The problem with SaaS metrics

As a venture investor and board member, I am relentlessly in pursuit of companies that can set forth aggressive goals, and then exceed them. One of my portfolio company CEOs likes to use the term “consciously competent” — which means being successful by design, rather than by luck. Clearly, this is a goal most startups aspire to (although luck is good too!), and it requires carefully tracking metrics that accurately measure the performance of your business model. For many SaaS startups, this has meant inventing new metrics to fit with their model, as many of the traditional ones do not. In recent years, those of us working in or with SaaS companies have become accustomed to variations on such metrics as committed monthly recurring revenue (CMRR), customer acquisition cost (CAC), lifetime value (LTV), churn, etc.

But there is a problem. Many of these companies will one day be acquired, and most of the potential acquiring companies out there do not use SaaS metrics — they use generally accepted accounting principles (GAAP). This creates a disconnect between the two parties, and if potential acquirers do not recognize the overall value of a SaaS company, negotiations are hindered from the start. However, with a little advanced planning, this disconnect can be resolved.

I had the pleasure of leading a seminar last month organized by MassTLC that explored various Software-as-a-Service (SaaS) metrics and how they impact business models and decisions. One of the key topics we addressed is an emerging issue in the era of the “subscription economy” — the misalignment of business metrics between startups and their potential acquiring companies.

As Tyler Sloat, chief financial officer at Zuora, explained during the seminar, traditional financial systems have not kept up with the emergence of SaaS companies, which charge recurring fees that are lower than traditional solutions providers. Tyler pointed out two big problems with traditional income statements that typically measure business performance.

First, income statements are backward-looking. They measure revenues based on how much money a company made in the last period. Second, they do not differentiate one-time revenues or expenses from those that are recurring. These are worrisome factors for a SaaS company selling multi-year subscription plans for ongoing services. And when it comes time to sell the company, the buyers are looking at traditional figures, and not SaaS metrics or accounting figures.

In their early stages, SaaS companies should identify and begin to closely track the metrics that are most important to potential acquirers. Jim Pluntze, the chief financial officer of Navisite (which was acquired last year by Time Warner), told the MassTLC crowd that there are several evaluation metrics involved in a typical acquisition, including revenue and EBITDA growth (earnings before interest, taxes, depreciation and amortization), churn, bookings and capacity. I explained that when evaluating SaaS companies, I compare a company’s total customer acquisition cost with its contribution margin and expected customer duration. And Sloat told us what he sees as the “only three SaaS metrics that matter” — recurring profit margins, retention rates and growth efficiency.

Assuming your startup does not go public one day, your exit options will be limited if potential acquirers do not recognize the value of your business metrics. SaaS company founders should track the metrics that accurately reflect their business performance. But to attain full market value down the road, they must also keep a close watch on the measurements that traditional companies care about most.

Matt Fates is a partner at Ascent Venture Partners. Over the last decade, he has focused on investments in data analytics and cloud business services. Ascent has backed more than 100 early-stage, enterprise IT companies since 1985.

Image courtesy of Flickr user Sterlic.