What does an investor look out for in a SaaS product?

Photo by Balázs Kétyi on Unsplash

With the increase in number of SaaS products, investors today have a large pool of startups to consider from. It has become much harder for founders to convince investors to invest in their startups.

In order to stand out, founders need to understand the thought process of investors and to know what are the key benchmarks that investors are looking out for.

Here are the top 10 metrics that investors look at:

1) Monthly Recurring Revenue (MRR)

The amount of revenue the company makes that recurs each month.

2) Annual Recurring Revenue (ARR)

Similar to MRR, but it’s the revenue the company makes that recurs each year.

3) Annual Revenue per Customer (ARPA)

ARPA = MRR / Total number of customers

4) Lifetime Value (LTV)

Customer lifetime value represents the total amount of money a customer is expected to spend in your company.

LTV = ARPA x Average Customer Lifespan

5) Customer Acquisition Cost (CAC)

The cost acquired to acquire a customer. The LTV must exceed the CAC, if not the company cannot be profitable.

6) Daily Active Users (DAU)

The number of daily users on your platform.

7) Monthly Active Users (MAU)

The number of monthly users on your platform.

8) Month Over Month (MOM) Growth

The rate growth from month to month.

9) Monthly Churn Rate (MCR)

MCR = Customers lost this month / Number of customers in the prior month

10) Net Revenue Retention (NRR)

To calculate net revenue retention, we need to consider the following 4 different values:

(A) Monthly recurring revenue of the last month (MRR)
(B) Revenue generated through upgrades and cross-sells
(C) Revenue lost through downgrades
(D) Revenue lost through churn

NRR = (A + B — C — D) / A

But what is the benchmark?

A recent report published by Bessemer Venture Partners on Sept 2021, showed a benchmark of 60–200% for ARR Growth, 120–140% for NRR, and a gross margin of 70%.

Source: Bessemer Venture Partners

According to the T2D3 approach invented by Neeraj Agrawal, one can turn a SaaS enterprise into a billion-dollar worth enterprise in 5 years. T2D3 stands for “triple, triple, double, double, double.”

“Most entrepreneurs will be able to tell you that they define success as getting to $100 million of ARR (annual recurring revenue) and, ideally, a billion-dollar outcome,” Agrawal notes. But how do they get there? What is the appropriate level of growth for SaaS companies? And how do they allocate their company resources appropriately to make it happen? For most founders, the answers to these questions are less clear.

Stages of SaaS growth through T2D3 approach:

Stage 1: Understanding pain points to establish product-market fit
Finding a good product-market fit is usually the hardest and longest part of the journey, and requires multiple iterations to get it right.

At this stage, the ARR has not been quite determined yet, hence angel investors are taking the biggest risk, and valuation is said to be more of an “art” than “science”, where there is a heavy emphasis is placed on the credibility of the founding team.

Funding Stage: Seed Round
Valuation: USD 1–10m (ARR Multiple: 20 to 100)
Expected Dilution: 5%
Funding: USD 50-500k

Stage 2: USD1 million annual recurring revenue (ARR)
Once a good product-market fit is found, the company would need to focus on building up its initial customer base and to reach a target of USD 1 million in ARR. The focus is on quality over quantity.

Funding Stage: Pre-A
Valuation: USD 19m (Based on Median ARR Multiple: 19)
Expected Dilution: 5–10%
Funding: USD 1–2m

EV Multiple = Enterprise Value / ARR

Source: Bessemer Venture Partners

Stage 3: Triple to $3 million in ARR
The company is ready for rapid growth, and focuses on developing a stronger sales team, and can confidently increase the marketing expense.

Funding Stage: Series A
Valuation: USD 60m (Based on Median ARR Multiple: 19)

Note: Valuations outside the United States tend to be ~50% lower.

Expected Dilution: 5–10%
Funding: USD 2.5–5m

Stage 4: Tripling to $9 million ARR
Focus on securing bigger and enterprise clients.

Funding Stage: Series B
Valuation: USD 125m (Based on Median ARR Multiple: 14)
Expected Dilution: 10–15%
Funding: USD 25–37.5m

Stage 5: Double to $18 million in ARR
Begin to expand internationally, but the management team should make sure to target one region at a time. It is better to go deep in the market than go wide.

Funding Stage: Series C
Valuation: USD 250m (Based on Median ARR Multiple: 14)
Expected Dilution: 10–15%
Funding: USD 25–37.5m

Stage 6: Double to $36 million in ARR
The company needs to strengthen its marketing channels and expand into new markets internationally.

Funding Stage: Series D
Valuation: USD 430m (Based on Median ARR Multiple: 12)
Expected Dilution: 5–10%
Funding: USD 21.5–42.5m

Stage 7: Double to $72 million in ARR
Focus on preparing for M&A or IPO and continue to maintain growth rates.

Funding Stage: Series E / IPO / M&A
Valuation: USD 860m (Based on Median ARR Multiple: 12)
Expected Dilution: 5–10%
Funding: USD 43–86m

Source: Bessemer Venture Partners

This T2D3 approach is also in-line with Bessemer Venture Partners’ study on “best” and “better” SaaS companies, where they are expected to reach a USD 100m AAR in 6–7 years, at which they have attained unicorn status and are ready for an M&A or IPO.

One Last Thing
Fundraising is a tedious process but it can ultimately be very rewarding for both the founders and the investors. A key mindset for success is to regard the relationship. between the founder and investor to be more of a partnership rather than a mere transactional process.

As usual, don’t hesitate to leave a comment and reach out to me at https://www.linkedin.com/in/waynerbee/ for further inquiries.

If you find this article useful and you want to learn more. Check out my other articles at https://medium.com/@waynerbee

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VC Investor | Strategist | Entrepreneur | Connect with me at https://www.linkedin.com/in/waynerbee

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Wayne Wee

Wayne Wee

VC Investor | Strategist | Entrepreneur | Connect with me at https://www.linkedin.com/in/waynerbee

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