of software is exchanged for a monthly fee, this is the most fundamental component to measure.
2. Net New MRR: As Mamoon said, this incapsulates everything about a business. He calles it the “Engine of SaaS.” How you’re able to close new deals, how you’re able to manage existing business. And also how engaged the user base is b/c it accounts for users that are churning away. Remember that Mamoon’s advice here is that Net New MRR should always be increasing. If not month-to-month, then definitely on a quarter-to-quarter basis. There are four sub-components used to calcualte Net New MRR. They include…
1. New MRR: New logos/businesses signed up
2. Expansion MRR: More $ generated for existing logos/businesses
3. Canceled MRR: Logos/businesses lost
4. Contraction MRR: Reduced $ for existing logos/businesses
3. ARR: Very similar to the MRR but annualized. MRR allows for calculation of annual recurring revenue, which is also critical to look at.
4. Gross MRR Churn: This is expressed as a percentage and is calculated based on the total dollars of churn in the current period, divided by the MRR from the previous period. Mamoon often looks for companies w/ Gross MRR Churn less than 3%.
5. Net MRR Churn: Prefer a negative number here. For every dollar I’m generating per customer today, I’m generating more than a dollar per customer the next year. Calculate this by using the Net New MRR divided by the previous period’s MRR.
6. Average contract size: $Revenue made per customer per month
7. Average contract length: # of months the average customer is retained.
8. Average contract value (ACV): $Revenue per customer, per month * the contract length
9. Price per Seat: $ Revenue per user per month
10. Sales Efficiency: How many reps do you have. How much quota does each carry. Multply them and you get your quota capacity.
11. LTV: Lifetime Value. Attempting to measure the total value of a customer over their total duration as a customer. Mamoon doesn’t like this metric b/c it makes a lot of assumptions and is not based on the data today. As you could imagine, you’d have to assume a lot about what the contract length will be in the future and how much expansion MRR will be charged in different periods over many years.
12. CAC: Customer acquisition cost. Simply the amount it costs to convert a new customer. Again, this is another metric that Mamoon treats cautiously b/c it also assumes a lot of unkowns based on today’s data.
13. Quick Ratio: Added MRR / Lost MRR. So any new MRR (new logos signed up) and any expansion MRR (more $ per logo) sits on the top line. And on the bottom line is Canceled MRR (lost logos) and contraction MRR (reduced $ per logo). Clearly, this number must be positive and it seems that Mamoon looks for companies to invest in that have a Quick Ratio of 4x or greater. Naturally, this will be more relevant in year two+ and beyond when expansion and contraction revenue can be calculated. And this is a critical metric for Mamoon b/c it quickly reveals if the startup is having a significant churn issue.
As a correlary to the metrics we just reviewed, I will also include two links in the post on the site. One from David Skok called SaaS Metrics 2.0 and the other from Derek Piling called Negative Churn. Both are great resources if you’d like to continue reading about various SaaS metrics.
So, now that we’ve reviewed the metrics themselves, let’s transition to the levels that Mamoon looks for, on key SaaS metrics…
First, three levels that he wants to see:
- $1M ARR or greater within 12 months of launch
- New MRR is increasing quarter-over-quarter
- Seed Stage company should be adding 5-10k of MRR per month
- Series A should be adding 10-20k per month
- Quick ratio greater than 4
and second, what to watch out for that he doesn’t want to see:
- Net new MRR is flat or down quarter-over-quarter
- Quick Ratio is less than 2 (which indicates that new sales aren’t converting fast enough and churn is too high)
- As a result of these factors it often takes 18 months or more to get to $1M ARR, which is not preferred
So, if you are a SaaS investor or advising a SaaS company, I hope today’s material was helpful. If a SaaS company is not measuring some of these basic metrics, big red flag. And conversely, if you come across a startup with $10M in ARR within 12 months, like Slack… please give me a call.