Finance & Operations

Introducing OpenView’s Expansion SaaS Benchmarks Data Explorer

September 23, 2019

We’re living in a remarkable era for investing. Particularly within the SaaS world, where the allure of high returns in the private markets has resulted in all-time funding records due to the rise of the megaround, Softbank’s Vision Fund, and more. In this world, where top assets are scarce and capital is plentiful, double digit revenue multiples have become the norm and it isn’t unusual to see some SaaS companies achieve valuations approaching 30x their revenue.

The most popular visualization of SaaS valuation data has revenue multiple plotted against growth (see the left-hand chart below). The correlation is undeniably strong at nearly 0.7. High growth means high valuation, so growth is all that matters – and that is where most folks stop.

However, when we look “under the hood” (the metrics supporting growth) of public SaaS companies (see the right-hand chart below), we find that just 7 (one in ten) public SaaS companies will generate substantial negative profit margins this year. The other 58 are either profitable or could generate profit in a quarter or two if the conditions necessitated. Said another way, public SaaS growth rates are rewarded because they’re supported by strong underlying efficiency metrics paving a clear road to profitability.

Efficient growth – the balance of growth and strong efficiency metrics, creates value.

So then why has the axiom of growth at all costs persisted for so long?

Growth at All Costs

Chamath Palihapitiya (CEO of Social Capital) described growth at all costs in his 2018 Shareholder Letter:

In an internet-connected world, several kinds of businesses – platforms, marketplaces, aggregators, and social networks, to name a few – stand to become enormously valuable and profitable should they reach a certain critical mass. There’s a reflexivity to these network-based businesses. They reason, “as we become large, our product will become better and our business more valuable. Therefore, we should spend money to become large. We’ll obtain that money by raising equity at a high valuation, which is justified by how large and valuable we will become once we spend the money.” Warren Buffett once observed that this kind of arms race is not unlike a parade where one spectator, determined to get a better view, stands on their tiptoes. It works well initially until everyone else does the same. Then, the taxing effort of standing on your toes becomes table stakes to be able to see anything at all.

In the decade or so since the 2008 financial crisis, the market’s demand for returns has enabled a risk-on mentality to permeate, driving the majority of investors and operators to believe that the phenomena described by Palihapitiya is the only way to achieve success in tech. However, the resurgence of global macroeconomic volatility is finally creating skeptics. We don’t have to look much further than the reaction to WeWork’s planned IPO for a case study in why growth at all costs shouldn’t be and isn’t the be all end all. While in theory WeWork is a perfect candidate for this strategy, the company has hit major setbacks in convincing the broader public markets of this (governance issues aside), proving there is a limit to how far one can push growth.

How to Avoid Growth at All Costs

Enduring business (think Cisco, GE, Walmart) must demonstrate the ability to repeatedly generate predictable earnings – turning the massive revenue scale they’ve achieved into shareholder returns (via share price expansion and dividends). Even for high-growth, venture-backed companies it is imperative to give investors permission to believe that repeatable, predictable earnings are eventually possible via efficient growth (particularly given the macroclimate). While in some cases it’s painfully obvious a business won’t ever generate earnings (yes, we’re looking at WeWork again), typically it isn’t so black and white.

Benchmarks are the only check on whether or not a business is generating efficient growth. Benchmarks act as a swim lane for operating a business and allow operators to build a hyper-growth business that provide permission to believe.

How Do I Know What My Benchmarks Are?

The right benchmarks for any business are those that compare against your exact peers – companies of similar ARR scale selling the same type of software to the same customers. If you want to get more precise, you can also compare based on ARR growth rates and the use of GTM strategies like product led growth. Our 2019 Expansion SaaS Benchmarks survey collected data from 500+ companies on growth, efficiency, profitability, and more. While our detailed report visualizes the key data operators need to compare across the metrics that matter most, readers have historically been limited to what we publish – until now. To solve this challenge, we launched our Expansion SaaS Benchmarks Data Explorer as part of our 2019 Expansion SaaS Benchmarks report.

To leverage this data explorer most effectively and find your exact peer benchmarks, follow these five steps:

  1. ARR: select your current or expected year-end ARR scale
  2. YoY Growth Rate: if you want to limit data to just the fastest growers, set limits here
  3. Target Customer Size: select the profile of your ideal customer
  4. Software Category: finally, select your software category (e.g. Horizontal)
  5. Product Led Growth: to visualize data for PLG vs. non-PLG companies, use this toggle

Voila! You have your peer benchmark set. How do you turn them into insight?

Value Driver Framework

As you can tell from the data explorer, we focus on six key metrics as part of a Value Driver Framework at OpenView. The metrics we’ve included in our framework include:

      • ARR Growth: Change in annual recurring revenue between two periods (i.e. at the end of 2018 vs. 2017). Expressed as a percentage.
      • Gross Margin: Gross profit on total GAAP revenue in a period, expressed as a percentage.
      • Monthly Operating Cash Burn Rate: Net monthly operating cash burn rate, often expressed as a trailing 12 or trailing 3-month average.
      • CAC Payback: Months of subscription gross margin to recover the fully loaded cost of acquiring a customer. Expressed in months.
      • Net Dollar Retention: Annual net dollar retention (after churn, upsells & expansion) seen in cohorts. Expressed as a percentage.
      • Logo Retention: Annual logo retention seen in cohorts. Expressed as a percentage.

By benchmarking private company Value Drivers versus peers per the above, we can understand a company’s trajectory and gain conviction in the potential for continued value creation (below). Again, growth is not the sole driver of the valuation for SaaS businesses – gross margin, burn rate, and efficiency metrics such as burn, CAC Payback, and retention are critical; therefore, exiting the benchmark “swim lane” in these Value Driver metrics meaningfully influences valuation.

Value Driver metrics viewed in the isolation of just a particular month or year won’t be helpful, the long term trend is critical, so here are a few tips to get you started:

Track from Day 1

Start tracking each Value Driver monthly as early in the game as you can. Numbers will be skewed in the early days because you won’t yet be operating at scale, but even then you will benefit from keeping your target metrics and peer benchmarks in sight and you’ll begin to create a data-driven culture.

Explore the Inputs

Tracking from early on also gives you the greatest opportunity to understand the inputs to each Value Driver in excruciating detail. By measuring and investigating fluctuations in the metrics (i.e. growth slowed, the cause was a decline in net dollar retention, this happened because of execution issues with our team that handles renewals), you’ll start to understand the underlying inputs more thoroughly and also get a better sense for how these metrics work together in your business.

Stay In Your Swim Lane

Assuming you understand these inputs, you can then act appropriately, but only if you know what your proper “swim lane” is! If you’re growing faster than the median but burning more and far less efficient, do a deep dive back into the key inputs. Perhaps you need to adjust sales compensation, maybe the top of your funnel needs tweaks or maybe you’re not pricing correctly.

Why These Metrics?

Rules of thumb like the “Rule of 40” or LTV:CAC guidance of 3-5 are just that – rules of thumb. Both metrics abstract away from the inputs that matter and don’t tell you exactly what is happening to your revenue, expenses and customers. Why not “Rule of 10, 20, or 30?” Why not LTV:CAC of 5, 6 or 7? Both of these measures are the outputs of the Value Driver inputs. Instead of seeing a drop in LTV and having to investigate whether this was due to CAC, retention, or both, our framework goes straight to the source. The Value Driver metrics provide direct insight into what’s happening and produce immediately actionable insight.

Don’t Forget About Growth Completely

To be clear, we aren’t advocating that all businesses take their foot off the gas and turn cash flow positive tomorrow, rather an alternative: efficient growth. Efficient growth requires that all phases of a company’s lifecycle demonstrate the potential to eventually become a large and enduring business like Cisco, GE, or Walmart. While admittedly there have been companies that have achieved great success, delivered incredible shareholder value, and made a positive global impact in pursuit of growth at all costs, only time will tell if these companies can become truly generational or if they will soon crumble under the weight of their capital needs (#webankrupt). As the alarm bells for recession sound louder and louder, there is no time like the present to embrace an efficient growth philosophy.

Vice President

Sean leads Corporate Development as Vice President for OpenView. Since joining OpenView in 2018, Sean has led the firm’s Proactive Portfolio Management function and also acted as director of corporate development, supporting the portfolio on inorganic and balance-sheet-related initiatives. During that time, he released four versions of OpenView’s SaaS Benchmarks reports, supported on numerous follow-on equity investments, M&A transactions, and venture debt raises with OpenView’s portfolio.