How to survive the SaaS valley of death

Critical metrics for software-as-a-service startups
A long barren road into a sunny valley.

When a new SaaS venture starts, it can be easy to get caught up in the rush of success. A great idea is born, a team comes together and praise starts rolling in.

But how do SaaS startups prepare for the long, dry spell often referred to as “the valley of death?” This is the ominous term for the early stages of a company, before it achieves a sustainable level of monthly recurring revenue (MRR).

“The SaaS model is sexy,” says Susan Richards, the co-founder of Ottawa-based accounting firm numbercrunch. Unfortunately, the SaaS model is also entirely unique in that it isn’t driven by net profits like so many businesses used to be. Instead, success is measured through other key metrics.

As a virtual CFO, Richards believes there are several measures startups should take to make it through the valley of death – all of which are informed by key SaaS metrics. For her, a company successfully leaves the valley of death once it hits an MRR of $100,000.

“Once you hit a critical threshold of customers proving out product/market fit and customer acquisition costs are less than a third of the lifetime customer value you can attract investors and essentially accelerate revenue growth exponentially with VC cash injections,” she explains.

“That’s what all the sexiness is about. But it’s getting to that point that’s a challenge.”

Think strategically

When Benbria brought Richards on board as its virtual CFO, her work largely came down to helping the Kanata-based SaaS company leverage key metrics.

“It’s so critical in the SaaS model to be strategic in what you’re placing your bets on,” says Richards.

SaaS companies have the unique challenge of needing to make many small, recurring sales in the form of subscriptions. As Benbria CEO Jordan Parsons puts it, “How do you keep customers happy when they can leave at any time?”

To navigate this, Richards identifies the following metrics as key to a young SaaS company’s success:

Monthly recurring revenue (MRR) is the amount of revenue a company expects to earn in a given month. This number is especially important in SaaS, since most are sold through a monthly subscription fee. To attract investors, month over month MRR growth needs to be close to 10%,

Lifetime value (LTV) is the overall gross income a company expects to earn from a given customer. If, for example, you expect them to stay with your company for 24 months and your monthly subscription fee is $20 and your gross margin is 80%, then the lifetime value of that customer is $384.

Customer acquisition cost (CAC) represents how much it costs to convert a customer. This boils down to what was spent on sales and marketing in order to get them to “buy” or “subscribe.” The desired ratio between LTV/ CAC is at least 3:1 to demonstrate to investors that there will be a solid return on their investment.

Churn refers to the rate at which customers opt-out of a service (or, stop buying). The smaller the churn rate the greater the lifetime value of the customer base.

Monthly Burn refers to the amount of cash a business is losing each month. In the SaaS startup stage, burn rates tend to be high as software is developed and sales and marketing efforts begin.

Runway is effectively the amount of time before a company runs out of money. It’s calculated by dividing the funds available to the company today by its burn rate.

Have a bookkeeper

Organization is key in leveraging SaaS metrics. Without tracking revenue and expenses, it becomes easy to lose sight of where a business stands.

Richards explains that numbercrunch often has clients come to them after months or even years of operation without a bookkeeper. Many realize too late that they have a mess on their hands in terms of the company’s finances.

“Clean up is expensive,” she says.

In an effort to support Ottawa’s startup community, numbercrunch offers free bookkeeping to startups for up to a year.

“We want to help companies get it right from the start,” says Richards. “Ultimately, the spirit of what we’re doing is trying to help businesses, not just be a business for ourselves.

Outsource

Measuring and understanding these metrics isn’t enough for SaaS startups. Successful companies also find ways to manage them as best they can. While growing a company requires that you spend money, it also means being selective in how you do so.

Richards recommends SaaS startups first aim to obtain 20 paying customers while spending as little as possible. Then, they can start to invest in marketing and sales, when a little hustle no longer does the trick.

As a virtual CFO and an entrepreneur herself, she suggests selectively outsourcing to save on expenses at the outset. For SaaS, this might mean leveraging local development partners and having a 50/50 blend of employees and contractors so that you can easily expand and contract. This would allow a fledgling SaaS businesses to extend its runway with a flexible resource team.

Many startups now, whether SaaS or otherwise, also outsource their financial support services.

“We have the ability to have professional financial services provided to us at a fraction of the cost while we’re a young, emerging SaaS company,” says Benbria’s Parsons. While he no longer views Benbria as a “young” SaaS company, he recognizes that they’re still in a phase where outsourcing the firm’s financial services makes the most sense for their business.

“Susan makes it very easy for me to stay focused on the business, instead of worrying about the financial side,” says Parsons. “She gives me a very pragmatic, realistic view about things I need to be concerned about and ways I can make changes.”

Numbercrunch is a one-stop-shop for business financial services. The company offers cloud-based bookkeeping, and virtual CFO and Controller services. To learn more or to request a quote, visit numbercrunch.ca