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Is the pace of software M&A increasing again?



Top 10 Laws for Being ‘SaaS-y’

By Byron Deeter, Partner, Bessemer Venture Partners

Running an on-demand company means abandoning many of the long-held tenets of software management and adhering to these new principles.

In the emerging sector of Software as a Service, one of the biggest challenges for many of the top CEOs is the lack of successful role-model businesses. There are still only a handful of public pure-play SaaS businesses, and thus the body of ‘best practices’ is very limited. Ironically, on top of this, one of the hardest things veteran software CEOs have to do when they start to run a SaaS company is to forget much of what they know about running a software company.

As we worked with our SaaS portfolio companies, it became apparent that savvy SaaS companies were following a new set of rules – most of which didn’t apply in the traditional software world, and many of which they were making up in real-time. We then set out to capture the new ‘best practices’ of the on-demand model.

To pull these insights together, Bessemer studied over a hundred SaaS companies – both pure-plays and hybrids – and recently hosted an invitation-only SaaS CEO Summit to compare perspectives and discuss the findings. Many of the insights gained during this research and these discussions are condensed into the following list of ten new ‘laws,’ which help govern the success of SaaS companies.
  1. Your Key Business Metrics Are: CMRR (Contracted Monthly Recurring Revenue) and Cash – ‘Bookings’ Are for Suckers.
    All insightful, experienced software executives know that there is a single critical metric by which the health of a growth-software business can be judged: ‘Bookings.’ However, in the SaaS world, ‘bookings’ is ambiguous at best and often very misleading. A simple example would be if Customer A signs a one-year deal at $10,000 per month, and Customer B signs a three-year deal at $5,000 per month. The traditional metric of Bookings would value Customer A at $120,000 and Customer B at $180,000, despite the fact that any good SaaS CEO knows that Customer A is much more valuable to the business as they will likely generate $360,000 of revenue for the business with renewals over that same three year period.

    To achieve better business visibility, top-performing SaaS companies have begun to focus on Monthly Recurring Revenue instead of bookings. We recommend companies actually take this a step further and keep a forward view of ‘contracted’ monthly recurring revenue net of the expected churn. This metric, Contracted Monthly Recurring Revenue (CMRR), is the single most important metric for a SaaS business to monitor as the change in CMRR provides the clearest visibility into the health of any SaaS business.

    Visibility into the current cash position and the change in the cash position has always been important for software executives, but is even more critical for SaaS businesses because the working capital requirements are higher and the payment terms are much longer. Given the high cost of capital for private SaaS companies, wise executives will often offer slight MRR discounts to customers in exchange for quarterly or annual pre-payment terms.

    A third metric to watch is customer churn, which is embedded into our CMRR metric at the top level but should also be tracked in deep detail by the management team. SaaS companies have to remember the ‘Service’ in ‘Software-as-a-Service.’ It’s very difficult and expensive to grow subscription businesses if you have moderate customer churn, and prohibitive, if your churn is high. The top performing SaaS companies typically achieve annual renewals on a customer count basis above 90% (much of which is often due to bankruptcies, acquisitions, and other events beyond the company’s control), and over 100% renewals on a dollar value basis due to up-sells into this installed base.

    We believe in these metrics as SaaS value drivers so strongly, that like to see executive teams tie their annual bonuses directly these metrics almost exclusively.

  2. It Takes At Least $300K of CMRR to Climb the Sales Learning Curve – Stop at Three Sales Reps until At Least Two of Them Are Making $100K MRR Quotas.
    Years ago, Bessemer was fortunate to invest behind Mark Leslie at Veritas and as a result our firm became big believers in a concept Mark helped pioneer around the Sales Learning Curve (SLC). The core concept is that software organizations often fail because they staff up their sales efforts too quickly and make them too large before the sales model has been refined.

    The SLC worked well in the traditional enterprise software business and works well for the SaaS model – with a few key modifications. To understand when the business has started to climb the sales learning curve and is in a position to hire more reps profitably, you have to think in terms of CMRR instead of bookings. You know you can profitably scale sales when a couple of sales reps are at an annualized run rate to sign annual contract values (MRR x 12 months) equal to twice their fully-burdened cost of sales. For a direct, enterprise sales business model, this is likely to be $80,000 – 100,000 MRR (approx. $1 – 1.2M annualized), and for tele-sales models, this may scale down to $60,000 – $75,000 MRR ($720,000 – $900,000 annualized). It is usually time to accelerate sales hiring when at least two out of three sales reps are hitting quotas at these numbers, and the business has at least $300,000 of CMRR.

  3. Separate Your ‘Hunters’ and ‘Farmers’ – As Soon As You’ve Climbed the Sales Learning Curve, Begin Ramping Your Sales Force by Hiring Renewal-Oriented Account Managers. Keep the Hunters Moving, and Let Farmers Tend to the Crops.
    When a SaaS company starts to hit the sales inflection point, it is important to keep the new business reps (the ‘hunters’) busy with finding new deals, while a team of account managers (the ‘farmers’) tends the established customers. CMRR is a function of new sales net of churn from your existing accounts, so you should have dedicated experts for each of these two revenue groups as soon as is practically possible. Once a company has a few sales reps achieving quota and a significant customer base, it is time to hire dedicated account management experts who are compensated to focus exclusively on customer service, renewals and upsells. These farmers should be compensated on the net change in CMRR among their installed base accounts.

  4. It’s a Whole New Ecosystem – Channels Are Very Hard for SaaS Companies to Build, So Don’t Base Your Plan on SIs and Traditional ISVs. You Will Need to Sell Directly for a Long Time.
    SaaS products, by their nature, don’t require massive amounts of systems integration (SI) work to implement, so they’re not a great fit with the traditional SI business model. They don’t pull through large stacks of hardware boxes and software licenses so they’re not very attractive to traditional independent software vendor (ISV) partners either. Channel relationships are very hard for any small company to establish, but even more difficult for most SaaS companies given the restricted value proposition to the SI and ISV community.

    Unfortunately, many software executives have spent years building deep relationships with executives at the major software and integration companies like IBM, Oracle, HP, and Accenture…only to find they aren’t much help to SaaS businesses.

    Most SaaS businesses have to be comfortable with the fact that they will live or die by their ability to sell directly, and only if they are successful alone will they be able to build meaningful channel relationships with the new generation of partners and resellers. In the interim, many SaaS businesses focus on joint sales and marketing activities with the emerging SaaS incumbents (Salesforce.com, Webex, etc.) and the new generation of smaller, more nimble and SaaS-savvy SI firms.

  5. Stay Local – Prove Your Business in North America First. Only After Reaching $1M in CMRR Should You Consider Hiring European Sales and Services Execs behind Customer Demand. Save Asia for Post-IPO.
    Almost all businesses will look to go global at some point if they continue to grow. But SaaS vendors face more barriers to globalization than traditional software companies because you can’t just localize the UI and ship a new CD to some remote country. Given the different architecture and high service-level expectations in the SaaS industry, companies are faced with questions about latency, data access and security through replicated local datacenters, in-country customer support personnel, packaged integration with other regional software and SaaS products, and other similar issues.

    Simply put, North America is a massive market with a rising tide around SaaS. There is no need to go global early and force this cost and complexity upon your organization. A rough rule of thumb is that you should look to pass $1M CMRR ($12M annualized) before even considering Europe, and even then you should let customer deals pull you into the region as you incrementally hire sales and services professionals. Unless you have some extremely unfair advantage in Asia, wait until Europe is a clear home run before even considering opening up a sales war on another front. Your default position should be to consider Europe as your pre-IPO growth story, and Asia only after you’re a high-flying public company.

  6. One Datacenter – Invest Early in Backup and Disaster Recovery, but Stick to One Data Center, At Least until Well After IPO.
    SaaS companies have this debate all the time, and yet the recent data is pretty clear: Most SaaS companies can get by with a single datacenter in North America until well past their IPO. In fact, Salesforce.com is approaching $1billion in revenue and just recently announced plans for additional datacenters.

    Data centers are extremely expensive and create significant organizational complexity on every level. Many of the historical issues around data backup, disaster recovery, and global application latency that caused companies to add a second datacenter can also now be better addressed in other ways.

  7. Single Instance, Multi-Tenant – Have Only One Version of the Code in Production. Really. ‘Just Say No’ to On-Premise Deployments.
    This is a guiding architectural principle for best-of-breed SaaS companies. The notion of multi-instance, single tenant situation only applies to legacy software companies moving to a dedicated hosting model because they don’t have the luxury of an architectural re-design. It is possible to use virtualization to provide multiple instances, but this hybrid strategy is very inferior for the organization. If designing a SaaS product out of the gate, the best situation is single instance, multi-tenant. It is a hard and fast law that shouldn’t be debated. Any CTO who thinks otherwise (for a conventional use-case) should be fired.

  8. By Definition, Your Sales Prospects Are Online – Savvy Online Marketing is a Core Competence (Sometimes the Only One) of Every Successful SaaS Business.
    You sell a product that requires an Internet connection and a web browser for access, which means your prospects are online! Numerous studies show that your customers are now doing most of their primary research online. You should therefore be aggressive in marketing to them online.

    This is a clear example where business-to-business (B2B) marketers need to learn from their business-to-consumer (B2C) counterparts. The most innovative B2C companies are lead generation machines, leveraging search engine optimization (SEO), viral marketing, and other technically advanced methods. Yet many B2B companies don’t have a clue.

    The incumbent technology leaders like IBM, Oracle, or SAP, have done very little with regard to marketing automation, search engine optimization, search engine marketing, email marketing or viral marketing. Private SaaS companies have so many disadvantages against the larger incumbent vendors that it is imperative for them to exploit this potential advantage. Whether they use an automated product like Eloqua (as is the case with almost a dozen of our companies) or a team of marketing analysts and spreadsheets, online marketing is simply a must for SaaS companies.

  9. Constantly trade off cash vs. Growth – If You Must Replenish Supplies While Still Crossing the Desert, Optimize Your Growth Rate (Sales Rep Recruitment and Marketing Spending) So That You Maximize Your Recurring Revenue Run Rate When You Need to Fundraise Next.
    There’s no denying that the cash flow characteristics of a SaaS business are wonderful in the long term, but lousy in the short term. The traditional software model with $1 million licensed software and ‘net 60’ payment terms presents a far rosier cash flow picture than monthly subscription streams of $5,000 – $50,000. This means SaaS companies must have impeccable financial stewardship.

    As a business, it is critical to weigh forward investments carefully. SaaS businesses typically require multiple rounds of investment and a good amount of capital.

    Top execs must optimize functions around CMRR metrics – the basis for subsequent valuations. If you are planning to raise more funds in nine months, you need to invest in areas that will produce measurable CMRR returns within that nine-month window and often hold back on longer-term initiatives.

  10. Be Prepared to Cross the Desert – SaaS Requires R&D and Sales Expense Up Front for a Multi-Year Stream of Revenue, So It Demands Enough Investment Capital to Fund 4+ Years of Runway. Load Up for the Long Trip and Pace Your Consumption of Calories!
    SaaS businesses provide wonderful visibility and predictability at scale, but take lots of time and capital to get to cash flow breakeven over several rounds of fundraising. There are many good SaaS startups that stepped on the gas too early and were wiped out as a result. Always model the business with a comfortable cash cushion and recognize that most SaaS businesses actually consume more short-term cash if you start growing faster.

Bonus Law: You Can Ignore One of These Rules, but Not More – Great Companies Innovate, but Pick Your Battles
You might be reading this and saying to yourself, “Well, our sales model doesn’t match these laws, but I’m sticking with it anyway….” To which we would say, “Go for it!” Nothing is absolute, and we certainly believe it is possible to ignore one of these core tenets and still succeed. Maybe it’s about the ecosystem; maybe it’s the datacenter. Whatever that one exception is – great! We welcome it. Many of our most successful companies historically were able to run against one well-established business principle and exploit this difference successfully.

However, if you find yourself questioning several of these Ten Laws, then it’s probably time to step back and take a hard look at your business. As a former SaaS CEO myself and a current SaaS investor, I have learned the hard way that much of the battle is just learning from the mistakes of those who went before you. In our analysis of more than a hundred SaaS businesses, we encountered several successful companies that were on the borderline with one or two of these laws each, but none that challenged several of them. We hope that these laws can help you run your SaaS business more effectively, and we always welcome new insights in these or related areas.

Byron Deeter is Partner at Bessemer Venture Partners, a top-tier international venture capital firm with 8 offices worldwide and over $2B of assets under management. He was previously the founding CEO of a Software-as-a-Service business (Trigo Technologies) that was acquired by IBM in 2004, and currently sits on the board of a half-dozen companies, including three pure SaaS companies: Eloqua, Cornerstone OnDemand, and Retail Solutions. For article feedback, contact Byron at byron@bvp.com 

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