At BuildGroup, our permanent capital approach means that we can hold investments in companies until they have unlocked their full potential, without the need to liquidate our positions due to fund timing. What this means for you is that when we invest in your business, we are in until YOU decide it’s time to sell. We want to be your long-term partner.
Given this long-term focus, we have become obsessive about customer churn. High levels of customer defections and downgrades can quickly kill a company. And this is especially tough in companies that mostly sell to SMB accounts. I call this the SMB “churn vampire,” and it has haunted my dreams for years.
And it’s not the sharp teeth or confusing attire that scares me. It’s the way vampires do math.
Say you have a company with $1 million in ARR, and your unsinkable sales and marketing team knows how to add $1 million in new ARR each year. And assume you have about 25% ARR churn each year, about average for an SMB-focused software company. Over the next year, you will add $750K net ARR to the business, accounting for both new revenue and churn. 75% growth is pretty good, right?
Now, let’s say you are at $5 million ARR, and that same awesome sales and marketing team can still add $1 million new ARR. At the same rate of churn, your net ARR will be -$250K, because you can expect $1.25 million of ARR churn each year before your sales and marketing team team holds their annual b̶o̶o̶n̶d̶o̶g̶g̶l̶e̶ ̶ all-hands strategic planning kickoff.
In fact, in this scenario, your sales and marketing crew has to sail 25% faster just to stay even with churn. Even worse, you are trading cash-creating install base revenue for cash-consuming new customer acquisition revenue.
Now, it’s common knowledge that when a vampire bites a person, they live forever. But as vampire math indicates, getting the lifeblood sucked out of your business will only feel like it.
So how do stay ahead of the churn vampire? Let me introduce you to a big wooden stake: the mid-market. With a small account, typically the first sale into that account equals 100% of their “wallet” (the total amount they can spend on your products). They may love you and give you all their business, but there is nothing more to get — the best that can happen is they don’t leave. Even if they refer other customers, those tend to be small accounts.
In a mid-market account, the first sale might only represent 10% of their wallet, leaving you plenty of room to expand in that customer. There’s usually a person in that company called your champion, and they tell everyone else about the big problems you’re solving, so then they call you and buy more.
The resulting account expansion can offset any ARR loss from accounts that leave you. If you can achieve negative net churn, when ARR from growing accounts more than offsets churning accounts, you avoid inviting the churn vampire into your house. (Apparently, vampires can’t come in unless they are invited…)
In another post, I’ll cover another similar topic: “The growth of growth equals growth.”
We hope this is helpful stuff!