Why Can’t SaaS Companies Just Mint Cash?
I’m an investor in maybe a dozen companies. Next year they are all going from a few million to >$10m in ARR, but the burn rates are all, all, all over the place. Some are barely burning any cash.
But … the key is … they are all different. Each SaaS company is different.
If you read a lot of the SaaS and even Wall Street press, you’ll think that SaaS companies basically have to burn cash almost forever. Salesforce didn’t generate significant free cash flow until it crossed $1b or more in ARR. Box is at $300m in ARR and isn’t yet cash flow positive, though it’s planning to be next year. Hard to imagine DropBox is cash-flow positive. Evernote clearly isn’t. Zenefits is burning a few nickels on its way to the fastest growing SaaS-ish company ever. Etc. etc.
But … it’s not the whole story. Why is Veeva profitable? Why is Netsuite? Why do Oracle and SAP just rain cash? Why did sales-driven Qualtrics get to $70m+ in ARR without ever raising a nickel, and generating more than $20m a year in free cash flow?
So is SaaS cursed? Does it cost so, so much to host a few million lines of code on AWS?
Well let me just step back with my learnings as you do your own planning:
First, assuming you are growing > 80% YoY or so, have a lot of pre-paid annual contracts, … you should be able to be cash-flow positive almost no matter what somewhere around $5-$8m in ARR. How many people do you really need just to keep the app up? 30? 50? 200? Sales, done right, should be accretive (although expect sales efficiency to ultimately decline post-Initial Scale). And your marketing costs should be manageable as your mini-brand kicks in. Now once you hit say, $5m ARR, and the renewals kick in (which rain cash), and the pre-paid annual contracts kick in … you should be able to pull in 120% of your MRR even month in cash, possibly even more. You can’t run your core team on $6m in cash per year? Or $10m? Really?
The renewals, upsells, and pre-paid contracts just are cash engines if you are growing fast enough.
Second, if your quotas are real, and attainable, sales shouldn’t be that expensive. You have reps with an OTE of $120k on an $800k quota … I mean, if they come close to quota attainment, then sales shouldn’t break the bank.
And third, most of your leads become free or free-ish. Ultimately, almost everyone in B2B SaaS, down the road, ends up getting 80%+ of their leads through their brand, through word-of-mouth, through second-order revenue, etc. These leads cost almost nothing. They do need to be nurtured, and managed, and showered with love, demos, and attention. That costs real money. But really these core leads aren’t that expensive. It’s the extra, incremental leads that cost so much. More on that here.
So what makes SaaS burn so much cash, once you have enough revenue to cover the costs of the core teams you need to build and service the product?
One, reps often end up with really low realized quotas, especially in low ACV, high-competition spaces. If your sales team is weak, either truly weak or simply weak competitively … and/or your ACVs are low … the real, realized quotas are often really low in many fast growing SaaS companies — even $250k or less. Similarly, even in the best SaaS companies, lead-starved sales teams often end up with relatively low realized quotas. Maybe that’s a fair use of cheap Unicorn capital, I don’t know. But if you lower the effective, realized quotas (no matter what you claim the nominal quotas are) … costs skyrocket.
Two, fiefdoms can consume a lot of cash. Do you really need 12 people on the product team? 18 in marketing? You do? Really?
Competition simply drains cash. Fast. As soon as your competitor cuts prices and quintuples their marketing budget … and is everywhere … can you stay out of the arms race? I’m not sure you can, in many cases. This burns the most cash of all. Gotta go Platinum at Dreamforce now. More on dominant strategies in SaaS competition here.
The incremental customer can become extremely expensive. We talked about this a while back here. Even if 90% of your customers are pretty cost-effective to acquire and close, growing that extra 10%, 15%, 20% a year can be phenomenally expensive.
So net, net I have one main point and then a few semi-actionable insights.
The main point is there is no reason SaaS can’t mint cash. It certainly can.
And if you can raise $100m+, and you are in a competitive space, and you can crush your competitors with that $100m, I think it’s worth it. More on that here.
But … if your competition is bounded, your brand is positive, your churn is net negative, and your contracts are pre-paid … and your ACVs aren’t abnormally low … SaaS can rain cash.
So if cash matters, past $5m-$7m or so in ARR, here’s what I’d do to make it rain:
- Go upmarket. Get your ACVs up. Raise prices tomorrow. Same work, more cash.
- Ask for 1 and even 2 years cash paid up front. Big companies are happy to do it. Often for a nominal discount you would have given anyway.
- If your competition is fierce, raise prices even more. I know this seems counter-intuitive. But break away. Go more enterprise. Get more differentiated. Get better. Don’t just play the arms race game. Redefine it.
- Don’t wait to invest in customer success and account management. Mining your existing customers for upsells is the best way to rain cash. It just takes a while.
My uber-point is this: in SaaS, there is no magic “Magic Number”. There isn’t. Once you are on the way to Initial Scale, you can drive it and influence it.
And if you have $200m in the bank, ignore this post.