By Monika Ghosh
When you first start your business, the metrics you are concerned about are probably only revenue and cash flow. However, when seeking investment, founders have to produce more than just a revenue forecast or break-even analysis.
Even if you are bootstrapping, it is important to correctly evaluate your financial position and detect potential pitfalls. How well is your startup really doing? When will it achieve profitability? When will your business run out of money? Are you spending too much on acquiring customers, or losing customers faster than you can acquire new ones?
Tracking essential metrics can, therefore, help entrepreneurs effectively determine their efficiency, provide key insights into the financial health of the company, and also help provide a clearer picture of the startup's potential and sustainability to investors.
Essential metrics that founders need to track vary based on their product/service and industry. In this article, we look at 10 essential metrics that investors examine while considering investment in a Software-as-a-Service startup with a subscription-based model.
For a subscription-based SaaS business model, the number of customers not only determines your Monthly Recurring Revenue, but also helps you understand how well your service is doing. A growing base of customers is indicative of how well your service is being received and provides investors with a clear view of your startup's potential to grow.
Moreover, for any startup, their customers act as their brand ambassadors, recommending the services to others who may ultimately convert into revenue generating customers in the future and add to your customer base.
Customer churn rate is a critical metric for any SaaS startup, and refers to the rate at which you lose your customers. In other words, it is the percentage of your service subscribers who discontinue their subscription over a given period.
A double digit churn rate in a SaaS startup could be indicative of a fundamental defect in your product or service offering. However, tracking churn rate may not be enough if you do not investigate the reasons behind a customer's decision to discontinue their subscription.
Customer retention over long periods increase your chances of survival in the long term. While customer retention merely refers to how many customers you retained over a period, NRR indicates the net revenue left over from your customers over a given period (usually calculated annually).
NRR, also referred to as the Dollar Retention Rate, takes into account the total revenue earned in the previous year, minus any contraction in revenue caused by customer churn, or customers who have downgraded their subscription, while considering all increase in revenue caused by cross-selling, upselling, customers upgrading their subscription, or increases in subscription plan rates.
For SaaS startups, an NRR rate of 100% or higher is indicative of a successful business with satisfied customers, while a lower NRR rate indicates that your startup is losing too much revenue annually.
Perhaps the most important metric for any SaaS startup with a subscription-based business model is MRR. As the name suggests, it is simply your total revenue generation each month, and can be calculated by adding up the revenue from every customer.
By tracking MRR, you can track your business' growth or decline in revenue, and develop accurate revenue projections for investors.
ARR can be calculated by multiplying your MRR by 12, while also factoring in MRR churn and other relevant factors. It is most relevant when subscriptions have a term duration of one year or more. For investors, ARR is one of the most important metrics, as it provides an almost accurate revenue estimate and a good indication of future revenues.
6. Annual and Total Contract Value of new bookings:
Annual Contract Value (ACV) refers to the value of subscription revenue from each new contracted customer, averaged across a year. For example, let's say a customer signed a 2-year contract for $10,000 and paid a one-time fee of $500. Your ACV would be [$10,000/2] = $5,000
Total Contract Value (TCV), on the other hand, is the total value of each contract that a new customer signs. The contract duration could be greater than or less than 1 year and also includes one-time fees, if any. For the above example, the TCV is $10,500.
7. Customer Acquisition Cost (CAC):
CAC can be calculated by dividing the total expenses incurred to acquire customers, like the cost of marketing campaigns, or the salary of sales and marketing staff, by the number of customers acquired in any given period.
The CAC, as a metric, indicates the viability of the business model to founders, who can use it to optimize return on investment in marketing campaigns. To investors, this metric indicates the scalability and profitability of the startup.
8. Life Time Value of a typical customer (LTV):
LTV refers to the prediction of revenue that a customer will generate for a business in their lifetime. Calculating LTV can offer key insights into what you are doing right and how you can improve.
It can also help you determine the most profitable customer segment, what they want, and how much you can spend to acquire them in order to have a profitable relationship.
9. LTV to CAC ratio
LTV to CAC ratio indicates the return on your marketing investments. In other words, it helps you understand whether you are making, or are likely to make, a profit from your customers.
In order to survive, a business needs to make a profit, and the LTV to CAC ratio can help you understand if you are spending too much on acquiring customers who do not generate enough revenue for you to recover your cost of acquiring them.
The LTV:CAC ratio is usually benchmarked at 3:1 which means that a customer should generate at least three times the cost you incurred in acquiring them.