We’ve talked a lot recently about evaluating SaaS vendors at every step of the process. From security protocols to contract details and renewals, we’ve laid out what we know about how to best navigate these murky waters.
And we get it: everyone at any given organization has a different perspective. IT must ensure that all security requirements are met and exceeded (if possible). Finance demands that the business have the most advantageous terms throughout the contracts process. Legal makes sure that contract language is clear and enforceable. And what about the end users? They just want to make all parties happy so they can start using their new SaaS!
Let’s take a step back for a minute. What if, before everyone jumped on this fast-moving SaaS train, we asked a few key questions that could predict the potential success (or failure) of a SaaS vendor? Before your team is committed to using a new platform, and before finance goes through the lengthy contract negotiation process.
What would those key questions and answers be? To get another perspective, we talked with Satya Patel of Homebrew and Nic Poulos of Bowery Capital. Their investment firms both focus on startups, including numerous SaaS companies.
What to ask to determine the financial stability of a SaaS business
You’d think SaaS would be a pretty complex beast, in terms of how to determine financial success. But in reality, investors are looking for some pretty straightforward performance indicators. According to Poulos, a SaaS business should be able to demonstrate the acquisition of paying customers at a price that’s proportional to their operational costs. So they can’t spend more acquiring customers than they actually make selling their service.
Beyond that, Poulos wants to see that a SaaS company can retain those customers they’ve acquired for a long time, in a market that’s large enough to provide ample opportunities for growth. If the business brings on a high volume of customers but loses half of them in the first year or has a tiny addressable market, they’re not considered stable.
The best way to gather this information in a comparable format is to ask for a few specific metrics that capture these concepts. There are a ton of metrics out there for evaluating SaaS - we’re just offering up a few. Here are a few of the most important ones, according to Patel:
Monthly Recurring Revenue
Most SaaS businesses sell their service per duration of time, and many bill their customers in monthly increments. Monthly Recurring Revenue (MRR) is the dollar amount a business is bringing in each month in fees from that service. Plotting out MRR over time can demonstrate growth over time.
The percentage of customers that cancel their service for any given time period is called churn. It’s a great indicator of the overall viability of the business. Churn will never equal zero, but a low churn rate is indicative of a satisfied customer base. A high churn rate may indicate the opposite.
Quick Ratio takes two important metrics, monthly recurring revenue and churn, and compares them to each other. This gives investors a visual representation of money coming in and leaving the business for any given time period. If a business brings in $100,000 in monthly recurring revenue for August, and loses $10,000 in churn for August, the quick ratio is 10. That means you’re bringing in ten times more revenue than you’re losing each month.
Some SaaS businesses will be open with these metrics, and some won’t. However, there are other contextual questions you can ask to get a sense of future success or failure. According to Poulos, one of the biggest risk indicators for a SaaS platform is the failure to test, learn, and iterate, in all aspects of the business (not just the product).
Another one for Patel is organic lead velocity. “The best SaaS companies are the ones that have been able to build their businesses through word of mouth or network effects rather than spending wildly on sales and marketing,” he said.
Metrics may help, but your objectives are tantamount.
Getting the answers to these questions will help give you a more accurate picture of a SaaS company. And really, going through the exercise of asking will give you an idea of how the SaaS provider will respond in the future. But one thing Patel and Poulos agree on is this: these answers aren’t the most important thing to consider.
“The most important thing is finding the platform that meets your specific needs, rather than just buying the platform that is most used by other companies,” said Patel.
Poulos takes it one step further, saying that working with early stage SaaS companies requires that companies be open to innovation. If they aren’t, they risk missing out on the newest technologies developing in the market.
As with any purchasing decision, you can do your homework on a SaaS platform. Ask for performance metrics to see what a SaaS provider will share. But take those metrics with a grain of salt, and consider your business’s goals and appetite for innovation before turning anyone down.