No Churn: Keep Customers And Improve Your Saas Company Valuation – 2015 Update
CUSTOMER RETENTION PAGE 1
NO CHURN: KEEP CUSTOMERS AND IMPROVE YOUR SAAS
COMPANY VALUATION – 2015 UPDATE
This is an update to a white paper we wrote nearly three years ago and remains one of our
most important pieces of work and popular downloads. Largely, the points remain the same,
but we wanted to refresh the numbers with current market data and results from our recent
survey of over 400 private SaaS companies.
This paper empirically demonstrates revenue retention rates directly impact a SaaS
company’s valuation in a significant way and to a much larger extent than typically
recognized. Our data indicates that for every 1 percentage point increase in retention,
a company’s valuation could increase 12% after five years. The impact is dramatic
because: retention impacts multiple valuation drivers (MRR, growth rate, contribution
margin, addressable market), and it has a compounding effect over time.
Retention, and its inverse, churn, are the least standardized of all the various SaaS
metrics. Broadly, churn is measured as a percentage of your total business lost in a
given period. The definition we use in this white paper is lost monthly recurring dollar
revenue (not customer count) over the period of a year.
Specifically, if all your customers generated $250,000 in MRR in May 2014, how
much MRR did those same customers generate in May 2015? If it was $200,000, your
retention rate was $200,000/$250,000 or 80%, and your churn was 20%. There are many
ways to measure churn, but we find this one the most intuitive. It’s easy to understand
“keeping 80% of your revenue,”compared to the harder to conceptualize monthly
churn equivalent of 1.85%.
Slightly more‘in the weeds’, but a new and important distinction that is gaining common usage, is gross vs. net
retention. In the example above if you also added $50,000 in revenue from the retained customers through up sells
(price increases or additional licenses) or cross sells (additional products), your net revenue retention would be
100% (($250k - $50k + $50k) / $250k), or a net churn rate of 0%. Gross retention is 80%, while net retention is 100%.
Up selling and cross selling adds real, meaningful MRR, and in this paper, and when working with SaaS companies,
when we talk about churn, we mean net churn. That said, for management teams trying to understand the impact
of churn and why it is happening, it should be measured in many different ways including net, gross, by customer,
and by cohort.
WHITE PAPER: CUSTOMER RETENTION
For every 1
increase in revenue
retention, a SaaS
increases by 12%
after five years
CUSTOMER RETENTION PAGE 2
Having defined churn, we will now turn to its impact on a SaaS company’s valuation. To start that discussion, we need
to briefly hit on the value drivers of a SaaS company.
How SaaS Companies are Valued
Much has been written on this topic, so we will not try to
cover all the nuances here. However, it’s empirically true
that the two biggest factors driving the valuation of a SaaS
business are simply: its scale (measured in revenue), and its
Profits are less of a driver because of a SaaS company’s
inherent financial structure. Investors both private and
public assume SaaS revenue will generate significant profits in the future, and so the size and growth rate of its
revenue today is a proxy for the magnitude of its profits in the future.
We agree on this approach, but whether you agree or not, it is currently how SaaS businesses are valued. There is
no correlation between profitability and valuation in the public SaaS market today. Other considerations are: how
big will the company get (Total Addressable Market, or TAM), how profitable can it be (Unit Economics), and, how
predictably will it get there?
First we will look at some empirical public company evidence to demonstrate the direct linkage between revenue
scale, growth, and valuation. Then we will use a case study of two otherwise identical companies with different
retention rates to demonstrate the effect churn has on each of the metrics and ultimately, valuation.
We probably didn’t need a chart to demonstrate that larger SaaS businesses are more valuable than smaller ones, but
the data is laid out below. Larger revenue SaaS businesses have the capacity to generate higher future cash-flow, and
are therefore worth more today.
Drivers of SaaS company valuation are:
1 Size of revenue stream
2 Growth rate
3 Unit economics
4 Size of the company’s addressable market (TAM)
5 Predictability of above metrics
$0.0 $1.0 $2.0 $3.0 $4.0 $5.0 $6.0 $7.0
Source: Pacific Crest Securities and SaaS Capital, 2015
Figure 1 - Public SaaS
CUSTOMER RETENTION PAGE 3
Deviations from the size/value relationship shown above are almost entirely explained by different growth rates.
Below are the same companies charted by growth rate and revenue multiple. For further perspective, the valuation
(market cap) itself is shown by way of the size of the bubbles. Faster growing business have the capacity to
generate more future cash flow per current dollar of revenue, and so they trade at a higher revenue multiple. The
opposite is true for shrinking companies; Covisint is valued at less than one year’s worth of revenue.
-10% 0% 10% 20% 30% 40% 50% 60%
Source: Pacific Crest Securities and SaaS Capital, 2015
Revenue Growth Rate
As is evident in the Figure 2, the size and growth rate of revenue are the two major drivers of valuation in a SaaS
business. In fact, no other factors (TAM, CAC ratio, gross margin, or net income), have anywhere close to the impact
of these two metrics.
What we will demonstrate next, through a simple financial model, is the numeric impact of churn on both revenue
metrics and the resulting impact on valuation.
A Tale of Two Companies
At SaaS Capital, we have seen the financial statements of hundreds
of SaaS businesses and talked to hundreds more. From these
interactions we have seen a“typical”profile emerge that allows us to
offer a model that demonstrates the significant impact that churn can
have on company valuation.
As with any model, there are assumptions and variables that may
differ from your business. But for the sake of illustration we would like
to introduce two fictitious companies: Retention Inc. and ChurnCo
This data is as of June 12, 2015. On June 15, 2015, it was announced that DealerTrak was acquired for
about 60% more than its previous closing value; others noticed it was undervalued, as well.
Figure 2 - Public SaaS
to Growth Rates
CUSTOMER RETENTION PAGE 4
Both Retention Inc. and ChurnCo Solutions are B-to-B SaaS companies who are each booking 10 new customers
per month at a subscription rate of $1,000 per month. Both companies spend $120,000 per month on sales and
marketing for customer acquisition (CAC). Holding these variables constant between the two companies allows us to
zero-in on the impact of churn on company valuation.
The following table summarizes each company’s monthly operating performance over a five-year period.
So how does churn impact valuation?
As we mentioned before, churn impacts every single one of the drivers of SaaS valuations. This creates a
multiplicative effect and is one reason the overall impact is so large. Let’s look at them individually:
Size matters…Obviously the most direct impact churn has on the value of a SaaS business is through its impact on
revenue. As discussed above, SaaS businesses are valued almost exclusively on revenue and not profitability, so the
bigger the revenue, the higher the valuation. The key concept to note here is the compounding effect of churn. Over
5 years, the difference in revenue between ChurnCo with 20% churn and Retention Inc. with 5% churn is not 15%
- it’s 40%. After 10 years, it’s almost 100%. It is compounding interest in reverse and the impact becomes very large
Growth rate matters more… Somewhat less obvious, but with an even larger impact on value, is the effect of
churn on the company’s growth rate. High growth SaaS businesses are worth 6 to 12 times annualized revenue,
and slow growth businesses are only worth 2 to 4 times annualized revenue. So while Retention Inc. and ChurnCo
have the exact same bookings rate, ChurnCo is growing 50% slower by year 5 than Retention Inc. just because of
its higher churn. That difference in growth will have a significant impact on the revenue multiple that prospective
buyers or investors will assign to the business. Based on the slope of the line in Figure 2, the revenue growth
difference accounts for a multiple difference of between 2 and 4 times. Retention Inc., would be worth 6 to 8 times
revenue based on its growth rate, and Churn Co. would be worth 3 to 5 times.
Month 12 Month 24 Month 36 Month 48 Month 60
Retention Inc. (95% Retention)
Customer Count 117 229 335 436 532
Monthly Revenue $ 117,288 228,844 344,948 435,867 531,854
Run Rate Revenue $ 1,407,454 2,746,126 4,109,377 5,230,404 6,382,249
Annual Growth Rate - 95% 46% 30% 22%
Monthly Sales & Marketing $ 120,000 120,000 120,000 120,000 120,000
Contribution after CAC $ (2,712) 108,844 214,948 315,867 411,854
ChurnCo Solutions (80 % retention)
Customer Count 110 199 272 332 381
Monthly Revenue $ 109,589 199,161 272,374 332,214 381,125
Run Rate Revenue $ 1,315,066 2,389,937 3,268,485 3,986,569 4,573,495
Annual Growth Rate - 82% 37% 22% 15%
Monthly Sales & Marketing $ 120,000 120,000 120,000 120,000 120,000
Contribution after CAC $ (10,411) 79,161 152,374 212,214 261,125
Table 1 - A summary of Retention Inc and Churn Co Solutions monthly operating performance over a five-year period.
CUSTOMER RETENTION PAGE 5
Profits matter too, indirectly… In looking at the monthly contribution margins after sales and marketing in year
5 on the table, the low churn business generates $151,000 more in cash each month. Even if we assume $30,000 of
that cash was invested in customer retention activities to achieve the lower churn, the Retention Inc. business can
double its investment in sales and marketing to $240,000 and still be as profitable as ChurnCo. That will accelerate
growth further without any more capital required. For this analysis, our assumption is that a doubling of sales and
marketing spending would take Retention Inc.’s revenue growth rate from 22% in Figure 2 to 30%. The increased
growth, again based on the slope of the line in the Figure 2, accounts for a revenue multiple difference of 2. (8 times
vs. 6 times)
Translating theses values into the private market, and overlaying our own experience on top of data from the 451
Group and Pacific Crest, we believe a 30% growth SaaS business is generally worth a 4x to 5x multiple of revenue,
while a 15% growth business would earn a 2x to 3x multiple. And while we realize that in real life there are hundreds
of factors that contribute to what one company will pay for another, growth rate is the single biggest common
There’s a reason every VC pitch deck has a TAM slide… Knowing that there is a large Total Addressable Market
(TAM) out there willing to pay for the product is a critical component of any investment decision. Surprisingly, higher
retention actually increases the size of the addressable market. For Example: If the TAM for each of our companies
was 1,000 customers, they would both sell to their last new customer on the 100th month (they are adding 10 new
customers per month). Retention Inc., however, would have fully exploited its TAM at a $9.8 million revenue level,
while Churn Co’s revenue would peak at $5.8 million because of all the customers it acquired and then lost. Higher
churn effectively reduced the addressable market size by almost 40%.
Revenue predictability improves multiples … The calculation of a valuation multiple is also driven, in part, by the
predictability of the business’future cash flows. This is valuation 101: the more unpredictable the future cash flow
streams are, the higher the discount rate applied to those future cash flows will be, and the less they will be worth.
Year 1 2 3 4 5 6 7 8 9
Retention Inc. (95% retention) Churn Co. (80% churn)
Source: SaaS Capital 2015
After 5 years, Retention Inc:
- Has 40% more revenue
- Is growing 50% faster (15% vs 22% per year)
Figure 3 - Chart of
Retention Inc. and
Over 10 Years
CUSTOMER RETENTION PAGE 6
(The revenue multiple is inversely proportional to the discount rate.) In the real world, this means a corporate buyer
or investor will be much less worried about a high retention business imploding after the purchase and will pay a
higher price for that lower risk. And while it’s difficult to isolate the direct valuation impact of retention independent
from its effect on growth and MRR, we believe the churn differential in the model could easily account for one
incremental revenue multiple.
The bottom line for Retention Inc. and ChurnCo Solutions
For our two little companies, how does this all add up? By the 5th year,
Retention Inc.’s higher retention resulted in a revenue run-rate of $1.8
million more than that of ChurnCo. So, without factoring in any increases
to the valuation multiple itself, as a starting point Retention Inc. is 40%
more valuable than Churn Co.
When the increased revenue multiple due to the higher growth rate is
factored in (5x vs 3x), the valuation increases by $18M. Add one more
increment to Retention Inc.’s multiple due to its larger addressable market
and more predictable future cash flow, and Retention Inc. is worth
$38.3M compared to Churn Co. at $13.7M, a total difference in value between the two businesses of $24.5 million.
After five years of closing the exact same amount of new business, Retention Inc. is worth almost 3 times as much as
If the results above seem overstated, cut each estimate in half, and maybe the impact is only a doubling in value
or possibly just a 50% increase. In all cases, meaningful. In the context of fundraising, the impact can be more
profound. We have seen SaaS businesses that fail to retain their customers, for whatever reason, be unable to raise
capital at any price. Our own underwriting criteria call for a minimum net revenue retention rate of 85%, and the
retention threshold for many VC’s is even higher.
Lastly, it might be tempting to dismiss the study as contrived; after all, a 15% difference in retention is huge. But all
these relationships hold true across more modest changes. Revenue, growth and profitability all increase directly
with improved retention, no matter how much or how little.
This is notable because improving retention in the real world takes time and commitment, and gains are realized
one percentage point at a time. And while the exact impact will be subject to some step functions and will vary
some depending upon the base-line valuation multiples, the fundamental relationship interpolated from this case
study is: for every 1 percentage point increase in revenue retention, a SaaS company’s value increases by 12%
after five years.
Retention Inc. ChurnCo
Year 5 Revenue Run-Rate $6,382,249 $4,573,495
Base Valuation Multiples 3.0x 3.0x
Base Case Valuation $19,146,747 $13,720,486
Additional Multiple for Growth 2.0x --
Additional Multiple for Profitability, Predictability and TAM 1.0x --
Total Year 5 Valuation Multiples 6.0 3.0x
Final Valuation $38,293,494 $13,720,486
Retention Inc. is worth
$24.5 million more than
CUSTOMER RETENTION PAGE 7
The relatively straight-forward numerical data laid out above, while accurate, does not account for the complexity
of churn itself. Dozens of factors drive churn, many of which may or may not be within the company’s near term
control. Decisions about the target customer base (SMB vs. Enterprise) are sometimes set once in a company’s life,
while other factors including better onboarding and relationship management are tactical and always evolving.
To help your SaaS business better manage churn, we thought it would be helpful to share a little more about what
your peers are doing. The following analysis is based on the results of our annual survey of B2B SaaS companies,
conducted in Q1 this year. We received our highest number of responses this year, more than 400.
So how do private SaaS companies in the real world think about and manage churn?
• 80% of companies in our survey have someone in charge of customer success. Of those, 50% are VP or C-level.
And in what we see as a testament to the maturation of the SaaS business model, even 58% of‘startups’,
companies with less than $1M in revenue, have someone in charge of customer success.
• Retention was listed as the first or second highest company priority for 2015 by 51% of companies, and trailed
only“new sales”as the single highest priority. Logic and SaaS math follows this prioritization: step 1, acquire
paying customers, step 2, keep them.
• But does all this attention to customer success work? Apparently“yes”. Companies that paid more attention to
churn in 2014 saw more improvement in the metric. See the table below.
So what is an“average”retention rate? Simpler applications with smaller price tags sold to smaller businesses are
not appropriately benchmarked against larger enterprise systems sold into much bigger organizations. To account
for some of these differences, we thought the best way to show‘average’retention rates was to segment the data by
the average contract value of the application.
To what degree do you track churn?
From 2013 to 2014, did your churn improve?
Tracking churn is not a focus 53% 47%
We treat it as an important metric that we track regularly 69% 31%
We treat it as an important metric; we tie it to compensation
Average Annual Contract Value
Source: SaaS Capital Annual Survey
<$1k $1k - $5k $5k - $10k $10k - $50k $50k - $150k $150k +
Figure 4 - SaaS
rates by annual
CUSTOMER RETENTION PAGE 8
Many companies selling a product with a monthly price of less than $100 are selling to very small SMBs, likely
sole proprietors, independent consultants or contractors, and“mom-and-pop”retailers. We expect to see higher
structural churn – companies going out of business, getting acquired, or independents / part-timers getting
employed by a larger company. Over time, we have generally come to estimate structural churn in the SMB space
to be 5% to 7%. Figure 4 above shows theses businesses are actually doing quite well at 90% overall net retention.
As the cost of the solution increases, its complexity and depth of integration into the organization do as well.
Customer size also increases with more expensive solutions – there are likely more end users on the system and a
more formal budgeting and procurement process. In short, purchasers of larger, more complex, more expensive
systems are less likely to churn and to do so less often.
Why retention rates trend back down when the average contact value exceeds $50,000, we honestly don’t know. It
could be noise in the data, or a combination of other factors including the fact those purchases get more ongoing
scrutiny. We will revisit this point based on next year’s data.
SaaS companies come in all shapes, sizes, and stages of development, and all have inherently
different levels of churn. What we set out to better understand in this paper is the quantifiable
impact of that churn, and what real world retention rates look like for private SaaS companies.
In summary, while you can tinker with the math, a company’s valuation is highly sensitive to
changes in renewal rate because it impacts all the drivers of the company’s value. Almost any
reduction in churn will have a seven-figure, if not eight-figure impact in valuation in a relatively
short period of time.
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