Investor: “How did Q1 go?” “Where are you now?”
SaaS Entrepreneur: “We booked/billed/collected…”
Investor: “Was it TCV or ACV?”
SaaS Entrepreneur: “We grew 100%”
Investor: “Was it MoM? YoY? QoQ? ARR? Logos?”
SaaS Entrepreneur: “We just hit $1M!!!”
Investor: “MRR/ARR/CARR/recognized revenue/deferred revenue?”
The calculations and definitions of SaaS businesses are fairly standardized, but the format of the data exchanged and reported on is all over the map. Having spent five years in the VC industry and seeing pretty much every variation of an up and to the right ARR chart out there (and down and to the right), I’ve decided to post my preferred format. Ideally this will prove helpful for startups and investors often juggling terminology and answering the question: “How did you do in Q1?”
#3: The Waterfall
Most of the industry uses a form of this waterfall, often reported through various charts, but because of the recurring nature of SaaS, it’s often tough to tell how well the company is actually growing. The idea of the waterfall is to get a picture of where you were at the start of the period measured, and the ups and downs your ARR took over that period, eventually landing at your Ending ARR.
The Ending ARR can be thought of similar to a balance sheet — “At this moment in time what is our ARR?”. The New, Expansion, Contraction and Churn ARR are all flow metrics, money is coming in and out over that period, while Starting and Ending ARR are point in time.
*Note this waterfall works for any given period, typically reported monthly for $0-$2M ARR businesses or quarterly for ~$2M+ ARR businesses. Whether it is tracked via MRR or ARR doesn’t matter, if you sign annual ARR deals, simply spread them monthly across the contract length.
#2: Net ARR Added
The reason for painstakingly building up to the waterfall is to evaluate what the Net ARR Added (NAA) is for that period. This change in ARR is a net figure because it incorporates ARR from New Customers, Expansion, Contraction and Churn. While this is simplistic, it completely removes the frankly brutal battle between “bookings”, “billings”, “New TCV”, “New ACV”, and breaking out one-time services. The difference from one period to another (quarter-to-quarter) is the NAA — if you started the period at $1M ARR and ended at $1.5M you added $500k in NAA.
So why do we care? The Net ARR Added is a core metric for running the business and best to be tracked right out of the gates. For early stage companies it is critical to know “when to put your foot on the gas”. If you can add $300k-$500k in new (diversified) ARR in a quarter, you likely have product market fit, assuming reasonable sales and marketing spend. If you can add $1M-$2M you’ve found go-to-market fit (even if 100% inbound) and there is real pull in the market — time for a VP of Sales and be thinking very seriously about a CFO to operationalize your growth plan.
For later stage companies, comparing your NAA to sales and marketing spend can be a good indicator if those investments are paying off. Taking the public SaaS company New Relic as an example:
*Note ARR here is calculated by annualizing the change in New Relic’s quarterly GAAP revenue as a proxy for ARR. This data was collected from SEC filings.
By using this proxy for ARR, it appears that New Relic has been roughly flat in their Net ARR Added over the past almost 10 quarters. There are exceptions in there and the trend may be picking up. Additionally, sales and marketing spend for each quarter has been steadily increasing. What are the takeaways? The company’s top line growth % will be decreasing as a result, and they are becoming less efficient with their sales & marketing dollars, or making investments that may be taking years to pay off.
#1: The Spreadsheet
The fact of the matter is it always comes back to the spreadsheet. Every startup has this spreadsheet in some form or another, but if not tracked well, it can make the waterfall and Net ARR Added calculation difficult.
…and the list of customers goes on and on (hopefully).
It doesn’t matter here if Customer #1 is paying month to month or annually, as this rolls up into the waterfall, it is best to spread the annual deals across the contracted time period, because expansion, contraction and churn can all happen within that period.
So where from here? This is just the start. This ARR spreadsheet is often a good place to track high level usage data, the pay tier or plan the customer is on and if they pay you monthly or annually. Additionally, the waterfall is really just the starting place for your SaaS calculations around ASP, magic number, and churn.
Investor: “How did Q1 go?” “Where are you now?”
SaaS Entrepreneur: “Our Net ARR Added was $400k!” “We now sit at $1.5M ARR.”
Looking for more SaaS guidance? Here’s a list of some of my favorite sources:
Tomasz Tunguz — Tomasz Tunguz
For Entrepreneurs, SaaS Metrics — David Skok
The Angel VC — Christoph Janz
From Impossible to Inevitable — Aaron Ross & Jason Lemkin
T2D3 — Neeraj Agrawal
Blueprints for a SaaS Sales Org — Jacco vanderKooij
— Reid Christian
