Venture capital is the engine that keeps the tech sector running. Other considerations aside, the possibility of founding a tech unicorn – a company valued at over $1 billion – is so tempting that many, many businesses get founded, and funded, every year in this sector. Have an idea, build it, try to get traction… if that fails you can always pivot or take a shot with a different idea.
This cycle of fail fast and try again means that investors need pretty fool-proof ways of assessing the startups in front of them. No one can see into the future, of course, but by analysing a tech company’s current metrics investors can at least avoid the more predictable failures.
If you run a tech company – particularly a SaaS company – numbers such as your churn rate, monthly recurring revenue (MRR), annual recurring revenue (ARR), customer acquisition cost (CAC), and customer lifetime value (CLV) should be very familiar to you. If they aren’t, read on to find out how they can be.
Why do I need to track SaaS metrics?
Every business needs a way to measure financial health. Unlike the more traditional service or product model, SaaS companies typically have a more complex model but higher growth and profitability potential – the market is often global, and delivery virtual. So, the way you measure financial health in a SaaS company won’t be the same as, say, a professional services company.
As a SaaS company moves out of the startup phase – during which everything could well have been bootstrapped – and into the hypergrowth phase, it will need plenty of cash to support its expanding requirements. Unless you have this cash already sitting in the bank, you’ll start talking to lenders and investors about funding. And you’ll need financial figures that help to demonstrate the growth and profitability potential I mentioned.
SaaS growth metrics aren’t just vanity numbers. This is a tried and tested model; it’s transparent, and it works. Take a look at any of the big SaaS companies and see how they keep track of their numbers. They all publish annual reports (Xero is a good example) that you can learn from to start looking at your tech startup through the same lens.
Typical accounting software doesn’t track SaaS metrics
If you’re gaining 100 new clients every month, that’s great. But if you’re losing 40 clients every month as well, that’s not so great. You have a high churn rate, and the lifetime value of your clients will be low. This is an indicator that the financial health of the business isn’t good, but this may not have been apparent if we only looked at more classic indicators such as cash flow.
Accounting software won’t know that you lost one client but gained two clients. It’s set up to provide revenue insight, not report on metrics such as churn rate. But these insights are obviously useful to tech entrepreneurs, so a lot of them will start tracking them manually in a spreadsheet. This isn’t ideal, because manual spreadsheets take time to manage, don’t provide real-time data, and are error-prone.
What can SaaS billing platforms do?
Because standard accounting software doesn’t meet this area of need, a better solution is to use a central SaaS platform with native reporting. A SaaS billing application could cover your CRM, quoting, trials, invoicing, payments, account management, etc., plus be able to provide the financial and metrics insights you need.
There are lots of potential layers of complexity in a SaaS business. You can have different pricing tiers that clients can change to, and the change might come into effect at the next billing renewal date or be implemented on a pro rata basis. Sometimes there is a usage element in the fee, or additional cost for adding users, storage, integrations, etc.
There are also challenges like revenue recognition. Let’s say customers pay you quarterly or annually for your software. This means you get revenue in one lump sum that actually represents revenue over a period of time. A standard accounting package can’t see that, it will just attribute your revenue to the month you received it instead of spreading it evenly over the months.
Billing platforms are set up to manage this gap. They won’t replace your accounting system entirely, but will connect to accounting so that you have a full picture. Another good thing about them is they’ll typically integrate with your website to manage the customer sign-up process, and allow for a self-service area where customers can change their plan, add users, download invoices, etc. This means you don’t have to develop and maintain all that functionality yourself.
At the business end, the billing platform sends the information you need into your accounting system in such a way that your financial reporting will make sense (e.g., if an annual subscription has been paid, your accounting system will know how much was paid and on what date, but also that this revenue needs to be allocated as 12 monthly payments).
The benefits of SaaS billing platforms
The leading platforms we see in use are Chargebee, Chargify, SaaSOptics, Billing Platform. Chargify recently bought SaaS Optics, and they are in the process of transforming into a new company called Maxio. Chargify has a Dublin presence, and we’re keeping a close eye on their development as it will be interesting to see what happens next with the company.
What’s great about these platforms is that they can help you maximise your active subscriptions in a way that benefits both the business and the customer. Let’s say a customer is on a lower-level plan, but their usage is quite high and they’re getting to the point of incurring additional charges (overage). The billing system will alert you to this fact and your sales team can reach out to the customer about moving to the next level plan. Now the customer knows how much to budget for every month because their usage won’t exceed their plan, and they won’t incur additional surprise fees. The business has successfully upgraded a customer and increased the MRR going forward.
This proactive approach is much better for companies that are scaling. A more basic system that relies on the customer being the instigator of change and moving themselves up to a higher-level plan isn’t going to drive sales. I’m seeing a worldwide trend in SaaS towards usage charges, and I think it’s the better model because if I’m actively using a tool and getting value from it, I’m perfectly happy to pay for it. There’s a logic to the model for the customer, but it is more complex to manage, so you’ll need a more comprehensive platform.
Two key SaaS metrics founders should track
Two good metrics that will give you an instant feel for the health of the business are the customer lifetime value (CLV) and customer acquisition cost (CAC).
Tracking lifetime value
Before I became familiar with SaaS models and accounting, I would have guessed you’d need at least a year of data before you could work out the customer lifetime value. In fact, you can start tracking this after just two months of trading.
You start with the number of customers you have and how many you lose after one month. Let’s say you have 100 customers and lose two after a month. This makes the lifetime of a customer 50 months, so you can simply multiply your average monthly fee by 50, and you have your lifetime value metric.
Tracking customer acquisition
CAC is another important metric. This is the average amount you put into acquiring a customer. It’s a simple calculation: the total cost of selling, advertising, and marketing – internal and outsourced – divided by the number of new signups.
Given the marketplace is so crowded now, getting existing customers to use more of your product or not to churn is going to be much cheaper than acquiring brand-new customers. People are time-poor and don’t have the energy to wade through all the search results and evaluate all the contenders. Even if your software is fantastic, it’s getting harder to attract paying customers.
Across the industry, I see lead times getting longer and competition getting more intense. The low-code revolution means the barrier to entry is pretty low for SMEs, who may be more inclined to build their own solution than turn to a SaaS product. There’s also the blurring of the lines between enterprise-level software and SME software, meaning that the market is even bigger than you might think. It seems much harder to get new customers these days, and I suspect that the best way for SaaS companies to scale will be to become more niche.
Choosing a SaaS billing platform
At this level of mission-critical functionality, don’t expect free trials or free/nearly-free plans. These are powerful machines that can drive real results for your business, so expect subscription fees to start at possibly €1,000 per month depending on the size of your business. We know businesses that are paying €100,000 per year in subscription fees.
There’s a real need for these platforms, but they are expensive, so you should be ready to scale in order to reap the rewards of their complex functionality. We have had a few smaller SaaS companies trying to manage all this using spreadsheets and Xero alone, and it’s very difficult. My advice is to jump in and invest as soon as you can, because a platform like this is going to serve for the next five to ten years.
You can, of course, build this functionality yourself. But it is very time-consuming and requires diverting resources away from your core work, so I think it’s rarely the right approach. These platforms have self-service areas for customers, so the billing platform becomes a key element of customer success. It’s so fundamental to delivering a good service, which comes back to my point about keeping existing customers rather than spending to acquire new ones.
The platforms I mentioned above are just a sample of what’s available, so you’ll need to research carefully to find the right fit for your business. Obviously, I advise you to choose a solution that is fully cloud and integrates with the leading accounting systems. I dislike the fact that you still have a dashboard in your SaaS billing platform and a dashboard in your Xero (or other accounting software). I would love a solution that brings them seamlessly together in one of those places, but no one seems to have cracked that just yet.
I hope you have a better understanding of SaaS metrics now. As you can see, this isn’t so much an accounting issue as an operational one. These metrics impact the money coming into the business, but are not simply accounting.
Learn to use SaaS metric language early on, because the minute you start talking to investors or agencies like Enterprise Ireland, they will expect you to know these numbers. This is how they assess your potential. These numbers matter because where a service company might hope to be sold for the equivalent of a year’s turnover, a SaaS company could sell for eight times that, and potentially much, much more.