Getting to Initial Scale

“My CEO Told Me To Stop Selling So Much”

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Jason Lemkin

Recently, I met with a sales leader I’ve known for years, and he told me The Most Curious Story.  His SaaS CEO asked him to stop selling so much.

Slow down.  You are doing too good of a job, the CEO said.  We can’t afford it.

motorpowerNow … how could this be?  Well, it does make sense, when you understand the scenario, a combination of two things:

First, this SaaS company has a mix of freemium customers and sales-driven customers (with higher ACV, lower churn).  The freemium ones really have no acquisition costs at this point (the main lead source is mini-brand).  The sales-driven customers are very profitable on a CAC basis, since their lead cost is $0, and so the ‘Magic Number’ or CAC/CLTV ratio is very favorable.  But … still … the sales team’s commissions consume cash in the very, very short term.

and

Second, this SaaS company had a very tight balance sheet.  About $1m in cash for a $5m ARR business.

And here, they just couldn’t safely invest.  Because every $10k, $20k, $50k customer they closed … Hooray!! … but … that sales commission, just put them into Danger mode on the balance sheet.  Even though in 4 months, they’d be in the Black here … for years to come …

A crying shame, really.

We get that, but what’s the “right” answer?  Many of us can’t raise a $50m Series Seed, and many others of us don’t want to get diluted to 0.0001% ownership.

I think in SaaS, and I learned this from an insight from Josh Stein at DFJ (first VC in Box, SugarCRM, etc.) at a board we’re on together, what I’m going to inelegantly call “The 0.5x Balance Sheet Rule.”

Which is, once you are post-Initial Scale, past $3m-$4m in ARR or so, even if you have 80%+ gross margins and a very efficient sales and marketing engine … once your cash dips below 50% of your ARR … you’ll have stress, and importantly — underinvest.  And this is the worst time to underinvest.  Because when you get here, every great hire starts to be accretive (more on that here) — as measured in 12 months or less.  But you need enough capital to make these hires and let them pay for themselves in 12 months or less.

I made this mistake myself, with hindsight.  I was proud we got cash-flow positive at $4m ARR or so, and shortly thereafter, I figured out the “everyone great is accretive thing” and told all the managers to hire whomever they want.  But … I should have gone further.  At ~$7m in ARR I think we had about $1.5m in cash on the balance sheet, plus some venture debt.  If I’d had $5m+ on the balance sheet, I would have made far, far more investments.  At $7m in ARR and cash-flow positive, I didn’t have to worry about failing.  But I still had to worry about the costs of making data-driven, well-thought through, but unproven mistakes.

Now I’ve watched this in action again and again, and Josh Stein is 100% spot-on.  Having 100% of your ARR on the balance sheet is a luxury.  Do that if you can.  But at least, once you’re at Initial Scale, make sure you maintain 50% of your ARR on the balance sheet.  It will destress all your investments.  Let you really go for it.  And let you be OK if the amazing team you’ve hired makes a few more mistakes on the way to $100m in ARR.

As CEO/founder, once you’re at even just $3m or so in ARR, and have a few good VPs on the team … really your #1 job is to empower them.  They need enough of a safety net, and enough runway, to do amazing things.

“Slow down, you’re selling too much.”  It can happen, at least, as a construct, to anyone.  Don’t let it be you.

 

Published on June 8, 2015
  • This even sort of happens at services businesses of the same scale (lower margins, easier to control). Selling more, and more suddenly is often the last thing we need. And yet, you can’t tell a VP/sales anything.

    • Jason Lemkin

      I bet. There the margins can be so tight, too many commission can probably kill you.

  • Jason – playing devil’s advocate here, but wouldn’t this be the perfect time to load up debt financing, it’s it’s purely a float / recoup issue?

    • Jason Lemkin

      It is. Debt financing has its limitations … it has to be repaid … but it’s a gift done right in SaaS. If you can get venture debt from SVB/Square 1 at 6% or less interest today, take it 🙂 These deals can be very helpful, but practically speaking are open to a subset of companies, often with material venture backing.

      Other interesting alternatives include things like Lighter Capital which will give you say 33% of your ARR in a longish-term loan you repay from cashflow, without convenants, which is pretty cool. For many SaaS companies this is simply a no-brainer.

      The key to debt is to take it, but to be able to survive without it. Then it’s low stress. Just use it to reach a little further, make that one or two extra accretive hires. Then debt is the best investment in the world.

      If you use it like equity though, then it becomes super risky. Equity is there for the high risk stuff.

  • When I see these plans I can’t help but ask ‘why not tie commissions to cash flows’? Forget the ‘closed deal’ metric; just pay folks based on the cash they bring in the door, as it comes in. If the sales rep get a year-long contract up-front, great! They can then have their commission up-front, too. If the company has to wait over the course of the year to get paid then maybe the salesperson should too. No?

    • Jason Lemkin

      Yes you can, and in fact, a high % of start-ups that are at say sub-$10m ARR only pash commissions upon receipt of check or credit card — I did myself. This helps. Where it breaks down in the early-days is when you have monthly or quarterly payments. You can’t really make the rep wait, they don’t make enough money, and second, you turn them into your Accounts Receivable departments. You want your closers … closing.

    • Jake – if the numbers work, do it, but usually you’ll have to get sales guys to front-load annual contracts.. if you’re in enterprise and high dollar, no problem. The best financing of all is sales from the client when it works!

      That said, most guys keep a short horizon and mostly seem to eat what they hunt – just my experience.

      • Jason and Roger – makes total sense. Thanks for your comment!

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