Annual Contracts: Maybe Not All They Are Cracked Up To Be

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  • Annual deal collections can be tough for start-ups. Bigger companies are good at this, but if you aren’t, you may not get the benefits of an annual contract if it takes you 4–6 months to actually collect the cash. Annual contracts require P.O., bills, “payment terms”, and often, repeated follow-up. Most start-ups don’t have a good enough finance person or firm to be good at collections. Forcing your sales team to do collections is OK in the early days, but doesn’t work perfectly either, and doesn’t scale. Monthly invoices can make things even worse, of course. But getting paid in a simple ACH or credit card payment each month can be magical.
  • Annual deals can create unnecessary customer friction. Big customers will want to pay annually. So for sure, do that. It’s how their procurement departments work. But if you have an incentive structure where even SMBs are pushed to go annual … best case, that will add friction to your sales process. Is it worth it? I’m not sure. Let SMBs pick annual or monthly, at least as an experiment. You’ll see what they really prefer. 25%+ of Zoom’s customers still pick month-to-month, even today. More here.
  • Annual deals get sent to legal for review, procurement for negotiation, etc. This makes sense for a $250k+ deal. But for a smaller deal, you are again just making it harder on the customer and slowing down the close. The odds if a deal gets sent to legal that it closes the same month are close to zero. This always at least takes weeks. Avoid it if you can.
  • Annual deals, done wrong, can create unnecessary (and even more importantly, perpetual) discounting. You almost always have to provide a 10%-20% discount to incent annual deals. Is it worth it? Maybe not as the account grows over time. In Years 2, 3 and 10, you may wish you had that discount back when you have to honor it, one way or another, in the renewal. You are robbing a bit of a long-term revenue stream if your over-discount to get an annual deal done now. This can compound with multi-year deals. If you tell a loyal customer in Year 2 you are taking away their discount … expect that loyalty to evaporate.
  • Annual deals mask churn. This can be bad, not good. You may like annual deals for a second reason — they take a year to churn. But that’s not really true. It’s only true in your financial statements and your numbers. But if a customer never renews in SaaS, or if they stop using your product even if they’ve already paid for it for the year, it’s basically like they never really existed at all. A customer you lose next year doesn’t help you at all to get to $10, $20m, $100m in recurring revenue. A deal has to recur or in the medium and long run, otherwise it just doesn’t matter. Worse, it may mask weak efforts in customer success and retention efforts, and disincent you to track and grow NPS early.
  • Annual deals are a tough fit with many API services and variable-usage services. It’s often better with variable revenue to move to an annual contract later in many cases, a few months later or even at renewal. But forcing customers to estimate variable usage before they are even in production, best case, again adds friction to a sales process. Is it worth it? I’d argue — rarely.



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Jason M. Lemkin

SaaStr. Pre-nicorn VC. Co-Founder CEO of EchoSign. Served as VP, Web Biz Svcs at Adobe. Also built nanobatteries implanted inside your body.