10 Habits Of A Highly Efficient/Successful SaaS Company

Over the past 24 months, software companies have been hit with a myriad of economic circumstances which have caused a deceleration in growth through both decreased new bookings and, for most, higher churn levels.

SaaS multiples have adjusted to this new reality: overall EV/LTM revenue multiples of public SaaS companies have seen a steep drop across the board from Jan.21, with high-growth unprofitable companies most penalized. However, some companies in the world of software have continued trading above 10x LTM revenues, considered as “best-in-class” valuations. What do these companies have in common in balancing growth and profitability? What lessons are to be learned? We explore the topic in this report based on Q2 figures and initially released to our clients on September 25th, 2023.

The last 4 years have been a roller coaster for SaaS startups. Following the start of the pandemic, software as a service (SaaS) became the hot investment sector. At the peak, Enterprise SaaS companies raised $24.7B in Q4 2021, but this level has fallen to $6.6B in Q3 2023, the lowest levels since the pre-pandemic quarters of 2018 per recent Pitchbook data. The IPO of Klaviyo was a bright spot for SaaS over the same period.

Compounding the problem for SaaS companies is that growth has been much harder to achieve. Over the past 24 months, software companies have been hit with a myriad of economic circumstances which have caused a deceleration in growth through both decreased new bookings and - for most - higher churn levels. But as we enter 2024, growth is picking up boosted by more favorable macro tailwinds.

This is also reflected in overall EV/LTM revenue multiples of public SaaS companies, which have seen a steep drop across the board from January 2021, with high growth unprofitable companies most penalized. Indeed, as future cash flows are increasingly discounted, high growth ‘Zero Interest Rate Babies’ (ZIRBs), suffered most as their ‘growth at all costs’ mindset rendered them less profitable than other public peers. These companies are trying to adapt to this new reality and have kept a lid on R&D and G&A spending.

But still some SaaS companies are faring very well: the very best (but few) SaaS companies have continued trading above 10x LTM revenues, with the average software EV/LTM multiple standing at c.5x as at September 2023.

This begs the question: What defines “the very best”?

At the highest level, the answer is: efficient growth. This is essential for balancing competing demands that a company produce high rates of growth while achieving profitability.

This may seem impossible, but it’s not. Even as startup valuations are crashing, stellar SaaS companies are being built. Still, it’s hard for investors to spot the winners among private companies and for founders to know how they can demonstrate that efficiency.

To unlock this riddle, we did a deep dive based on Q2 figures on 20 publicly traded SaaS companies across Horizontal and Vertical Applications and Infrastructure Software. Of those, 19 have been classified as best in class because they have valuations at 10X of their ARR. These include Adobe, DataDog, Atlassian, and Cloudflare. We added Klaviyo, which went public last September. And then we used the data from 96 B2B SaaS companies from Iconiq’s portfolio to serve as an additional benchmark. Please note that our study was completed as at September 25, 2023 and first communicated to our client base.

We wanted to identify the characteristics shared by these top-shelf SaaS companies. To do that, we created a framework of metrics to evaluate these companies.

Here are the 10 we found to be most highly correlated with Efficient Growth:

(1)    Gross Margin: Consists of a company’s revenue after the cost of goods sold. Typical expenses include hosting costs, software implementation costs, and services costs. The selected best-in-class high-growth SaaS companies have a median GM ratio of 76%. Most of these selected companies remain above the Iconiq index (74% GM). Note that with the shift to efficiency, many SaaS companies have cut their customer success and transformed the CSM role into a sales one, which should lead to Gross Margin improvements on the short term for SaaS companies operating an enterprise playbook at least.

(2)    S&M Expenses: Costs incurred by a company to promote and sell its products or services. Typical expenses include marketing, sales staff costs and sales commissions, CRM and software costs as well as travel and chancelry. Median LTM S&M spend as a % of LTM revenue stands at 34%. Over the past 6 quarters, the average S&M spend as a % of revenue is down by (5.2) pp.

(3)    ARR >$100k: Highlights whether the company is pursuing an SMB vs. Enterprise playbook as well as the company's ability to attract and convert high-value clients. This has proven to be one of the key levers in pivoting to efficient growth in the course of 2023. Note however that only a few of the companies analyzed disclose figures on customers with an ARR>$100k.

(4)    Gross Retention Rate: Indicates what % of revenue a company has maintained within its customer base, excluding the impact of expansion from retained customers. This figure highlights a company’s ability to retain customers. Only a few of the companies analyzed disclose figures on GRR, which is a key missing item as GRR is critical in assessing the quality of company’s growth. The average GRR of the selected companies is 95% (small pool of comparables).

(5)    Net Revenue Retention: Indicates what % of revenue a company has maintained within its customer base, including the impact of expansion from retained customers. This highlights a company’s ability to retain customers and expand revenue of existing customers. The selected companies display c. 120% NRR.

(6)    Net new ARR breakdown: Presents the breakdown of net new implied ARR in between existing customers and new customers, showcasing the Company’s reliance on the acquisition of new customers in order to generate growth. Net New Implied ARR breakdown in between new and existing customers reaches 63%.

(7)    Implied ARR per Employee: ARR per employee (presented on a headcount, non-FTE basis), showcases the Company’s operational efficiency and is a relatively straightforward indicator to capture efficiency. The Implied ARR per employee of the selected companies stands out at $350k on average. Most of the selected companies remain above the Iconiq index which stands at $255k.

(8)    Subscription Rev. Growth: The rate at which a firm’s subscription revenue (only) growth is evolving. Subscription Revenue annualized growth rate (based on last 6 reported quarters) for selected companies stands at 35%.

(9)    Rule of 40 on Op. margin/ on Op. CF margin: Indicates that a company's growth rate plus its operating margin or operating cash-flow margin should equal or exceed 40%. It helps assess if a company is striking a balance between rapid growth and profitability. Meeting or exceeding this benchmark suggests financial health, while falling below may require a strategic reevaluation. The selected companies reach the 40% bar (median). Adding working capital impact, the selected companies reach a 41% median. In our view, it is a better basis for calculation of Rule of 40 than taking into account Operating margin solely.

(10)   CAC payback: Rate at which the costs spent to acquire a customer (CAC) is repaid on a gross margin basis. Most of the selected companies achieved a CAC payback period of less than 10 months, for a median 6 months.

Though no metric can be predictive of future success, by optimizing their companies around these metrics, founders will increase their chances of raising late-stage capital or going to IPO by presenting a compelling case for resilient growth. At the same time, investors can have greater confidence that such high-growth companies have set themselves up for long-term success.

However, a word of caution: Even companies who have struck the perfect balance on efficient growth should not grow complacent. Current advancement in Generative AI technologies will completely disrupt both:

•       How SaaS companies grow through fundamental changes in Product design as well likely pricing increases as further value is delivered to users;

•       As well as their cost structure due to (i) additional costs for inference, fine-tuning and cloud but also talent and potentially infrastructure alongside (ii) savings namely on R&D, S&M and professional services as GenAI is embedded into internal processes for enhanced productivity and efficiency.

 What will the typical SaaS + GenAI P&L look like? What will tomorrow’s ‘Rule of 40’ be and what investments will it advise? This is the topic of our next study that we’ll share in the coming months. Connect with us on Linkedin and stay tuned to find out more!