Nobody could predict that 2022 would be that challenging—the U.S. may be heading for a recession and there’s war in Europe. During such turbulent times, founders of SaaS startups should take a closer look at their spending and adapt.
Christoph Janz, co-founder and managing partner of Germany-based Point Nine Capital, has some advice. He’s one of the world’s top VCs, whose fund has invested in over 160 startups, including SaaS companies like Algolia, Automile, Contentful and Typeform.
According to Janz, there are two options entrepreneurs should consider. One is to become “default alive”, meaning that a startup should make it to profitability with its current resources. This will help become less dependent on the financial markets.
It's desirable for every company to be “default alive” and to have enough resources for at least three years.
It's not always realistic to become “default alive” and, in some cases, may lead to wrong decisions. If a company took venture debt, for example, it may not achieve the set goals.
If founders can’t or don't want to cut costs to get a “default alive” status, they could consider the second option—to become “default investable”, when their metrics are good enough to raise another round in the current situation.
When deciding to invest, VCs look at different factors—there’s never a simple formula. But founders looking to become “default investable” should keep in mind these three metrics:
and Sales Efficiency.
1. Growth rate
Christoph Janz mentioned the growth rate benchmarks from Bessemer's cloud portfolio, which is based on the numbers from hundreds of companies collected over 15-20 years.
As you can see, the bar is still pretty high. It may go down a bit because of the company’s efficiency, but it's still difficult to get VC interest if a startup is not growing fast. Investors generally look for companies that can keep growing for a long time and produce needle-moving returns for a VC portfolio.
2. Burn Multiple
Nowadays, there are various ways to track startup efficiency and benchmark it. One is the Burn Multiple formula.
Founders can use it to compare companies that are at certain levels of ARR and look at how much of the total burn it took them to get there. It gives a good sense of the overall efficiency of these businesses. As a rule of thumb, a value for this metric of about 1.5 to 2 is considered to be good; 1 to 1.5 or lower is great.
This rule of thumb applies to SaaS companies broadly in the 1 to 25 million ARR bucket. If founders are significantly smaller than that, they will most likely have a higher Burn Multiple, because, in the beginning, they just have upfront costs that don't translate into revenue. So, quickly expect this value or this metric to go down, meaning to get better and better over time.
3. Sales Efficiency
Another metric is Sales Efficiency.
Depending on the type of business, founders can choose different periods. It could be figures from a specific quarter or month.
This formula helps to measure if a company's sales and marketing efficiency are profitable. And if it should therefore do more of them or instead pull back and try to get them to a higher level of efficiency before spending more on it.
In contrast to Burn Multiple, Net New ARR is in the numerator. With this formula, founders will want the metric to be as high as possible—0.75 to 1 is generally considered good; 1.5 is great.
Drawing a chart with these metrics
Now let’s look at these metrics—Burn Multiple and Sales Efficiency—together and put them on a chart. It will help to understand the current startup position between growth and efficiency.
If a startup is in the top right corner here, then its Burn Multiple is quite low, and it has high Sales Efficiency. Such startups are in a great spot—they are “default investable”.
But a startup can also be in the bottom right of this quadrant. It means that the efficiency of its sales is good, but Burn Multiple isn’t great. In this case, founders should increase marketing costs to ramp up their sales. Meanwhile, they may want to cut other costs.
If a company is in the top left quadrant, its Burn Multiple is okay, while Sales Efficiency isn’t good enough. Its growth is driven mainly organically and marketing doesn't contribute so much. In this case, a startup should lower its sales and marketing budget and try to find more efficient ways to acquire customers. Once founders achieve that, they need to slowly increase their sales and marketing spending again and see if they can keep high efficiency.
The worst scenario is when a business is in the bottom left of the chart. A startup has a high burn rate and its marketing is inefficient. Founders should cut costs across the board and try to become “default alive”.
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