The Value of Growth for SaaS Companies

I received a report from SaaS Capital titled “Leaders and Laggards: SaaS Growth and the Cost of Capital”. The subject of the report is how the public markets value a high growth SaaS company (their definition of high growth is >25% YoY).

The report states, “13 public SaaS companies tracked by Pacific Crest Securities have increased in value 40% since the beginning of 2008. During that same period, the S&P index has yet to return to its pre-recession value.”

It goes on to say, “…not all public SaaS companies have performed equally well. To be a standout in this space, growth needs to be greater than 25% per annum, and the market opportunity needs to be significant (e.g. CRM, ERP, HCM, etc).”

They claim that growth dominates over profitability for a couple of reasons. The first is that the SaaS market is still immature with only a third of the entire software market spend. The second is that these companies have been able to demonstrate significant profitability after sales and marketing spend is cut back.

I’m not sure I necessarily buy into this last statement because I’ve yet to see any high growth SaaS companies that have cut back on their sales and marketing spend in favor of profitability. In fact, I remember a few years ago speaking with Phill Robinson, the then-current CMO of Salesforce. His comment to me was that he had not reached a point of diminishing return from his investments in Google Adwords – and Salesforce has continued to invest heavily in sales and marketing – mostly “brand” marketing v demand marketing surprisingly.

Here is the chart that SaaS Capital showed with the relative performance of each of the 13 public SaaS companies.

So, it’s true for public SaaS companies but does high growth spell high valuations for private SaaS companies?

The answer is a resounding “yes”. In fact, even more so. For fast growing private SaaS companies, valuations have recently been over the top. In the public markets, the high multiple ranges but is about 10x-12x annual revenues.

In the private markets, a high growth SaaS company with “only” a 12x multiple could be a great deal for an investor. One of the companies I looked at last year had less than $5M in revenue but the pre-money valuation of the round when it was completed was in the mid $100M range – all because its YoY growth rate and its pipeline had grown so fast and it was in a very large and addressable market.

In contrast, a low growth SaaS company is in a precarious position. The authors of the SaaS Capital report cite a private SaaS company they have been working with that generated $11M in revenues and is profitable but only growing somewhere north of 10% per annum. The company was unable to find any interested strategic investors and is hoping to get a financial buyer to pay 1.5x revenue this year. If they do, I think they should consider themselves fortunate.

So, if you want a successful outcome for your SaaS business, by defnition it needs to generate high growth. To do that, you need the capital to invest in sales and marketing. And, as I have written about in previous blogs, in a high volume SaaS model, lead generation not sales capacity, fuels growth. This is one reason why I believe we haven’t seen any leading SaaS companies emerge that haven’t been venture backed at some point to fuel growth.

So, by definition, if you’re a SaaS company it’s incumbent upon you to find marketing personnel who are experts at lead generation. I know this is one of the critical hires in each one of my SaaS portfolio companies and it is becoming increasingly more difficult to attract this highly sought after talent.

Given the importance of lead generation for the SaaS model and company valuations, I suspect over the next few years, that marketers with proven lead generation skills in the SaaS market may see base + variable compensation on the same level as sales personnel.

  • Jae

    Good article. So the key takeaway for a SaaS company is:
    1) In order to maximize my outcome (10-12x sales)
    2) I require 25% YoY
    3) To achieve this 25% growth, I need marketing folks who are experts at lead generation.

    Two questions.
    1) I am in the life science enterprise SaaS space, where there is a limited industry track record converting folks to subscriptions directly from the web. This requires employing sales software experts, who go through the traditional sales life cycle, requiring thumping the pavement for 3~6 months, to close contracts. In your article what criteria were you emphasizing when you are seeking marketing folks? People with software sales experience to generate leads or folks with online marketing experience knowledgeable in SEO, SEM, etc. Or both?

    2) Assuming the assumption of 25% YoY is valid, when seeking financial capital, how much funds should I be seeking to raise. Is it an amount that helps me achieve the 25% YoY for a 3~5 year window?

    • brucevc

      If you are dealing with a new, complex product that requires educating your prospects and has a relatively high ASP, then that will necessarily affect your marketing strategy – for example, the ratio of how much you spend on SEO/SEM v investing in physical seminars.
      SEO/SEM only works well once people are actively searching for your product or a solution to their business problem. If you are in a new area where people don’t yet know what to ask for, or aren’t looking for a solution, you need a different set of techniques to reach your target market – speaking at key events, generating thought leadership articles in business/medical journals, etc.
      Nevertheless, whatever your situation, you need to have an overall “revenue cycle” strategy. A “revenue cycle” is defined as the ‘marketing cycle + sales cycle’.
      The “marketing cycle” is the time where you should apply relatively low cost prospecting techniques such as SEO/ SEM, email marketing, events, etc. and lead nurturing such as white papers, webinars, seminars, etc. until the lead reaches a point – or score – where it is finally a “Sales Ready Lead” and moves into the “sales cycle”.
      This strategy is discussed in depth at Marketo – http://www.marketo.com .
      Only when it is a Sales Ready Lead should you “spend” your expensive “sales cycle” resources on a prospect.
      So, I am not advocating turning your scarce sales resources into “marketers”. Instead, you need people who are solely dedicated and experts in the marketing cycle. They need to know how to create demand generation programs appropriate for your products/services. That may be SEO/SEM but it could also be seminars, webinars, email marketing, etc. depending upon what your company needs for its stage and maturity.
      The amount of funds you should raise is an interesting question. On average, successful SaaS companies – a public SaaS company is by definition successful – have raised about $42M in private equity before going public. Usually, the last round before IPO is about $25M and used for global expansion with sales/marketing.
      To figure out how much capital you should raise, I would figure out your average customer acquisition costs (sales + marketing expenses, all in) and figure out how many customers you need/want to acquire before raising your next round. Add that to all your development costs and the costs to run the business. Now you have a good idea of how much money you’ll need to build your business. Don’t faint.
      You need to balance this amount against the current value of your company. You want to raise as little as possible but as much as necessary to achieve good growth milestones. As discussed, for every $1M ARR, in a high growth private SaaS business, you might get a 10x, 15x, 20x or more multiple. So, if you can get on a fast growth path, you can raise a subsequent big round at a much higher valuation and give up a lot less of your company.

  • Michael Mankowski

    Hi Bruce – Is this report for pulic consumption?

  • Gary Damiano

    Hi Bruce …

    Great article!!!!

    I’ve long believed that a measured and integrated approach to managing lead generation in its many forms (digital marketing, field marketing and direct marketing), sales opportunity qualification and sales execution capacity is mission critical to the successful outcome of a SaaS business. Too many times, the business impact of lead generation is minimized or worse, the capacity to nurture and convert leads to qualified sales opportunities is sacrificed to support increases in or in some cases, maintain an ineffective level of sales capacity.

    It’s very interesting to see an industry study that helps bring focus on the issue and impact.

  • http://www.cosential.com Dan Cornish

    So to throw a bomb here, I believe that it is possible to achieve >50% YoY growth without venture capital. The trick is keeping the CAC ratio below .5 and to bill annually, NOT monthly. Another trick is to not follow the crowd in marketing but to invent new inexpensive ways. Social marketing and leveraging word-of-mouth works really well. One of the lessons I learned from the first dot com boom is that throwing lots of money at marketing does not work in may cases.

    Another issue to look at is that venture backed SaaS companies are leaving a large pricing umbrella up which makes them vulnerable to lower cost competitors.

    • http://www.interwest.com/software-as-a-service/ Bruce Cleveland

      Actually, this is a great post. If you can start and build a successful business without any venture capital, you should do it. Venture capital is an expensive source of capital but one that can play a critical role for you as consider how to build and grow your business.

      There are a lot fewer SaaS companies that have to bill monthly at this point, now that consumers and businesses are growing more comfortable with the model. I think most can at least get a quarter’s worth of service paid in advance.

      However, if you try to grow your SaaS business organically and your competitor takes down a $10-$20m venture round for growth, you are in a very precarious position.

      I have been a member of 3 non venture backed startups – Oracle, Siebel and my own. Each worked out fairly well. However, I think these are the exceptions. I would encourage any entrepreneur to look at capital as a tool and use the appropriate form as needed. This could be angel, venture, bank, etc and will change as the stage of the company changes.

      Sent from my iPad

  • http://twitter.com/BeverlyMurray BeverlyMurray

    Excellent article, Bruce. Spot-on observation regarding the role marketing, and thereby brand, plays in achieving productive momentum for a SaaS entity. As companies are seeking marketing leadership, staff and agency, it is of paramount importance that your marketing team not only exhibits, but is also granted, a seat at the leadership table. Our most successful engagements have not been derived from the greatest spend, but rather the greatest access. Understanding investment expectations, sales resources, revenue opportunities and the business plan strengthens our ability as an agency to develop and execute productive strategies to meet agreed-upon milestones.

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  • Naveedsy

    This is a very informative article on what needs to be done to see growth in SaaS companies. Of course as others mention that when you have great marketing leadership it definetly helps the growth of the company in the market.

  • Tradermaj1

    Hi Bruce,  Are you adding back deferred revenue to calculate your price to sales multiple? I did some  research and found that two SAAS companies (Unica and Aprimo) were acquired for much less than 12 times revenue. I am attempting to value ELOQ.

    Michael

    • http://www.interwest.com/software-as-a-service/ Bruce Cleveland

      Not all SaaS companies are created equal. Unica and Aprimo are relatively low growth which is why they didnt enjoy a premium on their multiple. SaaS companies such as CornerstoneOnDemand, Workday, and others with YoY growth rates that exceed 40% with a forecast that shows that the next twelve months growth rate will be at or above 40%, enjoy a multiple premium. Eloqua has only been growing around 25% YoY which is why its multiple isnt nearly a high as the ‘hyper’ growth SaaS companies.

      • Tradermaj1

        Thanks. When running the comps should I add back deferred revenue to calculate my price to sales and EV to sales multiples?  Should I also be using operating cash flow multiples? It seems that P/E would not be a good data point..

        Michael