The Official SaaStr Podcast: SaaS | Founders | Investors
00:05:12 · Christine Edmonds
[00:05:12] S2: Great. So let's dive into some of the actual results. We're gonna start with growth and then we'll spend some time on efficiency and bring it all together at the end with some 2022 insights. In the most basic manner, when we think of growth, we're looking at growth in ARR or annual revenue. And so to to just put some real numbers behind this, first, we wanna recognize that it is hard to get to 10,000,000 in ARR. It is very hard to sustain that growth through the 10 to 50,000,000 benchmark and then on beyond that. And so what we look at, we see our top quartile companies consistently hit doubling their ARR in those first two to three years, but more notably, continuing to have really robust growth in the years leading up to IPO with about 1.5 x. And so you see here the net new ARR doesn't just level off, which is something that is very easy to happen, but it's actually growing by an incremental 15 to 25,000,000 every single year. So what's driving this growth? Never before has it been more important to understand your customers, their health, their size, the concentration, and much of that is because it does relate really closely to the various drivers of growth and understanding how to think about where your revenue is coming from in every single year and every quarter. Fairly consistently, we see companies over time lean on expansion efforts more than new logo when they think about the contribution to gross ARR. There are also times like now where it can be much easier and really beneficial to be able to lean on that expansion motion when markets are a little more volatile, demand may be less predictable, but we did wanna highlight the importance of really nailing the ability to win new logos. All of you here who are founders, I'm... Have no doubt are in extremely competitive markets. And so building a really robust go to market motion and an engine that can sustain that growth but also capture a lot of those new logos early on is critical to have a strong base to actually expand into later on. That also makes sure that you won't have too high of a customer concentration, which, of course, can lead to some volatility when it comes to churn with every single customer mattering more.
00:07:17 · Doug Pepper
[00:07:17] S1: Yeah. I was gonna share an anecdote. I was lucky enough to be involved with Marketo from its founding and through IPO on the board for ten years, and it was founded in 2006. So it was actually one of the very first companies that was exploring this business model and many of these metrics. And I'll never forget a board meeting that we had probably around 150,000,000 ARR where we all collectively realized kind of simultaneously that the Chief Customer Officer who's in charge of upsells, expansions, had a bigger net new ARR number that year than the VP of Sales. And it really reoriented how we thought about customer success and thinking of it more as a revenue generation function than simply account management. But I agree with what Christine said. In the early years, Marketo and most of our very successful companies are focused on new logo velocity, winning the market, closing new deals from new logos. So speaking of expansions, obviously that's a key factor in what I think everybody in this room knows is a core metric to understand the health of a software business, and that's net dollar retention. And we looked at our top quartile of companies over the five years after 10,000,000 ARR, and you can see one thing here very clearly, that these companies very consistently have extraordinarily high gross and net dollar retention. But I'll call out a couple of nuances here. One, these gross dollar retentions for anybody who's running one of these businesses probably looks quite daunting. These are big numbers, and they are being dragged up as an average with some of the very top performing companies. When you look at the median, it's closer to 90 to 93 in terms of gross dollar retention, and even some of our businesses that are selling to SMBs, for example, do very well in the high 80s gross dollar retention. On net dollar retention, again, you can see that consistency, 120% or above, but we have a number of companies that do a whole lot better than that, and they do that in a variety of ways. Take Datadog, for example. They have just done incredibly well in rolling out new products and a land and expand motion as part of that.
00:09:28 · Doug Pepper
Snowflake on the other hand, with their usage based model and amazing value proposition, both of them have shown net dollar retentions well over 150%, which when you look at how they're valued in the public markets, they're rewarded handsomely for that. So we've talked a lot about top line growth, components of top line growth, net dollar retention. Let's talk a little bit about efficiency. But before we get into the details of that metric, we thought this was actually a really interesting slide for indicating the importance of growth versus efficiency in the minds of public market investors. And I'll try to make this slide simple. So the green line is growth. It's all about kind of growth, maybe growth at all costs. The blue line is rule of 40, which is a very normal measure of efficiency of growth. You're looking at revenue growth plus free cash flow. When the green line is above the blue line, public market investors are focused on growth, above efficiency. And you can see kind of pre pandemic, the blue line was above the green line. People cared about efficient growth. And then I think we all know the last two years, it was all about growth. The green line is way above the blue line. And of course, I think we've all felt the shift in the last few quarters where the blue line has made a dramatic move up and now public market investors are really focused on efficient growth again, which is why I think everybody in this room is probably thinking about that more now than the last two years.
00:11:02 · Christine Edmonds
[00:11:02] S2: Great. So with that, we're gonna spend a little bit of time talking through some efficiency metrics. The first question we often get when we start to talk about efficiency is does increased focus on efficiency come at the cost of productivity, And how do I make sure that I'm still feeding that engine and driving that growth as I shift focus towards efficiency? The short answer is no. They're not mutually exclusive. And one of the ways in which we look at this is on a per employee basis. For most SaaS companies, somewhere between 6075% of your costs will be personnel related. So it's a fairly simple and really important way to understand both your revenue generation as well as the efficiency of the spend. As you'll see here, right around that a $100,000,000 ARR mark is where we see these begin to flip in relationship and actually being able to generate more revenue on a per employee basis than you are incurring costs. If we extrapolate this chart out leading into IPO, we actually see the trend continue. So companies are able to incrementally increase ARR per FTE while maintaining OpEx per FTE right around that 200 to 220 k range.
00:12:08 · Doug Pepper
[00:12:08] S1: So diving into efficiency by function, not a lot of surprises here. You can see, again, year zero is when a company is around 10,000,000 ARR, and this is kind of the average of this great dataset, and then on to year five. And of course, at that 10,000,000 level, companies are spending a lot more than they are in revenue. But then over time, by year five, they're now spending less than revenue and flipping over into profitability. In those early years, of course, we're all investing and backing and building product oriented companies. So you see R and D is a very significant expense in year zero, around 10,000,000 ARR, but it shrinks as a percentage of OpEx from about 30% to 25% as you go through the years. But of course, we all know these products don't sell themselves. And so interestingly, even as companies get more efficient overall, they actually spend more in sales and marketing as a percentage of OpEx over time, kind of going from 50% of OpEx to 60 over those five years. To put some numbers on it, in our dataset of our companies by year five, companies are spending typically about $100,000,000 in R and D product and $160,000,000 in go to market by year five. So obviously another metric that I'm sure you've all read about and heard about the last few years to measure efficiency is burn multiple. And it's a very simple but pretty effective way to measure the efficiency of growth of the businesses that we're all involved with. And the obvious definition there is for every dollar that I'm spending, what am I adding in net new ARR? And you can see here, again, this is our dataset and this is the average. When a company's adding about 10,000,000 net new ARR, they are typically burning about 20. And so it's 2X. This is actually an old slide. So the real number here that we typically see is 2x burn rate multiple. And then it trends down over time. Typically what we're seeing, and again this slide is a bit off, we can give you the updated slide. By year five, companies are typically adding 50,000,000 net new ARR and burning about 50,000,000. So it's kind of one to one. And this is obviously a bit confusing here, but I will make kind of a nuanced point. The data set, again, as Christine said, is companies that are really far along.
00:14:37 · Doug Pepper
These are public companies, these are late stage private companies that largely went through this phase, call it five years ago or so. And what we've seen in the last two years, given the green line of growth was much more valuable than efficiency, companies really ramped their burn multiples. And we've been meeting with companies all the time in the last two years that are burning three, four, five times what they're generating in net new ARR, which you could understand given they were being rewarded for that in the private and public markets in terms of valuation. That's over. And so I think collectively investors, founders, entrepreneurs are having to reorient their burn multiples to what these great companies were doing five or ten years ago, and that's a hard process. We'll talk more about that.