How To Have Growth AND Profits? — part1

We will focus on the way to have growth and profits in transactional models (transactions-based business such as e-commerce or marketplace or subscription-based business such as SaaS) in part one.

Transactional models have a really great specificity for shareholders: user growth is correlated with revenue growth all things being equal. So here the tradeoff is not between growth and revenue but between growth and dividends (think of Amazon).

So this makes assessment easier than in non-transactional models one’s transaction-based firm’s financial potential, because monetization is at the core of their business.

How to measure growth and profits in transactional models

In transactional models, the best way to look at your growth is to always make sure that your MAU quick ratio* = (new MAU + resurrected MAU)/churned MAU) > 1.5 (good is > 2, great >4). If the MAU quick ratio is superior to 1, it indicates that your service is growing (otherwise each period you loose some users). This is done through a good retention rate and/or a fast enough acquisition rate (and reactivation rate).

Then if your MAU are growing, you just need to make sure they pay at least the same amount of money. Even better: grow your user AND the average price paid per user.

If we become more precise and give an overall dashboard, with growth AND profits, let’s say that you need to watch for:

The quick ratio, when you mix users and revenue, becomes :
(new + expansion + resurrected) / (cancelled + contraction).
As a rule of thumb, VCs from Social Capital are looking for Saas Companies with a MRR quick ratio > 4..

This accounting method a great way to monitor one’s growth, but it is not granular enough. You can’t know if your first users are still active or if churn occurs at some point (like 2 months after signing up). To answer these questions you need to make cohort analyses.

We won’t go into too much details here, you have lots of wonderful resources to do so when you have data to analysis (look for “SaaS analytics”, “cohorts analysis”, LTV, CAC, PP, etc.)

Growth and Profits: some formulas & benchmark

I personally really enjoy having the different approaches and graphs described in this wonderful serie of article by Jonathan Hsu (cohorts & revenue, cohorts & engagement, depth of engagement & quality of revenue).
Let’s just share some benchmarks. Numerous VCs and entrepreneurs, such as A16Z or Redpoint (this post shares interesting tips to make hypothesis on the future and estimate Expected Lifetime Value and Expected Payback Period), consider healthy to have:

Life Time Value > 3x CAC (and a payback period

And keep in mind that it is not always obvious that famous tech startups have a LTV above 3x CAC, as highlighted by Abhas Gupta from WildCat -note that it is highly dependent on hypothesis on lifespan, ARPU, contribution margin, CAC etc.)

Others, like Brad Feld consider healthy to have:
(growth rate + profits rate) >= 40%, meaning that if you grow at 60% MoM your profit can be down to -20% but if you grow at only 5%, your profit should be at least +35%.

Lastly, experts like Neeraj Agrawal assert that a good launch should follow the rule of T2D3: once you’ve reached $2M of Monthly Recurring Revenue, your annualized revenue growth should be x3 (reaching $6M), then double three time Year on Year (thus reaching $36M, $72M, $144M).

The rational belief behind, as pointed out by Christoph Janz of Point9, is that most of VC-backable startups should aim for at least $100M annual recurring revenue, which can make them an independant long time business. (Lots of investors assert that $100M is the indicator that a company is ready for IPO, a rule of thumb that is questionable.)

Now that we have good ratios in mind to reconcile growth and profits for transactional business, the question remains about all the other business models where monetization comes late.
Let’s dig into that in the next post.

* MAU quick ratio = (new MAU + resurrected MAU)/churned MAU)
** MRR quick ratio = (new + expansion + resurrected) / (cancelled + contraction)

Want to know more about startup funding? Read our articles:

Part 1 — Startup Funding: Growth Is The Only Way
Part 2 — The Jedi Trick: You Have to Choose Between Growth And Profits
Part 3 — If Growth Was Easy To Forecast, There Would Be Only One VC fund: Nostradamus Partners
Part 4 — You Need to Lose Money, But Some Loss Are A Really Bad Idea
Part 5 — How To Have Growth AND Profits? (Part1: Transactional models)
Part 6 — How To Have Growth AND Profits? (Part2: Non-Transactional Models)
Part 7 — What About Valuation For Late Stage Startups?
Part 8 — Fail Often, Fail Fast. Investors Do Half of That
Part 9 — What daphni will not invest in
Reminder: daphni investment thesis