David Spitz, Managing Director at Pacific Crest Securities: Measure Your Success: Tell Your Story Using SaaS Metrics (Video + Transcript)


SaaS metrics, such as LTV and CAC, are key to telling your story. Unit economics are destiny, however, you need to be careful. Don’t use convenient metrics just so your company looks good on paper; you’ll end up believing your own BS.

David Spitz, Managing Director at Pacific Crest Securities, takes the Hypertactical Stage to discuss how to use metrics to better run your business. As someone who’s been involved in many premier SaaS IPOs, he can certainly provide some eye-opening insights.

What is considered “good” or acceptable churn? Why should you look at gross churn rather than net churn? What is the Rule of 40% and why is it important? David answers these questions and more.

You can view David’s slide deck here.

And if you haven’t heard: SaaStr Annual is only one week away,  and we’ve made it bigger and better than ever! Join 10,000 fellow founders, investors and execs for 3 days of unparalleled networking and epic learnings from SaaS legends like Jon MillerDavid SteinbergJennifer Tejada, and Eoghan McCabe. If you don’t have tickets, there’s still time to grab yours today and bring your team from just $999! (Hurry before they’re all gone!) Get tickets here



Announcer:  Please welcome founder and CEO of InsightSquared, Fred Shilmover, to introduce our next session.


Fred Shilmover:  Good afternoon, everybody. My name is Fred Shilmover. I’m CEO and founder of InsightSquared, and I have the honor of introducing David Spitz today. For 13 years David has been Managing Director and Head of the Software and SaaS Practice at Pacific Crest, which is the tech arm of KeyBanc private market, and really is active as anyone in the space.

David has been personally involved in many of the premier SaaS IPOs including, SuccessFactors, Workday, ServiceNow, Viva, Zendesk, and last year Twilio, and BlackLine. He also sold their first major acquisition, a company called instruNet.

I had the privilege of working for John Somorjai for a time. I know he would tell you it’s been one of their most successful, one of their best acquisitions, bringing to the company executive, Alex Dayon and the beginning of the service cloud.

You may also recognize David and Pacific Crest from the annual SaaS Survey that they do. If you don’t read that or haven’t read that I highly recommend it. It helped me understand the underpinnings of SaaS business economics, and also what it takes to be successful.

David’s going to talk to you about SaaS metrics to better run your business. This is a topic that is near and dear to the heart of InsightSquared and myself. Without further ado, I’d like to welcome David Spitz.


David Spitz:  Thank you. Hi. Is this working? Can you hear me? OK, big group, really bright lights. I am going to start with something a little whimsical, but I think everybody uses this term in this industry, the so called, “leaky bucket.” This is basically SaaS for Dummies, I mean this is the way a SaaS business works.

I think the best way to think about this relative to this nice picture here is just to think about the fact that if you’re a company that aspires to grow at 50 percent, and you have a normal amount of churn, and we’re going to talk about what’s a normal amount of churn.  You probably really need to be thinking about growing something like 70 percent.

A lot of people will focus on, “Well, how do we make our churn lower?” That’s crucial, of course.

Regardless, it’s a natural part of life that you’re going to have to deal with a leaky bucket. Hopefully, you can repair it, and you can do all the customer success things that I heard about earlier today. Ultimately, this is the way you need to think about your business, and the way I guarantee you every investor will think about your business.

Maybe to look at it in terms of, this is a business that is one the verge of, it’s about $8 billion run rate.

They literally, let’s assume, they don’t disclose their churn, but they’re probably losing on the order, it would be normal to think, and I’m not talking about the net churn now, I’m just talking about the amount that they’ll lose by virtue of people getting acquired, leaving, or what have you, they’re going to lose $800 million next year of their business, of their ARR. That’s huge.

All of the things you do with respect to metrics relate to dealing with these issues, the CAC, the churn, and the LTV that results. We’re going to spend today some time talking about that. It’s probably the most topical. I know there are a lot of sessions around this. We’ve done a lot of work in this.

Churn, LTV, and those underlying unit level economics, they are destiny. They do determine how your business is run, but a lot of people do it wrong. A lot of people basically believe their own BS, and a lot of people will use the convenient metrics.

That’s fine, if you’re pitching someone to invest in your company, but ultimately, it will come home to roost, whether it’s in terms of how to repair things that are broken or just how to improve everything. Ultimately, you need to make sure you’re doing it correctly. There’s no one correct way, but there are definitely many wrong ways to do it.

The next thing I’m going to do in this discussion is encourage people to think beyond the unit level economics and think about the real economics. I’m going to sound a little bit like a banker there, but the more time I’ve spent with the very high quality companies, the more I’ve analyzed and my team has analyzed what makes these companies work.

What makes some companies great and some other companies not as great is the underlying economics. Those two do meet eventually.

If you’re $8 billion, of course, they’ve met already. Even if you’re 20, 40, 50 million dollars in ARR, they will start to meet, and you better have some good answers as to why you’re either burning a lot of cash still or what that means relative to how fast you’re growing. We’ll spend some time there.

Then, finally, we’ll spend at the end, we’ll actually look at how companies are valued in the public markets, companies in the sector because it does set the stage for how you’re going to be valued if you’re doing your B round or ultimately if you’re going public or selling your business. The basic question, what constitutes good or acceptable churn?

There’s no one answer to that question, but it does help to start just by looking at what’s out there. We’ve got profiled here a number of public companies at the time that they went public what was the number that they relayed in their S1, in their prospectus. What you can see is these numbers are all over the freaking map.

To make matters even worse, they’re defined, every company defines it differently. We’ll come back to this chart, but this is the again whimsical apples and oranges and lots of different kinds of apples and oranges and even a rotten tomato in there. I won’t say who I’m thinking is a rotten tomato.

We’ve worked on many of the prospectuses for those companies that you saw on the previous chart and some not. Look, if you’re selling your business in an IPO you want to put the best light on it and you do have license to look at the business in a way that makes sense, but also puts it in its best possible light. That’s what people do.

You’ll see that for example ServiceNow is one of the lower numbers on this page, but there’s an asterisk next to it. There aren’t a lot of asterisks on this page. This is just one example, and it’s one I think many of you are familiar with the notion that we call gross churn versus net churn or net dollar retention.

In the case of ServiceNow their numbers are so good that they’re able to actually just put the gross retention as some people call it, but basically the four percent from 96 to 100 that’s what they lose without the benefit of the upsells whereas some other companies on here, most of them in fact, if you look at Cvent which is no longer public.

That’s a net number, so their gross churn isn’t three percent. It’s significantly higher because there’s a lot of upsells. You see Veeva and Twilio they are the biggest numbers on the page. Of course, they’re over 100 percent, so they include the up sell. It’s hard to navigate that.

I’ve got a great team and they put together a really in depth review of how people do these calculations for the purposes of their S1. These are the only people that actually have to write them down in a way that the SEC reviews and if you lie you’ve got issues. They’re real, but each one is very different, and some are conveniently defined, honestly.

You can define it in such a way that you get the benefit of for example if you started a deal in the middle of one year and you record the gap revenue from that year versus the gap revenue from the next year you get an immediate uplift. Is that really land and expand? No, it’s not. It’s just timing.

What I would encourage you to do strongly because in order to get this right you really need to understand what the starting points are. You should go and download this document if you’re into this geeky stuff. This presentation is available I think through the SaaStr app or something like that. I encourage you to do that and understand that.

I’m going to hit a few high level topics here with respect. The churn is so critical when you think about lifetime value because it’s typically a very small number hopefully. It sits in the denominator of the calculation of Lifetime Value. It is such a critical number. Working from the bottom up on this page, most public companies tend to report net dollar retention. Why?

It looks the best. That’s certainly the cynical view, but it’s a valid number to be looking at. If you’re looking internally to try to figure out what’s really going on in your business, you should be looking at gross churn.

In fact, if you’re actually calculating an LTV in most cases, LTV by the way is Lifetime Value. Sorry about that. In most cases you should be using that gross churn number for that LTV calculation, in my opinion, not always, but usually.

Finally, if you’re really trying to figure out what’s going wrong or what’s going right with your business, you should be looking at something I call non renewal rates. If you’re consistently booking two or three year deals, your churn can look a lot lower than actually your customer success, customer happiness is.

You may have 30 percent non renewal rates, but people only get to renew every three years, it’s going to look like you only have 10 percent gross churn. Really, you’ve got something else and that’s not as good.

The folks that are doing this well internally should be looking at all three of these metrics and some others. By the way, if you’re selling stock to a sophisticated SaaS investor, a venture capitalist, or somebody who really gets to look on the inside, they’re not going to just take your net dollar retention number. They are going to want to understand these other two numbers and the derivatives thereof.

Fred had talked earlier about our SaaS survey. I think some of you are familiar with it. I’ve interspersed a few pages here of the results of that survey. Again, you can find this online. It’s a pretty thick document. It’s definitely not something to go through in a setting like this in detail, but I threw in a few.

It’s about 300 companies that responded. We asked anonymously, got responses. What’s your net dollar retention? We defined it. Over the entire group, that number is about 102 percent, meaning the expansions and upsells are actually more than balancing out the gross churn that the average company has, or the median company has, just to give you some context.

My point as well on this, is you really need to be careful. The number of times I’ll go in and meet with a company that will tell me…They’ll go calculate this LTV calculation. I’m sorry to go through this so quickly, but our time is limited.

A lot of people will tell you LTV to CAC, “Yeah, I’m losing a lot of money, but it’s worth it. Because my lifetime value of a customer, that is the value of the customer over time based on the churn and based on the margins that I receive from those customers over time, that’s a large multiple of my customer acquisition cost. CAC is customer acquisition cost.

David Skok , who’s been a partner of ours for some time, he republishes our survey, he’s thrown out the notion that a 3x LTV to CAC is the break point where a business starts to be really interesting.

That’s debatable. I think that is a good number to start with, but my first key thing that people trip up on is they’ll often compare LTV and CAC on an apples and oranges basis.

I don’t want to get buried in the details, but for most companies that do upsells and do expansions, there is a cost to that. As a result, you can’t get the benefit of those upsells and those expansions if you’re not also penalizing yourself by not looking at the net churn, but looking at the gross churn.

I’m a big believer that in most cases…Every company is a little bit different and I don’t want to get too buried in the weeds here, but in most cases, you need to look at gross churn.

If you’re losing 10 percent of your base every year before counting the upsells, that should be a starting point for thinking about what churn number you’re going to put in that LTV calculation, that lifetime value calculation.

But, it goes on from there. The other thing people do is they’re very formulaic. They’ll look, they’ll say, “All right, this is what I spent on sales and marketing last quarter and I’m going to say that’s what led to my increase in ARR, my increase in my subscription rate in the following quarter.”

They’re going to look at that quarter also and say, “Here’s how much I lost of the base. I had this many non renewals and my churn in that quarter…Or even if I average it over the last four quarters, my churn,” again, I like to use gross churn, “was five percent, so I’m going to plug that number into the LTV calculation and I’m going to come up with LTV to CAC of eight. Eight times.”

Eight is a huge number, by the way. If you truly have eight times LTV to CAC, it’s a dynamite business. The issue is this point on the bottom of the slide here, which is does five percent churn, even if it’s averaged over the last year, does that really mean you’re going to have a 20 year life? How many products have a 20 year life? Not many. Not many.

My point on this front, and again, if you’re trying to really be honest with yourselves and be forthright with potential investors, is you should probably come up with a number for gross churn that you think really reflects longer term what’s going on with your business.

It would be pretty rare that you’d actually say 20 year life on these things. I’ll get off my high horse, but I think it’s also really important…

Even though I am saying use the gross churn and don’t get caught up in the land and expand in terms of the calculation, I am a big believer, and I think the data really does support, that if you’re doing things right and you’re doing things in a way that’s really economic, earlier on than most companies do, you’re thinking about the upsells and you’re thinking about the expansions, because they’re a heck of a lot cheaper.

This is the CAC ratio as a lot of people call it. This is basically how much does it cost to get a new dollar of ARR in terms of sales and marketing, customer acquisition costs. These are the median numbers that we got from our survey.

$1.13 is the median for just new ARR from a new customer, so just banging down a new door versus upselling at 27 cents, expansions at 20 cents. It’s like one fifth of the cost, so it is extremely meaningful and you should be looking really carefully at that.

We’re going to switch gears here. This is the part two of the discussion and this is kind of new. I haven’t really gone through this before, but there are a lot there more people who were getting focused on, understandable reasons, just how much capital does it take to get to a certain level?

We’ve talked some about that on a high level, but what we’ve done with this presentation is really looked at…There’s the standard metrics, and we’ve used this in our survey. There’s something that we call, and others called the CAC ratio, which is what I was just talking about. How much does it cost to acquire a new dollar of ARR?

It’s not how much does it cost to acquire a customer, which some people talk about as CAC. To us, this is a little bit more economic. It’s in dollar terms. The one that’s easier to understand that’s directly related to this CAC ratio is the inverse. You have to stick the gross margin in and then multiply times 12. This is the CAC payback period.

Forget about churn, but you get a new customer or a new dollar of ARR, how much does it cost you? How quickly can you pay it back with the gross margin from the new ARR that’s earned? I’ll get to that in a minute. I didn’t say that very clearly. It’s basically, “How long does it take to pay back the cost to acquire that customer?”

Then the last one is probably the most important one in many ways at the end of the day. Your business model, factoring in everything, factoring in your entire cost structure and factoring in how people pay you. Some people, we’re able to bill customers upfront. Others are not, but ultimately how much capital does it take to get a certain growth in your ARR, to get to a certain level of ARR?

That’s at the end of the day what’s really going to matter because that’s what’s going to force you back to the market to raise more money, get dilution. All those things ultimately matter. As I mentioned early on, those unit level economics, they are destiny in that they will determine ultimately in a big way how this burn is working.

At the end of the day, if the two aren’t meeting, you’re probably not thinking about something in the right way. We’re going to look at that third one in some detail. Before we do, I just thought I would hit the CAC payback period because again it’s the one that’s easiest to think about. This is on a gross margin basis. Some people will talk about it on a revenue basis.

That’s fine, but a business that has 60 percent gross margins should be thought about in a different way than a company that has 90 percent gross margins. There are both. There are great businesses on both fronts, but you really should ultimately be thinking about the margins involved. The median from our data? We didn’t ask people this question directly, by the way.

We used to do that, and we’d iterate each year. In the most recent survey that came out in a September/October time frame we actually asked the components and got 18 months. You can see there’s a fairly widespread. This is what’s new. This is probably a little hard to see and a little hard to follow, but this is NetSuite.

What we did is we posited that you can go look at a company that’s gone public. If they haven’t gone through too many machinations, too much M&A. A lot of companies now will sell founder stock before but if you just look at it when it’s fairly pure. NetSuite from what we can tell was pretty pure going in. There was a lot of money that went into the company historically.

You can look on the balance sheet. You can look at basically the money. You can see how much capital has gone into the business. You can double check that with services like PitchBook that will look at the financings. Then you should subtract the cash that’s still on the balance sheet, because you haven’t burned that capital yet. Obviously if there’s debt, you need to account for that, too.

When NetSuite went public, they had gone through. They had burned $160 million of capital. They were at a run rate. We just took the last quarter and annualized it. Their subscription run rate was $100 million. You have the orange line, I think that’s orange,    basically tracking the cumulative capital. You can see they were fairly break even free cash flow wise.

That’s not always the case, by the way. Fairly break even from a free cash flow basis, which is what public market investors care most about, more than EBITDA or something like that. Then you can see the trajectory of the ARR on the top line, the blue line, versus the capital consumed. They turned to cash flow positive a few years later and then in a more major way.

Of course, we know what happened nine months into 2016. They got bought for $9 plus billion enterprise value, but they had a very solid business. I think this is a really good way to think about that notion of capital burn versus ARR. I’m not saying you should stack up against NetSuite. Not everybody has an Uncle Larry.

Nonetheless, there are companies that will burn through more money or less money. This is a somewhat random group, obviously some really well known companies. It’s people who filed S1s. We did the same exercise for these businesses and basically went through where they were at the time of the IPO.

After the IPO, it’s a little tougher to go through the exercise if they’ve done a lot of M&A and things like that. Anyway, it’s still doable. You can see Workday they were at a cumulative burn, so they had burned $160 million and achieved 169 million. Then the last column just basically says, “How much capital cumulative net,” because some of these turn positive, “did you burn for that size?”

I would caution you not to compare that right column. They’re not all apples to apples. People were at different points in time. A company like Castlight, it’s almost unfair because they just happened to go public really early. They were a pretty big burner. It’s not unfair in that sense, but there are companies that have clearly over performed versus their peers.

ServiceNow and Veeva are some of the best, from an economic perspective at the time that they went public, some of the best companies. They were both very cash flow positive. ServiceNow actually had turned somewhat negative around their IPO because they revamped their operations as I remember. Literally, and it’s in the footnotes, those companies had been generating cash for some time.

They were each at 160 and 135 million dollars in ARR. It’s pretty incredible, but this is a good guidepost. And that graph that we had on the previous page you could draw the same thing including post IPO to get a sense of where you are. We ask this question, by the way, in our survey. It’s all self reported.

The results I don’t think are as reliable as what we did for the public companies when they were going public. You can see here. Again, this is the median company self reported to get to $5 million in ARR took $8 million median of capital burned. It took three years and so on. We do 5, 10, 20, 40 million dollars in ARR. That’s just the median.

Anyway, they’re not completely out of line with the previous companies. All right. The last piece of this. I’m going through this faster than I thought I would, but I’ll have time for questions if people have them. There’s a lot of interest in this Rule of 40. Actually, somebody said to me the other day, “No. I don’t hear that as much anymore.” We still hear it, but we’re probably a few steps removed.

It really doesn’t start to apply until you get to some size. I don’t know what size that would be. It’s somewhat arbitrary. At least I would say 10 million in the ARR and probably more like 30 or 40 million. I imagine to a lot of people this is a distant benchmark to hit. The underlying concept is prescient, and it’s pretty valid.

Because the public markets are, as we’ll see in a minute, focused on growth and profitability as measured by free cash flow over time or at least that it’s demonstrable profitability. There are some companies that are growing really fast and losing a fair amount of money, but they’re still rewarded for it. It’s the notion that you should add your growth rate plus your margin.

Think of margin in this case as free cash flow in most cases. Sometimes you don’t have that data. What we did here on this page is basically looked at a bunch of SaaS public companies and plotted on the X axis. We plotted the revenue growth. On the Y axis we plotted the margin. Then we drew the diagonal line, which is the Rule of 40 line.

People above and to the right are doing better when they add their growth plus…You look at Twilio. They are losing money. They’re losing less than they were, but their free cash flow margin is in the negative 5 to negative 10 percent range. They’re growing 60/65 percent, so they’re well above or nicely above the Rule of 40.

You can see which companies sit above and which companies sit below. If you’re below, it’s bad, but it’s something that investors are going to take note of. We did the same for the private companies in the survey. Here again it’s self reported. You have to take it with a grain of Kosher salt, as I like to say.

There’s a little bit of tableau in this, so the size of the ball relates to how big the company is. You can see there’s one on the top right that looks pretty amazing. I wish I knew who it was. It’s anonymous, so I don’t. I get a lot of investors who call me, “Can you just send me your data?” “I don’t have it. I really don’t have it.” You see the ones in red are below and obviously small balls.

That’s not a big deal. It’s not like you need to be above the Rule of 40 when you’re still a young company. That does matter over time as we’ll see here in a second. I thought it was interesting to note. If you look, there’s no way you can read this.

My team looked at, “All right. How many of these companies that are above that line, above that Rule of 40,” again a somewhat arbitrary line, “what percentage of them are above?” About 40 percent it turns out of the SaaS universe of public companies are above the Rule of 40 line.

However, if you look at market cap and you’ve got companies like ServiceNow, Veeva, and Salesforce, close to 80 percent of the market cap is above the Rule of 40 line. That’s really interesting. If you look at our private company universe, we don’t ask people how they were valued. We don’t have that. We do have the fact that about one in four is above.

The other three and four are not. Now they’re younger companies. It’s not necessarily a bad thing. It’s just it is. The last piece of this discussion just relates to, well, I wonder if Rule of 40 or, said better, this quantity of growth plus margin is somehow a determinant of valuation, maybe more so than growth.

It turns out    this moves every day, of course    it does tend to be a better indicator of value. It’s not scientific here, but we actually plotted growth plus margin on the X axis.

On the Y axis we put the multiple, just the enterprise value to revenue multiple. That’s what most people will look at as what the value is. It’s on a projected revenue basis because that’s how the public market thinks.

It looks pretty good. Again, for the geeks in the room, the r squared is 0.64, so the correlation is pretty good. We’ve looked at this over time just to see. Sometimes we’ll see this at 80 percent, so it flips around. We even have the formula. It’s about 10 times that quantity of growth plus margin plus two.

I’m not saying that’s how you should value your company, especially in the earlier days, but it’s interesting. If you just look at it on the surface, it does tend to make you think, “Well, I got to look at both of these things really carefully.”

The trap that you may fall into if you do that, you should not lose sight of the fact that when you do this next year, you do the same exercise next year, the multiple that you’ll be working with will by multiplied times your size, your revenue.

Don’t lose sight of the fact that revenue growth is a heck a lot more important than profitability. A heck a lot more important because you will make a lot more money if you get bigger in terms of the valuation that you will have.

This notion of how you’re going to be valued is going to be crucially linked. My advice to people would be, “Yeah. This is important, but step on the gas as long as you can back it up that it makes sense.” You don’t want to lose some oodles of money in the process.

My closing thoughts and this is not anything I didn’t already say. This is, tell them what you told them, but I still believe that the SaaS metrics rule like the churn, the CAC, the LTV, but be careful. Don’t believe your own bullshit. A lot of people do.

Number two, the unit level economics as I said in the first bullet, they do matter. The thing that’s going to bring the investors to the table or in your case, not bring too many investors to the table, where you get lots of dilution, focus on the long game of capital consumption for growth.

It really is the most important thing at the end of the day, even if the SaaS metrics will determine how you stack up. Don’t wait to focus on that.

Finally, the public markets do focus on this notion of growth and profitability. 12 months ago, they were maybe too far on that, but don’t be fooled. As I was just saying a few minutes ago, high growth is much more important than generating free cash flow in the current period.

That’s all I’ve got. I’m happy to take some questions. I have a minute left if there’s a question. If not…I got one back there. I don’t know if I can hear you. Is there a mic in the room?

Audience Member:  [off mic]

David:  I’m having trouble hearing you, unfortunately, probably my ears.

Audience Member:  Enterprise versus consumer.

David:  Enterprise versus consumer? Basically, one of the biggest determinants and I assume you’re asking relative to churn and consumer. Anything that cost less is going to have more churn virtually. That’s why smaller customers tend to churn more. Of course, the ultimate small customer’s the consumer. You’re going to have churn.

I had this debate with Jason Lemkin about some of this stuff. If your customer acquisition cost is sufficiently low, that may be fine to have higher churn.

I don’t think you live and die necessarily by the churn. If you have really good land and expand in the consumer model and your customer acquisition cost because of a freemium model or something like that is attractive, that can be great.

I guess I’m out of time. Thank you very much. You’ve been fun.

Published on January 29, 2018

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