Secrets from the Boardroom: The 5 C's of SaaS Investment

In order to make the most of venture capital, entrepreneurs in the SaaS (Software-as-a-Service) market need to have a clear idea of what investors are looking for. Understanding the metrics upon which potential investors base their decisions will crystalize a stronger business model and prepare the company for the scale-up it requires to be profitable in the years to come.

The main objective of most VCs is to provide enough financial resources for a SaaS company to develop their sales to the point where they can either get A) traded on the public market, or B) sold to a larger company.

In developing an investment proposal to VCs, SaaS entrepreneurs should start with the five C’s of investment. As Allan Wille writes, the five C’s are generally understood to be:

1.     CMRR, ARR, ARRR. CMRR refers to committed monthly recurring revenue, usually from subscription based customer acquisitions. ARR refers to annual rate of return, or the ratio of return on net income of an investment. ARRR refers to run rate revenue, which is essential taking yearly performance and projecting it into future revenue. These three metrics are integral once a start-up has hit phase two, when revenue hits over $1 million. 

2.     Cash Flow. The relatively simple assessment of costs vs revenue, cash flow is one of the most important factors in phase one of a company as it tries to build a profitable base. 

3.     CAC (customer acquisition cost payback period). CAC refers to the time it takes for a customer’s revenue to exceed the cost of acquisition (lead generation, sales outreach, etc.).

4.     Customer Lifetime Value. Measuring the potential revenue from a single customer over the entire relationship helps an investor understand how much profit is at play if the company can generate 100 more customers. 

5.     Churn and Renewal Rates. A churn rate is the inverse of a renewal rate, such that if a company recorded a 70% customer subscription renewal rate they would also record a 30% churn rate. Like cash flow, churn rate is an important indicator in phase one of the potential growth. 

Showing data on all these fronts is an important part of any proposal. But these are purely financial metrics measuring the health of a start-up, and while they are an integral part of a company’s overall package, for some VCs they are not the most important indicators of potential success. 

There are three primary non-financial indicators that VCs will look for.

Non-financial indicators are:

·       A committed leader who will stop at nothing to be successful

·       A clear plan for how VC money will be invested

·       Solid position in a market that has growth and opportunity

There is a very nuanced relationship between the financial health of a start-up and the potential it has. Potential is measured as much by strong leadership and a solid position in a growing market as anything else – and the SaaS market is booming at the moment, so investors are far more likely to overlook a low CMRR if the product is excellent and the leadership is strong. 

Rounding It Up

Due to increased competitiveness, venture capitalists operating in SaaS are only interested in the complete package. Entrepreneurs looking for VC funds need to understand their market as much as their own balance sheets. That way they can undergo stable growth in the early stages and remain a viable investment option. 

Do you operate a SaaS company? Invest in SaaS companies? Please share your thoughts in the comments section below as I learn as much from you as you do from me.

This article was reposted with permission. Originally published by Morgan Hill Partners: "Secrets from the Boardroom: The 5 C's of SaaS Investment".

ABOUT THE AUTHOR:

Jim Barnish is founder and CEO of StartUp Solutions, a boutique consulting firm helping entrepreneurs/startups build scalable and fundable (VC-ready) solutions, methodologies and business processes. Jim's 10+ years of experience as a strategic change leader in global and integrated operations, sales, and marketing uniquely qualifies him to the lead the firm. Over the course of Jim’s career, he has successfully worked with companies undergoing accelerated business development, process improvement, change management and operational transformation initiatives.