Écart knows that in the world of Software as a Service (SaaS), the business model is significantly different from its more traditional sectors, such as services and packaging. SaaS businesses are more financially complex and require specific Key Performance Indicators (KPIs) to measure and drive their performance.
In this industry, betting on certain KPIs also involves a different level of risk and a different way of doing business. It is important to consider this as an entrepreneur.
Financial complexity
SaaS businesses differ financially because revenue has a different dimension. Revenue comes in over a longer period of time because customers pay monthly subscription fees. The direct additional costs involved are usually lower compared to traditional businesses.
However, development costs are high in the beginning. On top of that, each new customer also requires significant commercial costs that are not immediately repaid. This therefore explains why growing SaaS businesses are often cash flow negative in the early stages and require additional capital.
Cashflow
Over time, however, the ratio of costs to revenue per customer decreases significantly. Development costs are spread across multiple customers. Moreover, the commercial costs incurred per customer are recovered over time through subscription revenue.
It makes it important to monitor cash flow closely. The consideration and decisions to spend cash in the short term to increase cash flow in the long term is crucial. This is where specific KPIs like MRR (Monthly Recurring Revenue), CAC (Customer Acquisition Costs), CLV (Customer Lifetime Value) and Churn rate (annual percentage of cancelled subscriptions) are critical.
- MRR = ∑(Number of customers per pricing plan × Monthly price per plan)
- CAC = Number of new customers / Total cost of acquisition
- CLV = Average monthly revenue per customer x Average life of a customer in months
- Churn rate = Number of customers left during a period / Total number of customers at the beginning of the period
Each KPI has its own short-term and long-term trade-offs, which come with a different level of risk.
Level of risk
For example, some prefer to go into the market aggressively and push costs significantly ahead of revenue. For example, if commercial costs and marketing expenses do not lead directly to results, this can mean that the CAC becomes relatively high with a limited MRR increase. Thereby, negative cash flow may put the business at risk in the short term. On the other hand, if the costs incurred do lead directly to revenue, it may cause the company to make a revenue growth spurt and nice results in the short term.
The other prefers to incur limited costs first and wait until he feels sure traction. With that, he will first incur limited commercial and marketing costs and see to what extent it brings in customers. Once it catches on, a higher gear can be shifted. This means less short-term risk, but does mean that the engine will start up later.
It is important to agree on a common vision for this with your possible co-founder and/or investor in advance.
Forms of entrepreneurship
After all, they are different forms of business. You often see that most investors expect high returns within a certain time horizon and are happy to take risks for that. This tactic almost always works in practice for the investor, because they have spread their risks over a large number of SaaS businesses, and only a small portion of these need to make high returns to realize good returns across the board.
However, this structure and maturity can affect you as an entrepreneur and, if you are more risk-averse, force you to take more risk. You are also more likely to promise more than you would like or actually think you can meet.
High acceleration
Investors with a long-term horizon and fewer businesses in their portfolio will make different trade-offs in terms of risk. They need to make a good return with most if not all SaaS businesses to achieve a good return across the board. Therefore, this type of investor will be more risk-averse and more patient in spending. In practice, more time will be taken to move up a gear.
We understand that the SaaS industry generally takes more risk, however, we see that experiencing precisely limited time pressure works well for SaaS businesses. Thus, Écart, together with the entrepreneur, has realized good to very high returns in the vast majority of its (ex-)participations.
