Software-as-a-Service (SaaS) Secrets to Raising Venture Capital

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From the SaaStr 2015 Annual Conference: you ever wanted to learn how to raise venture capital as a Software-as-a-Service (SaaS) business, read the secrets in this presentation. In this overview, we cover SaaS revenue growth and how it has accelerated from 2007 to 2014.Then we look at why we pass on SaaS companies even when they are growing top-line revenue (hint: we care more about gross churn and especially negative net churn). And finally, we introduce a new metric - the SaaS quick ratio - which can help you understand how an investor benchmarks the amount of new sales and expansion revenue gained in a month relative to cancellation and contraction revenue lost in the same month. In the appendix, we show you a sample company to illustrate how to structure your data, build your graphs, and present your data to investors.

Mamoon Hamid is a General Partner at The Social+Capital Partnership, a VC firm based in Palo Alto, CA. Mamoon has invested in iconic SaaS companies such as Box, Yammer, Slack, Greenhouse, Intercom, Castlight Health, Act-on Software, and a dozen others.

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Software-as-a-Service (SaaS) Secrets to Raising Venture Capital

  1. THE SOCIAL+CAPITAL PARTNERSHIP (Ad)Venture Capital: What are we funding and why? Mamoon Hamid, The Social+Capital Partnership
  2. What we’re going to talk about MRR and Churn but first… Source: Knowyourmeme.com
  3. No, seriously… MRR and Churn but first…
  4. Product Engineering Finance HR & OpsMarketing Sales Support Analytics & BI Security & Control Data Infrastructure Enterprise: Our Investments Productivity & Collaboration InfrastructureEndUser
  5. Our investing guideposts We prioritize these signals based on our point of entry Increasing Maturity Pre-Revenue <$2M ARR run-rate $10M+ ARR run-rate •  Stellar team •  Strong conviction in the target market •  Stellar team •  Strong conviction in the target market •  Early customer validation indicating strong product market fit and best in class product •  Business is compounding in a rapidly growing market •  Best in class product and world class team •  Clear path to being a unicorn Seed & Series A Check Size: $1m-$5m Series A & Series B Check Size: $5m-$10m Series B+ Check Size: $15m-$25m
  6. When we first invested ($ARR) Increasing Maturity Pre-Revenue <$2M ARR run-rate $10M+ ARR run-rate
  7. 0 2 4 6 8 10 12 0 6 12 18 24 30 36 AnnualRecurringRevenue($M) Months since launch Enterprise Software growth in 2007… 39 Company A launched in 2007 Source: The Social+Capital Partnership Internal Data Invested
  8. 0 2 4 6 8 10 12 0 6 12 18 24 30 36 AnnualRecurringRevenue($M) Months since launch Enterprise Software growth in 2009… 3933 Company B launched in 2009 Source: The Social+Capital Partnership Internal Data Invested
  9. 0 2 4 6 8 10 12 0 6 12 18 24 30 36 AnnualRecurringRevenue($M) Months since launch Enterprise Software growth in 2014 ! 393311 Company C launched in 2014 Source: The Social+Capital Partnership Internal Data Invested
  10. 0 2 4 6 8 10 12 0 6 12 18 24 30 36 AnnualRecurringRevenue($M) Months since launch And now for the unmasking… 3933 Source: The Social+Capital Partnership Internal Data
  11. $0M $1M $2M $3M Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Lifecycle of a SaaS investment Our prepared mind approach: we invest early and monitor portfolio company growth to pre-empt future rounds Jason Lemkin introduces us to the opportunity After observing 2 quarters of strong MRR growth we pre-empt the Series A We invest $1M in the Seed - strong conviction in team, market and early customer validation Annual Recurring Revenue ($M) Source: Company Financials
  12. Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Lifecycle of a SaaS investment We take notice when we hear about products entrepreneurs love Intercom gets founded and raises seed round Social+Capital leads a $6M Series A after hearing rave reviews from early customers Intercom raises Series B led by Bessemer Annual Recurring Revenue ($M) Source: Company Financials
  13. 0K 100K 200K 300K 400K Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Lifecycle of a SaaS investment We use our pattern recognition to invest right before a company is about to take off Tiny Speck rebrands as Slack; beta launch of enterprise product Slack raises a round led by KPCB + Google Ventures Daily Active Users (K) Social+Capital leads the first VC round in Slack. Early data shows off the charts engagement compared to any enterprise product ever Source: Company Internal Metrics
  14. Why did we pass on this investment? $0K $100K $200K $300K $400K $500K Q2 2012 Q4 2012 Q2 2013 Q4 2013 Q2 2014 Q4 2014 MonthlyRecurringRevenue($K) Net New MRR ($K) Beginning MRR ($K) Nice looking growth, but doesn’t tell the whole picture Source: The Social+Capital Partnership Internal Data
  15. -5% 0% 5% 10% 15% 20% 25% Q4 2012 Q2 2013 Q4 2013 Q2 2014 Q4 2014 MonthlyChurn% Gross MRR Churn (%) Crazy Gross Churn We look for monthly Gross MRR Churn << 3% Source: The Social+Capital Partnership Internal Data
  16. -5% 0% 5% 10% 15% 20% 25% Q4 2012 Q2 2013 Q4 2013 Q2 2014 Q4 2014 MonthlyChurn(%) Gross & Net MRR Churn (%) Gross MRR Churn Net MRR Churn Net Churn better, but still high …And monthly Net MRR Churn << 0% Source: The Social+Capital Partnership Internal Data
  17. Our reaction…Crazy Gross! Source: Memegenerator.net
  18. -$40K -$20K $0K $20K $40K $60K Q2 2012 Q4 2012 Q2 2013 Q4 2013 Q2 2014 Q4 2014 MonthlyRecurringRevenue($K) Cancelled MRR ($K) New MRR Added ($K) New MRR barely outpacing Cancelled MRR Source: The Social+Capital Partnership Internal Data
  19. Only expansion MRR allowed it to grow -$40K -$20K $0K $20K $40K $60K Q2 2012 Q4 2012 Q2 2013 Q4 2013 Q2 2014 Q4 2014 MonthlyRecurringRevenue($K) Cancelled MRR ($K) Expansion MRR ($K) New MRR Added ($K) Source: The Social+Capital Partnership Internal Data
  20. 1 4 7 10 13 16 19 22 25 28 31 34 Month Cancelled MRR Expansion MRR New MRR 1 5 9 13 17 21 25 29 33 37 41 Month Cancelled MRR Contraction MRR Expansion MRR New MRR 1 3 5 7 9 11 13 15 Month Cancelled MRR Expansion MRR New MRR The SaaS Quick Ratio – Added MRR/Lost MRR Two companies we invested in and two we passed on Company A Portfolio Company 1 Company B Portfolio Company 2 Source: The Social+Capital Partnership Internal Data 1 3 5 7 9 11 Month Cancelled MRR Contraction MRR Expansion MRR New MRR
  21. 1 4 7 10 13 16 19 22 25 28 31 34 Month Cancelled MRR Expansion MRR New MRR 1 5 9 13 17 21 25 29 33 37 41 Month Cancelled MRR Contraction MRR Expansion MRR New MRR 1 3 5 7 9 11 13 15 Month Cancelled MRR Expansion MRR New MRR Company A Portfolio Company 1 Company B Portfolio Company 2 Source: The Social+Capital Partnership Internal Data 1 3 5 7 9 11 Month Cancelled MRR Contraction MRR Expansion MRR New MRR $126 New + Expansion $32 Cancelled = 4.0x $76 New + Expansion $17 Cancelled + Contraction = 4.5x $304 New + Expansion $188 Cancelled + Contraction = 1.6x $77 New + Expansion $22 Cancelled = 3.5x The SaaS Quick Ratio – Added MRR/Lost MRR Two companies we invested in and two we passed on
  22. Recap – what’s good, what’s bad ‣  What you want ‣  Get to $1M ARR ~12 months after launch ‣  Net New MRR keeps increasing quarter over quarter ‣  Maintain a Quick Ratio > 4 ‣  What to watch out for ‣  A Quick Ratio < 2 – churn is too high /new sales aren’t working ‣  Net New MRR is flat or down quarter over quarter ‣  As a result takes 18+ months to get to $1M ARR
  23. Take churn seriously…for IPO’s sake The penalty for a ~5-point change in Net Churn is extreme - $500M ARR lost by year 8 ! $500M+ARR! $0M $150M $300M $450M $600M $750M $900M 0 12 24 36 48 60 72 84 96 AnnualRecurringRevenue($M) Months since launch 0.75% Gross MRR Churn / (-3% Net Churn) 1% Gross MRR Churn / (-2% Net Churn) 2% Gross MRR Churn / (0% Net Churn) 3% Gross MRR Churn / (2% Net Churn)
  24. And remember… Source: Reddit
  25. APPENDIX: SaaS metrics on sample company Moonware Inc. Source: Reddit
  26. The engine of SaaS is Net New MRR $0K $100K $200K $300K $400K $500K $600K 0 2 4 6 8 10 12 14 16 18 20 22 24 CommittedMonthlyRecurringRevenue($K) Months Since Launch Net New MRR Beginning CMRR
  27. $0K $100K $200K $300K $400K $500K $600K 0 2 4 6 8 10 12 14 16 18 20 22 24 CommittedMonthlyRecurringRevenue($K) Months Since Launch Net New MRR Beginning CMRR Take for example Moonware, Inc. $80K CMRR at year 1 $500K CMRR at year 2 This is a sample company growing from 0 to $500K CMRR by year 2
  28. -$10K -$5K $0K $5K $10K $15K $20K 0 2 4 6 8 10 12 MRRAdded/Lost Months Since Launch New MRR Cancelled MRR Let’s decompose Net New MRR… This is monthly New MRR added and Cancelled MRR lost plotted on the same axis for the first 12 months of the company’s lifespan New MRR is added… …and some early customers start to churn
  29. -$20K $0K $20K $40K $60K $80K 0 2 4 6 8 10 12 14 16 18 20 22 24 MRRAdded/Lost Months Since Launch Expansion MRR New MRR Contraction MRR Cancelled MRR Net New MRR decomposed, Year 2 Expansion typically hits after year 1 Contraction also occurs in year 2 In year 2, you start to see expansion and contraction enter the picture as annual customers come up for renewal and decide to upgrade / downgrade.
  30. $0K $100K $200K $300K $400K $500K $600K 0 2 4 6 8 10 12 14 16 18 20 22 24 CommittedMonthlyRecurringRevenue($K) Months Since Launch Net New MRR Beginning CMRR Zooming in on Net New MRR Let’s look at a single month to see how Net New MRR is calculated
  31. +50 +45 +20 -10 -5 -20 -10 0 10 20 30 40 50 60 70 Month 23 Month 23 Net New MRR Zoomed In Net New MRR Breakdown + New MRR (new logos) + Expansion MRR (upgrades) - Contraction MRR (downgrades) - Cancelled MRR (existing logos) = Net New MRR Net New MRR has 4 components: New, Expansion, Contraction, Cancellation MRR
  32. +50 +45 +20 -10 -5 -20 -10 0 10 20 30 40 50 60 70 Month 23 Month 23 Net New MRR Zoomed In + 45 New + 20 Expansion - 5 Contraction - 10 Cancelled = +50 Net New MRR Net New MRR Breakdown Net New MRR has 4 components: New, Expansion, Contraction, Cancellation MRR
  33. Cancellations and Gross MRR Churn Churn is lost revenue from customers who cancelled, expressed as a % of the prior period CMRR 0.0% 1.0% 2.0% 3.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Gross MRR Churn -12 -10 -8 -6 -4 -2 0 0 2 4 6 8 10 12 14 16 18 20 22 24 Month Cancelled MRR
  34. Cancellations and Gross MRR Churn Churn is lost revenue from customers who cancelled, expressed as a % of the prior period CMRR 0.0% 1.0% 2.0% 3.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Gross MRR Churn -12 -10 -8 -6 -4 -2 0 0 2 4 6 8 10 12 14 16 18 20 22 24 Month Cancelled MRR Cancelled MRR Beginning CMRR
  35. Cancellations and Gross MRR Churn Churn is lost revenue from customers who cancelled, expressed as a % of the prior period CMRR 0.0% 1.0% 2.0% 3.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Gross MRR Churn -12 -10 -8 -6 -4 -2 0 0 2 4 6 8 10 12 14 16 18 20 22 24 Month Cancelled MRR 1% Gross MRR Churn is really good ! 3% Gross MRR Churn is getting dangerously high L
  36. 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Net Expansion Expansion and Contraction Expansion is customers upgrading from existing plans, while contraction is customers downgrading. Net Expansion is the difference between the two. -10 -5 0 5 10 15 20 25 2 4 6 8 10 12 14 16 18 20 22 24 Month Expansion & Contraction MRR
  37. Expansion and Contraction Expansion is customers upgrading from existing plans, while contraction is customers downgrading. Net Expansion is the difference between the two. -10 -5 0 5 10 15 20 25 2 4 6 8 10 12 14 16 18 20 22 24 Month Expansion & Contraction MRR Expansion (Upgrades) Contraction (Downgrades) Expansion – Contraction Beginning CMRR 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Net Expansion
  38. 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Gross MRR Churn and Net Expansion Net Churn Negative churn is the result of Net Expansion outpacing Gross MRR Churn
  39. 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Gross MRR Churn and Net Expansion Net Churn Negative churn is the result of Net Expansion outpacing Gross MRR Churn
  40. 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Gross MRR Churn and Net Expansion Net Churn Negative churn is the result of Net Expansion outpacing Gross MRR Churn When Net Expansion exceeds Gross MRR Churn...
  41. -2.0% -1.0% 0.0% 1.0% 2.0% 3.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Net Churn Negative Net Churn In other words – existing customers are upgrading faster than customers that are cancelling or downgrading You get negative Net Churn J 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 2 4 6 8 10 12 14 16 18 20 22 24 Month Gross MRR Churn and Net Expansion
  42. Thank You! mamoon@s23p.com andy@s23p.com

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