The first SaaStr post that got widespread distribution was this one — “Want to Understand SaaS? If Nothing Else — Understand That It Compounds.“
The excerpt here:
“What does this mean, that SaaS compounds?
- It means it’s really, really hard to get revenues going. You close a customer for $120 in annualized revenue, you only get to recognize $10 of that a month. A lot of work for ten bucks. Think of trying to get a train out of a station with a very small engine. Tons of work, tiny revenues to start.
- It means you’ll really have to struggle to get to cash flow positive. Unless you get a lot of annual prepayments, cash will lag. This will be painful.
- It means once you get to about $2m in ARR, your business is real and solid. It isn’t going to evaporate, unless churn in massive … which it most likely isn’t once you get to this inflection point. Now is the time to invest, in team and product at least.
- It means once you get to about $10m in ARR, some level of real success is almost inevitable. Next year, you will have a $14m, or an $18m, or maybe even a $20m+ business. I don’t know which. But I know it’s one of them.
- It means once you get to about $25-$30m in ARR, you are unstoppable. The flip side of the struggle to get any revenues going. That train ain’t gonna be stopped by no one. Until you disrupt travel and no one even needs a train anymore.”
I thought at that time this was true for every startup in SaaS, but it turns out it’s really true more for a large but material subset of SaaS companies.
>> Because you have to hit 50+20 by $10m in ARR for SaaS to really compound.
What is 50+20? If you are doing it right, if your customers are super happy and your NPS is high and you are shipping product at a healthy pace, then:
- 50% or more of your revenue by $10m in ARR, or earlier, should be from “zero cost” marketing; and
- 20% or more of your revenue should be expansion revenue.
Most of the best SaaS companies hit both, sometimes earlier than this, sometimes a little later. When you do, that means 70% of your growth is qualitatively fueled by customer happiness, and quantitatively, by almost zero cost marketing. This is what lets you scale efficiently.
Let’s break this down slightly, and discuss the implications.
Once you have a mini-brand (maybe around $2m in ARR) and then a real brand (as you approach $10m in ARR), something magical should happen. Second order revenue, and just in general, word-of-mouth should kick in. The bottom line is the best software and SaaS companies start to get 50%+ of their new leads from word-of-mouth, brand, “I heard of you”, and other “zero cost” lead sources. In fact, many get 80%+ of their new leads all from brand, word-of-mouth, and referrals.
This doesn’t mean these leads are literally zero cost. You still have to nurture these leads, do webinars, give them collateral, do a customer event, and sell them. The sales cost is still real and the marketing cost isn’t literally zero. But it’s very low, when the lead source is “organic.”
And second, what should happen except in perhaps the most SMB-y models, is that your start to have material “net negative churn” by or well before $10m in ARR. That your customers buy more from you over time. Net of actual churn, that ideally is 120% cohort growth year over year, or more. Net net, you want to see at least 20% of your annualized growth come from your base by Year 3. This is super capital efficient, even if you pay your success team and your sales reps here.
This is pretty common for best-of-breed SaaS companies — 50+20 at 10. And if you can pull it off, you basically can go cash flow positive whenever you want, within reason. You can spend a fair amount on marketing programs, because the “free” leads will bring down your blended marketing costs. And you can pay your sales team well, because the true blended CAC is low, and the true CLTV is high. All this Magic Number stuff works, and magic indeed does happen as you scale past $10m ARR.
But it you don’t hit 50/20 at $10m in ARR, best case, you’ll have a capital inefficient mess of a business. You’ll be super “Magic Number” sensitive. You’ll scrutinize every marketing program and every sales spend. Your sales team will feel like a cost center, not a profit center. You’ll hold back on those extra SDRs and AEs. You’ll have to run ever faster to keep up with your targeted growth.
And importantly — you may never go cash flow positive.
So what’s actionable here?
- Broken record, but, focus like crazy on CSAT and NPS, at $1m ARR or even earlier. Measure it, raise it, make it happen. Even at just $5m ARR, it will almost be too late. And don’t be too confident if you are at say $1m and growing like a weed, but your NPS and CSAT are low.
- Don’t pat yourself on your back because of your ‘pretty good’ Magic Number. Hooray, you pay back your sales and marketing costs in 13 months. But if you don’t have 50+20, you’ll hemorrhage cash at $10m ARR. A healthy Magic Number really assumes a lot of zero cost leads and strong, positive revenue retention.
- Be wary of comps. You’ll have a hard time getting a real picture of how those Hot SaaS Startups are doing. The higher the zero cost lead ratio, and the higher the revenue retention, the more they can actually be sloppy in the rest of their metrics.
- Don’t let a high burn rate creep up on you. Most of us don’t have this luxury, but if you are going to burn a lot, at least do it with intent. If you are venture-backed and can’t hit 50+20 at 10, your burn rate may well grow linearly with ARR. That can be a trap it’s hard to get out of. At least pick a max burn rate and stick to it. And have that max quarterly burn rate always be less than your new ARR add that quarter, after the early days.
- More CSMs. Hire more customer success professionals on the way from $1m to $10m ARR. This can only help. Hire 50% more than plan. Make sure every customer has coverage. Make sure every single one of your top customers is visited every quarter, in person. No matter where they are.
- Know your lead sources. This may sound obvious, but we often come up short here. Many of the startups I meet with don’t really know where many of their leads come from. Track first, second and third touch. Ask your customers during the sales process, before they forget (I didn’t pay my reps unless they logged the customer-stated lead source, and you couldn’t close the Opportunity without filling in this field). Don’t allow any material amount of “Don’t Knows” as your lead source. No, the lead source is not “Intercom”. You need to know. Or you won’t really know how you are doing in terms of zero cost marketing.
- Visit your customers. Not only will they love you more, but this is one of the only ways to really learn why you aren’t getting to 50+20, and what to do about it. Not on the phone. Get on a jet, or at least, into a Lyft.
- Invest in your long tail (if you have one). Your small customers may not seem worth it as time goes on. But if they are free / cheap to acquire and happy — then you can get 100-1000 extra brand ambassadors from your long tail from every single Big Co you close. They’ll blog about you, tweet about you, bring you into their next company. And sometimes, grow into a big company themselves. This is usually a great marketing investment, even if it stops feeling that way after a while.
- Take action. If it isn’t looking after $2m ARR or so that these metrics are improving, that you’ll get to 50+20 at 10 … then take action now. While you have time. The closer you get to these metrics, the easier life will be as you approach and pass Initial Scale.
If you can hit/exceed 50+20 at $10m ARR, all will be good. It will.
If you don’t, it will be hard.
You can do it.
Make it so.