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Summary:

Many SaaS startups will eventually be acquired. Unfortunately, most of the acquiring companies don’t use SaaS metrics. As Matt Fates of Ascent Venture Partners explains, if potential acquirers don’t recognize the overall value of a SaaS company, negotiations will be hindered from the start.

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As a venture investor and board member, I am relentlessly in pursuit of companies that can set forth aggressive goals, and then exceed them. One of my portfolio company CEOs likes to use the term “consciously competent” — which means being successful by design, rather than by luck. Clearly, this is a goal most startups aspire to (although luck is good too!), and it requires carefully tracking metrics that accurately measure the performance of your business model. For many SaaS startups, this has meant inventing new metrics to fit with their model, as many of the traditional ones do not. In recent years, those of us working in or with SaaS companies have become accustomed to variations on such metrics as committed monthly recurring revenue (CMRR), customer acquisition cost (CAC), lifetime value (LTV), churn, etc.

But there is a problem. Many of these companies will one day be acquired, and most of the potential acquiring companies out there do not use SaaS metrics — they use generally accepted accounting principles (GAAP). This creates a disconnect between the two parties, and if potential acquirers do not recognize the overall value of a SaaS company, negotiations are hindered from the start. However, with a little advanced planning, this disconnect can be resolved.

I had the pleasure of leading a seminar last month organized by MassTLC that explored various Software-as-a-Service (SaaS) metrics and how they impact business models and decisions. One of the key topics we addressed is an emerging issue in the era of the “subscription economy” — the misalignment of business metrics between startups and their potential acquiring companies.

As Tyler Sloat, chief financial officer at Zuora, explained during the seminar, traditional financial systems have not kept up with the emergence of SaaS companies, which charge recurring fees that are lower than traditional solutions providers. Tyler pointed out two big problems with traditional income statements that typically measure business performance.

First, income statements are backward-looking. They measure revenues based on how much money a company made in the last period. Second, they do not differentiate one-time revenues or expenses from those that are recurring. These are worrisome factors for a SaaS company selling multi-year subscription plans for ongoing services. And when it comes time to sell the company, the buyers are looking at traditional figures, and not SaaS metrics or accounting figures.

In their early stages, SaaS companies should identify and begin to closely track the metrics that are most important to potential acquirers. Jim Pluntze, the chief financial officer of Navisite (which was acquired last year by Time Warner), told the MassTLC crowd that there are several evaluation metrics involved in a typical acquisition, including revenue and EBITDA growth (earnings before interest, taxes, depreciation and amortization), churn, bookings and capacity. I explained that when evaluating SaaS companies, I compare a company’s total customer acquisition cost with its contribution margin and expected customer duration. And Sloat told us what he sees as the “only three SaaS metrics that matter” — recurring profit margins, retention rates and growth efficiency.

Assuming your startup does not go public one day, your exit options will be limited if potential acquirers do not recognize the value of your business metrics. SaaS company founders should track the metrics that accurately reflect their business performance. But to attain full market value down the road, they must also keep a close watch on the measurements that traditional companies care about most.

Matt Fates is a partner at Ascent Venture Partners. Over the last decade, he has focused on investments in data analytics and cloud business services. Ascent has backed more than 100 early-stage, enterprise IT companies since 1985.

Image courtesy of Flickr user Sterlic.

  1. Great article, Matt. I’ve seen this issue first-hand, at two different companies. And when an acquisition does go through, typical SaaS metrics, and the comp plans that SaaS companies work with, simply do not mesh with the typical license-and-maintenance model of traditional enterprise or even packaged SMB software. There’s no inherent reason this has to happen, flexibility and a common understanding of what drives enterprise value can manage these issues.

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    1. Thanks eisnero. For companies that have built these SaaS metrics deeply into their business model in an effort to be as transparent as possible about performance, such as your example of compensation triggers, the conversion to traditional metrics call really be challenging and often confuse the main objective they were designed to achieve. In my experience, there can be a lot lost in the translation.

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  2. Very informative read!

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  3. Christopher William Crawley Sunday, August 5, 2012

    Great editorial~if Zuck can do it in eight we’ll shoot for six!~Gig is simply the best keep it up great stuff~CWC

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  4. Sounds fine… As long as we do not return to funny-money accounting of the 90′s startups or endorse Groupon-style shenanigans.

    A SaaS venture needs to act like a business, focusing on customer reach, customer value, cost, and return on investment just like any other business. If a more mature company that responds to such pressures is not seeing the value of a booming SaaS startup, I would be much more worried about the startup’s and its investors’ groupthink than. “They don’t get it” is the easy explanation. Often people, even and perhaps especially outsiders, are swayed in favor of hype, not against it. So if the buyer is skeptical, is more likely to be for the right reasons, not because of some mismatch of metrics.

    -gb

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    1. Good point GB. I was in venture in the ’90s when we called SaaS companies ASPs (application service providers) and I agree that there was a fever of over-exuberance. There has certainly been some evidence of this type of behavior returning to certain internet sectors.

      What I am trying to get at here is that there are some fairly fundamental differences between SaaS business models and those of traditional software companies, and it can be hard to make the two mesh, especially in the case of business metrics. Clearly, the overall business case has to be sound and the market traction authentic. Most of the SaaS businesses I am aware of use these newer metrics in an effort to be more transparent about progress, not less. Traditional companies often “dont’t get it”, at least not initially, and that is what enables innovative new entrants to come in and gain market share. I am sure you are aware of Clayton Christensen’s Innovators Dilemma which is a great book on this theme.

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  5. I will never understand why venture capitalist make things harder than they need to be. Subscription based services have been around for a long time (tabloids, newspapers, telephone, television, utilities to name a few). These industries have dealt with subscription based business metrics for decades. But that isn’t good enough for Mr. VC.

    The VCs want to come up with another method to inflate the value of their investments. So let’s create NEW metrics to make things look better.

    How about measuring your business using profit? Remember that thing we used to use to measure success?

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  6. Samuel Vengrinovich Monday, August 13, 2012

    Hey Matt–I really enjoyed your article! It was a great read and I think my readers will really appreciate it as well. Thanks so much. How can I read more?

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