Have you ever wondered how investors evaluate SaaS startups? And what kinds of things they're looking for in the due diligence process?
In this video, Karan Mehandru, General Partner at Trinity Ventures joins Robert J. Moore, Founder and CEO at RJMetrics, and a former VC analyst, to discuss what investors look for in top-performing SaaS companies.
Bob: Ladies and gentlemen, welcome to “Evaluating SaaS Startups: The Investor's Perspective”. I am Bob Moore, CEO and co-founder of RJMetrics and I am extremely excited to be bringing you this webinar today, along with the rest of the RJ Metrics team and of course, our special guest, Karan Mehandru who I will introduce in a moment.
We've got a really great crowd here today and we're very excited to be sharing a lot of Karan's knowledge about investing in SaaS startups, along with some insights we've picked up along the way here at RJMetrics. Just to give everybody a general sense of how the webinar will play out today, I'll be leading a Q&A at the end of the presentation. So as you have questions along the way, we will be monitoring the hashtag #SaaSInvest. So if you just can submit your questions via Twitter with that hashtag, we'll be keeping a running list of them and we will do our best to get to as many as possible at the end of the webinar.
Of course, we are recording the show today. As many of you know from our past webinars, we will be following up with an e-mail after today's presentation. We'll include the link to the show if you want to share it with friends or colleagues and all kinds of other resources that are related to the things we talk about today.
Of course, the last bullet about cupcakes which everybody always loves, be sure to stick around. From among the crowd that is actually in the room today, we will be selecting a winner and sending some cupcakes your way. So stay tuned for that giveaway at the end as well.
With all that out of the way, I couldn't be more thrilled to be introducing Karan Mehandru, a general partner at Trinity Ventures today. Karan has one of the most awesome kind of up and coming SaaS portfolios in the marketplace in my personal opinion. RJMetrics happens to be a part of it, so there's a bit of personal bias there, but it's been really amazing watching Karan's portfolio flourish and grow and really make a name for itself in this SaaS marketplace from a venture perspective over the course of the past couple of years of us working together.
I can't thank you enough, Karan, and welcome to the program today.
Karan: Hey, Bob, great to be here and thanks for having me.
Bob: Awesome. So we'll learn a bit more about Trinity in a second. But what I want to share with the audience is what they're going to learn here today in the webinar. Just a couple of high-level bullet points. We're going to talk about what investors are looking for in the due diligence process where they are observing and trying to assess whether or not a company is worthy of investment. We're going to talk about the signs that might indicate where there are big opportunities from an investment perspective and some of the areas that might even extend beyond just the basic operational metrics that give investors [inaudible 00:02:43] a company can really get.
Of course, we'll cover those high-level metrics themselves that really matter for quantifying company performance and talking about when you're evaluating a SaaS company; specifically, what matters the most to investors and what is always going to be looked at very thoroughly before an investment happens. So for people in the crowd who have raised the venture round, you might hear some familiar things and learn a few things as well. If you are an aspiring fundraiser, this should be a very, very educational process for you.
The webinar today is brought to you by RJMetrics. We are a complete analytics platform for online businesses. So whether you are a SaaS company, an e-commerce company or pretty much anyone who is selling something over the Internet, we are really a fully-integrated solution that allows you to go from a state where your data is stored across many disparate sources, to a world where you have complete control over all of the knowledge about the people and populations that interact with your business.
We've got a lot of really great SaaS companies like BeenVerified, Hootsuite and Formstack that work with us to understand not just the metrics that we'll be talking about today, but a whole universe of analyses that are relevant to building their growing businesses and making sure that they're always one step ahead of the growth that's coming their way and the competition in their marketplace. If you haven't tried out RJMetrics, definitely check us out at RJMetrics.com. We do a 14-day free trial, it couldn't be easier to get set up and I hope we'll see a lot of you.
I want to give Karan an opportunity also to just talk a little bit about Trinity Ventures, the venture firm where he is a general partner and also a firm that we've worked with. Karan, would you like to chat about Trinity for a second?
Karan: Absolutely. Thanks, Bob, and it's great to be talking to everyone today. Give you a little bit of an overview of Trinity Ventures. We were founded back in 1986 by our founding partner, Noel Fenton, who continues to be with the firm and we were founded on the principles of hard work, collaboration and dedication to our entrepreneurs and those are values we uphold to this day. In an effort to stay true to those values, for almost three decades, we've maintained the highest general partner to capital ratio of any top-tier Silicon Valley firm for one reason and one reason only, which is we were always available to our company.
We're currently investing our eleventh fund dedicated to partnering with early-stage tech companies with emphasis on Cloud and mobile infrastructure, Software as a Service, digital media and social and mobile commerce. As Bob mentioned, I'm one of the general partners in the firm and I invest in SaaS, Big Data, mobile and Cloud infrastructure and applications.
A little bit about my career. Prior to Trinity, I spent about a decade in the operating side and product development, marketing and software sales in various parts of the U.S. and Canada and then did a stint at a late-stage venture capital firm before joining Trinity in 2010 to focus on early-stage companies.
Since we're discussing SaaS companies here, just to give you a quick flavor of our SaaS portfolio, we have investments in companies like ServiceMax, which is a field service automation SaaS play, New Relic, application monitoring for developers, Act-On software, which is marketing automation SaaS, Taulia, Jama Software, Simply Measured and of course, RJMetrics. Many of these companies are ones that I'm fortunately involved in. So really happy to be talking to you today about that.
Bob: Great. I think all of that experience, I think what's really exciting about it is that you've got a background not just as an investor, but also in operational roles and working with later-stage companies and early-stage companies. So that should provide a lot of perspective that's relevant to pretty much everybody in the crowd.
We could talk about what makes a SaaS company interesting for hours and I think we have at various points in our collaboration, Karan, but I guess maybe just a broad-reaching question to start things out. I would love to just kind of get your gut take on where you start when you are evaluating a Software as a Service company?
Karan: Sure. I would say, in general, it's not too different than how to evaluate any company, but SaaS is particularly interesting for a lot of reasons, not the least of which is the fact that the predictability of the business itself lends itself to a lot of analysis and metrics, which is obviously good news for a lot of entrepreneurs like yourself and investors like myself who are data geeks. But I'd say the three things that I look at at a high level is the first thing I look at is where the company is in its stage of evolution and within that stage, I look at things like departmental maturity and operational metrics that are relevant to that stage.
But before I get into that, let me set a little bit of context and highlight some of my biases so that people have a sense for how I look at investment opportunities and companies, in general. First, my bias, my investment style is more thematic. I spend a lot of time looking at how technology trends will impact the evolution of SaaS products in markets. This allows me to pick markets that I think are poised for inflection and get more nuanced about those and how software, particularly SaaS can either disrupt or augment in those verticals. At the end of the day, as you and I know, SaaS is a business model and a underlying infrastructure. So the onus is still on us as investors to pick the right market. That's what I spend a lot of time thinking about.
Secondly, I would say identifying the risks. I'd say most startups, and by association, VCs, are taking one or more or four risks. They're either taking market risk, team risk, product risk or execution and scaling risk. Understanding where the company and the surrounding market are in their evolution and on that risk continuum is step one.
I would say with that as context, let me address your question. So within verticals that I've identified that I think are right for inflection and hence, investment, I typically classify SaaS companies in three stages. The first stage being pre-revenue to $1 million in annual recurring revenue. This is sort of when a company is just getting started. In this stage, I typically look for an A+ team and solid conviction in the target market they're going after. I like to over-index on a team if the market is already well-defined and large.
For emerging markets, which by definition are small, I spend a lot of time thinking about what the rate of expansion of that market is and what the right product would need to look like. That's sort of an area where Trinity has done really well. This is our bread and butter. Most of our investments are Series A and Series B. We're usually the first institutional investor in a company and as a firm, we've done a lot of investments in this category with companies like New Relic, TubeMogul, Docker, Preact, Dot & Bo, Taulia. All these companies who are in that sort of that pre-revenue to $1 million in ARR when we first invested.
The second stage that I classify SaaS companies in is about between the $1 million to $5 million in annual recurring revenue. This is typically when SaaS companies are at the cusp of breaking out. They're also at this stage exiting the right brain, as I like to call it, and appeal to an investor's right and left brain concurrently. I know you and I have had a lot of conversations about what the right brain and left brain contain and I'm happy to get into that.
But for the sake of this discussion, I'd say in this stage, I generally like to over-index on product leadership and I look for early, efficient growth metrics before it's hit the inflection point. That includes ARR, churn, sales efficiency, up-sales and a bunch of other metrics, which I'm sure we'll discuss later on in this webinar.
Bob: Yeah. We'll dig into all those acronyms for the folks that are writing furiously. We'll dig in in a minute.
Karan: RJMetrics, of course, was a great example of a company at this stage when I invested, which showed a hugely lucrative market. It was in need for disruption, an A+ team in product leadership and sales efficiency that went along with it. You know, the companies that we invested in at this stage include Act-On, RJMetrics, ServiceMax, Jama Software. This is sort of where I index on product leadership and early efficient growth.
I'd say the last stage is typically when companies get to the $8 million to $10 million in ARR. At this stage, you're primarily undertaking an execution and scaling risk. You're looking for category leadership and execution excellence and metrics that are generally leading indicators of long-term, sustainable growth. I guess in today's vocabulary, this would be termed as "a clear path to unicorn or decacorn status," I guess.
Bob: It's amazing how "decacorn" has . . . unicorns weren't quite enough. So I think that evolution of that term has been pretty entertaining. That's really interesting. It's actually maybe a relevant question in the capital markets that we've seen recently where there's a lot of very aggressive investing happening into SaaS companies. When you think about those three different categories, have you seen those buckets shift at all? If not for you, then for kind of the investment community more broadly? Or do you think that that's kind of a set of three categories that's pretty standard across the industry?
Karan: I think, in general, the evolution of the companies typically traverses those three categories. It's not rocket science why these categories exist. I guess from my perspective, what I've seen in my portfolio that it's usually when you get into these three categories when you tend to test and readjust many assumptions about your own business. This includes the scalability of the teams itself, the back-end infrastructure that you're using, the methods of lead generation that you're potentially employing to get customers through the funnel, the sales efficiency ratios that waver pretty widely in and around those categories and a bunch of others.
I think what's changed is the class of investors that are playing in some of these categories because of the abundance of capital that exists today in the ecosystem. So in the late-stage category, there's a lot of public investors that are investing capital in private companies and I think that's just a trend of a bull market. Usually when the markets are buoyant, you see that trend happening.
But in essence, I would say when we look at companies, and I'm sure that's true of other SaaS investors as well, I tend to look at sort of how mature the companies are, what the metrics are, the intrinsic metrics to sort of give me a sense of the health of the company, and I like to know where they are on that continuum and have they gone through that effort of reassessing and retesting [inaudible 00:13:16]. That's generally held the test of time for various different verticals, as long as you have a recurring SaaS business model with a high-velocity sales model.
Bob: Makes a ton of sense. I want to dig in a little bit on some of these operational metrics that we've been talking about. I think it's where a lot of people when thinking about data in their own business tend to gravitate toward learning first. I think it's probably a pretty good place for us to start.
This is a question that I'm sure has a lot of right answers, but what are those high-level operational metrics that really matter to you?
Karan: Sure. I'd say in general, I'm looking at the growth of the business, the capital efficiency and the unit economics and the underlying unit economics of the business. I think those are the three things that I spend a lot of time looking at.
Again, this assumes that you actually are at that stage where you have metrics to look at. Obviously, if you're pre-product, then you'd look at the things that I mentioned in the pre-revenue to $1 million ARR level. But let me just go through a bunch of high-level metrics that I think are really important to track and look at as you're growing your business.
Karan: To me, the most important metric that I look at is the rate of addition of new annual recurring revenue or as we like to call it, ARR, which is essentially the gross new ARR that you're adding, plus up-sells from existing customers less churn. That gives you the net new ARR for the business. That's, to me, the single most important metric because we are investing in companies for growth and that essentially gives you a sense for what the current momentum of the business is and the rate of addition of new ACV or new ARR gives you proof of existence of a new, highly recurring revenue stream. That's, to me, probably the most important metric to track, as you’re thinking about companies scaling from the different levels that I mentioned earlier.
Other things that are very important to look at are churn. I generally encourage SaaS companies to look at both customer and revenue churn. One of the things that I generally highlight, and I know you and I have had multiple discussions about it, is making sure that you're tracking discretionary churn and not just regular churn, which essentially means that you're tracking the rate at which you're churning dollars or customers as a function of the number of dollars that are eligible for renewal, as opposed to your total recurring revenue base. I think that gives you a very good sign of the health of the business and whether customers are getting value from the product that you're selling to them.
Other metrics, average contract values is generally a good indicator of whether a customer and companies have the ability to move up market over time. The lifetime value, which is a function of the average selling price and churn. The cost of customer acquisition or CAC as we like to call it. It's the fully-loaded cost of acquiring a customer and maybe we'll get into the details of this later in the webinar, but that has also evolved over time as things like customer success have played a key role in acquiring and retaining and growing customers. You have to make sure that you account for that as well.
Then looking at efficiency ratios and the unit economics, I would say ratios like the lifetime value to CAC ratio, the CAC payback or SaaS "magic number" as it's been known to be called, which essentially gives you a sense for how quickly you're recouping your costs of acquisition. In some ways, it's like the software equivalent of churns in a business.
Then the cash consumption rate or burn rate. Personally, I don't like the visual of my cash being burned, but that is how people refer to it.
Bob: You and me both.
Karan: That is how people refer to the cash that's being invested for growth. Then some qualitative metrics and quantitative metrics around the Net Promoter Score and customer satisfaction. I have some thoughts on that part, which I'm sure we'll get into later.
But those are generally the high-level metrics that I think will give myself and even the founders and CEOs of those companies a very good sense for what the health of the business is.
Bob: Awesome. I want to double-click on a few of those, because I think there was a lot of really valuable information there. Also just to remind our audience that if you check out the RJMetrics blog, you can actually find an infographic that contains pretty much all of the metrics that Karan just mentioned. That is, basically, the one infographic you need to visualize all of your SaaS metrics in one place. That might be a helpful companion piece to this webinar as well.
One thing that I wanted to explore just a bit, there's potentially a bit of nuance in . . . you mentioned ACV, the average contract value, which is pretty much just a reflection of how big the deals are that the company is signing up. It strikes me that for some of the companies that you mentioned that are even maybe in your own portfolio, ACV could vary quite greatly; a traditional enterprise deal could be worth six or seven figures a year, whereas some companies that sell to small to mid-sized businesses might have a much smaller ACV.
Can you talk a little bit about how businesses that have a big ACV versus a small ACV might look and behave differently from one another? Is there really a right answer to the ACV question or is it really just in kind of how well you play the playbook at your side of ACV?
Karan: Yeah, sure. I think at the end of the day, I think the ACV of the product is a function of sort of the market that you're targeting and what the price that the market is willing to bear. In some sense, I think if you're going into the high-end enterprise market and the Fortune 1000 space, I have some companies in my portfolio that are targeting that part of the market. I think the ACVs are generally higher and I think, as you sell into those markets, you realize the sales cycles are a little bit longer.
You might actually need a field sales force. The methods of lead generation are a lot more high-touch and you typically need a services organization or a customer service organization that is also high-touch because there's a cost of implementation and deployment of these customers. In general, I would say that the whole GoToMarket model, that sort of operational model is generally aligned with the high ACV customer selling to the large end of the market.
On the other hand, I also have companies in my portfolio like Act-On that are selling marketing automation software to the mid-market. Their sales cycle is about 29 to 30 days. The average ASP is around $15,000 a year and that model doesn't lend itself to having a very cost-intensive sales force or a very big services army. I think in that sense, we have a very high velocity inside sales team that essentially nurtures the customer through the pipeline.
I think in those models, there's a big ask from the product, which is that the product is intuitive and easy to use and customers can pretty much self-serve themselves or get a very good sense for how it's going to be valuable to them before even having the first conversation. I know RJMetrics spends a lot of time making sure that customers are getting what I call "time to value”, which is almost immediate. I think if you're selling to the mid-market or the SMB part of the market with a lower price point, you almost have to employ a very low-touch, high-velocity inside salesforce in which case, the ratios would still work if the cost of customer acquisition is low because your lifetime value would be a lot lower than if you were selling to the large end of the enterprise.
Bob: Makes a ton of sense. The other thing that I wanted to dig into a little bit, that first metric that you mentioned which basically amounts to net new ARR, so how much new business are you adding after you take away maybe companies who stopped paying you or companies who are paying you less than they were over the previous period. It's interesting that there are a lot of inputs to that. So on a gross basis, just how much new business are you adding? Then there's your churn rate, there's a certain rate around up-sells, there's a certain rate around downgrades, potentially.
Then I'm wondering, for a business that might be listening that's in a situation where they feel like they've got three out of four of those in good shape or two out of four of those in good shape and maybe their churn rate is higher than they wish or they haven't quite figured out up-sells yet, is there an order at which these metrics start to get optimized or become more relevant as a company matures? Or is it really kind of in an ideal situation, you want to have everything going in the most desirable, possible way kind of from day one? How do you see that evolve in businesses that kind of figure it out over time?
Karan: Yeah, sure. I mean, if you're in the $1 million to $5 million in ARR, and I'm using numbers, this is not an exact science. But in general, if you're still in single digit ARR land — annual recurring revenue land — I think the single biggest or most important metric of those three pieces, i.e., gross new ARR, up-sells and churn, is probably focusing on the first one, which is gross new ARR, which is a function of how much revenue you're adding with new logos that you're bringing on. So in that sense, I think the emphasis should be on a marketing and sales engine that is bringing in new logos.
I've often recommended to my early stage companies that even if you have to compromise a little bit on the average contract value, but getting in more logos, I think it would be a lot better and general in the long term of the business because those customers and logos will renew and up-sell and potentially add annuity to the business in [inaudible 00:23:18] years.
I think when you're getting to about the $8 million to $10 million in ARR, I think it's a lot more important to focus on churn because that essentially becomes a big drag on the business if you don't manage it. That's generally been the genesis of the whole customer success function, which has become hugely important for all recurring revenue businesses. I think that that's going to be a secular trend that's here to stay and a category that sees a lot of investment both from companies and from venture capital dollars.
I think in some of these organizations that are selling to large Fortune 1000 companies, and I have a couple, like I said, in my portfolio, a lot of times, the initial deal size is small but you realize that the potential in that account is a lot bigger. In those cases, I'd spend a lot of time thinking about how to drive up-sells, re-marketing within those companies. Making champions that can essentially become our advocates to grow the product into other verticals or other functional groups within those companies.
I think up-sell starts becoming a very big deal for those companies earlier on. But for folks selling into the SMB and mid-market, usually up-sell is about 10 to 30% of new ARR as the companies mature. In some companies, it's higher and in some companies, it's lower. But gross new ARR from new logos is a metric that I would encourage folks to think about very carefully in the earlier stages and then as you get to scale, up-sells from existing customers and churn are areas that are of extreme importance. Otherwise, it just becomes a huge drag on the business.
Bob: Great. That is hugely helpful and I think shows some really interesting nuance in how different sizes and business models can actually influence what the right metrics to focus on are there. The one last question that I want to get to before we move on to some of the more departmental-specific points about evaluating a SaaS business, these helpful ratios that are up on the screen now. I remember, Karan, the first time I ever met you, we sat down in your office at Trinity and I was a younger man with a bit more hair and a much smaller business. You said to me, "So, what's your guys' SaaS magic number?" I had absolutely no idea what you were talking about.
For a metrics-driven company like us, it was really amazing to get into a world where there are numbers that extend beyond just the "How are we doing at the moment?" or "What does the pipeline look like?" and actually starts to be a little more comprehensive and starts to speak to things like sales efficiency and capital use efficiency that matter a ton to venture investors. I think that, really, one of the most educational parts of working with venture firms as we've grown our business, has been really getting a strong grasp on those metrics and we track those in RJMetrics today and it's great to keep an eye on them in that way.
I wanted to just step through specifically, that one SaaS magic number, ARR over CAC ratio one more time. I know you talked about it a bit earlier. But maybe just talking about "What's the numerator? What's the denominator? Why does that number just matter so much?"
Karan: Sure. Absolutely. I think as far as growth, I think, as I mentioned, the net new ARR number is the most important. I think as far as looking at the efficiency of the business and whether it behooves more investment into the sales and marketing functions, I think you're absolutely right, the SaaS magic number is definitely a hugely relevant and interesting and important indicator.
Let me step through just the ratio itself. The magic number, by the way, you can calculate that on a quarterly basis, which is what I recommend to SaaS companies. For every quarter, I look at the net new ARR that's added in that period. So if you're thinking about Q2, which is where we're in right now, the net new ARR, which will be a function of, as I mentioned, the gross new ARR plus the up-sells from existing customers less churn of that quarter, that's the additive portion in that quarter. That's the numerator. That would include new logos and up-sells.
Then the denominator is usually the fully-loaded cost of customer acquisition or the sales and marketing expense incurred in the previous quarter. The rationale being that in SaaS businesses you incur the entire cost of customer acquisition up front and you’re paid over time. So there's a little bit of lag between when the sales and marketing expense goes into acquiring a customer and when you're actually paid.
That's usually the best way to figure out whether the business is economic and efficient. You want that ratio to be as close to one as possible and ideally, even above one, which essentially says that you're recovering your entire cost of customer acquisition fully loaded in less than a year, which is what the one ratio says.
The one thing that I would want to point out is that there's multiple ways that some companies calculate this ratio. Some people use gross new ARR in the numerator. Some people sort of figure out the cost of customer acquisition a little bit differently. I generally tend to be more conservative in the way I calculate this ratio for our SaaS portfolio. I know RJ is a good example of that where we take the net new ARR. So I think inputting or incorporating churn is important in the numerator and within the denominator, I've actually now recommended that people start including some portion of customer success as an expense in acquiring the numerator dollars.
There's a movement around customer success and the role means a lot of different things. But there's definitely a component within that that is responsible for acquiring up-sell dollars and so if we're going to include up-sell dollars in the numerator, I would generally recommend that you include some portion of customer success in the denominator and still have a ratio that's as close to 1 as possible, if not higher.
Bob: Great. I did see a question come in over Twitter around benchmarking this AAR over CAC ratio and the optimization around the number 1 is definitely interesting to look at. What's your reaction when you see . . . there have been a lot of S-1s that came out over the past year. Some really exciting companies including New Relic, a Trinity portfolio company where New Relic's got an amazing ARR over CAC. If you dig into their S-1 and look at the analysis on it, it's significantly north of 1.
There are other companies like Box, for example, where their ARR over CAC is closer to something like a 0.5. When you see that range of values for the magic number like this, is there a number that can actually be too high or is there a number that can be too low? Or is it all kind of based on the context?
Karan: Yeah. I'd say it's a little dependent on the stage of the company and their position in the market. But I would say in general, and I can speak for myself, personally. I'm an investor in New Relic or Trinity is an investor in New Relic. We're not investors in Box. But in general, I think if we see ratios that are above 1 for companies that scale and growing nicely, I tend to think that the business is being under-optimized or, i.e., they should invest a lot more in sales and marketing and potentially increase that growth rate even higher.
Anytime I see a SaaS ratio that is below a 0.75 or 0.6, I would say that that's a business that probably needs to look at how the customers are being acquired, how they're being retained because that's not a model that I would expect to hold in the long term.
Now, the examples that you mentioned, I think there's a third variable that investors are looking at, which is if these companies are truly category-defining or the leaders and visionaries in an emerging market, I think there is a tendency that some investors will tend to invest in growth at all costs. I generally don't recommend that to my firm as a SaaS investor and also, to [inaudible 00:31:38] CEOs and founders that are essentially building businesses. In general, I would say I think that the fast magic number should not go as low as some of the numbers that you just mentioned, even if you are trying to create a category.
We went from a system and an ecosystem where it was all about growth at any costs, which led to, in some cases, I like to use the analogy of "flooding of the engine" where there was a lot of capital flowing in that needed to get invested. People were looking at growth at any cost. I think now, we're moving into an environment where it's about growth, still. That is definitely one of the most important indicators for intrinsic and enterprise value for a company, particularly a SaaS company, but I think it's about efficient growth, it's not just about growth. That's my personal bias as an investor.
Bob: Got you. Makes a ton of sense. Let's spend a few minutes actually looking at a SaaS business department by department and speak to some of the elements that might represent departmental maturity within a SaaS organization that you're evaluating to potentially invest in or that's a part of your portfolio. I want to make sure that we leave some time for Q&A, so we'll just touch on each one of these briefly.
Maybe we can start by taking a look at marketing and some of the things that are important to you, but from a metrics standpoint and an organizational standpoint when looking at a marketing organization in a SaaS business.
Karan: Sure. I think I mentioned this earlier, which is that depending on the kind of product it is, the price point and the part of the market you're targeting, I consider marketing as sort of having a left brain component and a right brain component. Great companies will excel on both sides. It may not be the same person that is leading the charge on both. But a lot of times, they are very proficient on both sides.
So let's talk about both parts of the brain. I think on the left brain side, there's a lot of focus around demand generation, looking at the sources of lead gen, the quality and the quantity of the lead generation process. Funnel metrics are hugely important and I know that's something that RJMetrics spends a lot of time thinking about of how new leads are being generated, the diversity of those lead sources, how they convert from an MQL, which is a marketing qualifying lead, to an SQL, which is a sales qualified lead, and how quickly they're moving through the funnel or the funnel velocity of those leads. I think those are generally, the metrics that we track very closely for the left brain side of marketing.
I also like to look at sort of how the organic versus paid leads are trending. In general, in the earlier stages of a company, there's typically a lot of organic inbound and word of mouth marketing that pays dividends. Over time, you start to ramp up the paid channels as well. That's one of the reasons why the magic number actually looks really good in the earlier stages and starts getting worse over time.
Then I also like to look at, within the organic section, how content marketing and inbound marketing are playing a role. I think the great companies out there have done a phenomenal job with their content marketing engine with a much more cost efficient way of acquiring leads and acquiring customers.
The one thing that I will point out is one of the things I've . . . and I may be a minority in this statement, but I do typically like for my high-velocity SaaS companies, I encourage marketing to have their own engineering team, [inaudible 00:35:16] growth marketing, growth engineers or marketing engineers to sort of drive some of these initiatives and bolster creativity around lead gen. I know you and I, again, have had lots of conversations about this and in fact, we are staffed with a growth engineering team that reports in to marketing, as opposed to engineering. But I think that's something that I believe is going to be generally a trend that plays out more and more over time as marketing becomes a lot more left-brained and tries to create leads and in some ways, have the sort of build tools to help their own cause. That's something that I think is worth pointing out.
Karan: On the right brain side . . . by the way, you should comment on some of that growth and growth engineering concept that I think RJMetrics is using.
Bob: Sure. I think it's been really interesting to watch our marketing organization evolve over time. We're at a point now where a really meaningful percentage of our marketing team is, in fact, people with engineering backgrounds and that's partially what's been driving the growth of the business, nto just from a marketing enablement standpoint, meaning that we use the outputs of engineering to do things like build data-driven blog posts and create benchmark reports and other kind of content that generates organic leads or inbound leads, but also using the engineering sales that exist on the marketing side to enable and empower our sales organization.
So the leads that are acquired by our outbound team that are proactively reaching out to prospects, that team is being benefited greatly by the technology that gets implemented by and in some cases, actually gets custom-built by our growth engineering team to push them forward. It creates a really interesting situation where marketing's responsibility extends beyond just the organic leads. It actually includes sales-originated opportunities. Marketing has a hand in that because the marketing technology is actually influencing the sales org.
So it creates this really interesting kind of dotted line relationship for that growth hacking team that it's serving both the marketing and the sales organizations. If you can get it to work really well, the outputs can be tremendous because it means that definitionally sales and marketing are playing nicely together and that's going to yield the greatest number of overall sales opportunities, which is really the metric that we're looking for really closely. It's been exciting to watch that evolve here.
Karan: Yeah, it's great. Then you asked about tools and technologies. I would say I think some of the products that are viewable right now on the slides, to me, these are really table stakes. I don't have a single SaaS company that's not using a business intelligence or a data and instrumentation product. Most of them are obviously using RJMetrics. Marketing automation, which is more around mid-funnel . . . I like to look at marketing as a funnel. So there's a ton of products at the top of the funnel that are doing lead gen and lead acquisition. There's a few products within the mid-funnel which are marketing automation products. I'm on the board of Act-On software that does really well in that segment. That's also table stakes today.
Then at the bottom of the funnel, you have more CRM-like products that are essentially more opportunity-tracking products. I think there's going to be some disruption there as well. There's some other products within the periphery at the top and in the middle around lead scoring. Given the amount of the velocity and the quantity of leads that are being generated, there's a tendency to try and rank some of those leads to make sure that the inside sales folks that are looking at those leads are actually looking at the right leads. I think there's a little bit of innovation that's happening there.
So those, I think, are sort of table stakes today in marketing. I think the other part that's pretty interesting now that I'm tracking closely as far as an area is around, in general, the attribution and segmentation and sort of leveraging data, predictive analytics to determine which leads to focus on outside of storing. That's another area that I think will have quite a bit of innovation, both on the B2C and the B2B side of the house.
Bob: Excellent. Sounds like we could do a whole webinar just on that one. It's a pretty exciting emerging topic there. That dovetails nicely into a conversation about sales. Maybe we can just spend a few seconds here talking about what you're looking for in a sales org.
Karan: Yeah. Again, I mean, I think the one thing that I do want to make sure everybody keeps into context is that a lot of this is dependent on where you are on your evolution. In a lot of ways, I think depending on where you are on that continuum, your sales tactics, your sales strategies and your marketing strategies will change. But in general, you're looking for, A, just a great sales leader and a leader that is more tuned to the kind of business that you're operating with the deal sizes that you're selling to the customer that you're selling them to.
Have a combination of both inside sales and field sales-run organizations. The trend is definitely more in inside sales. That's cannibalizing a lot of field sales. So in general, I want the leader to understand how a funnel metrics-oriented sales organization is run in sort of the business model being more transactional, but the value sale being more strategic.
The ratios we track are things like what the demo to close rates are, what the lead to close rates are, how many of the leads are actually being generated through SDRs, which are sales development reps, that are essentially the lead to demo folks in an organization before an account executive comes and tries to close some of those customers. Sales cycle is another one that we look at pretty closely. The number of reps that are making quota, I typically like to see 75% of the reps making quota. That sort of says that your lead distribution algorithms and the health of the sales organization is generally healthy. Looking at the sales pipeline, the MRR per rep, those are all important metrics to track, obviously.
Then in terms of technology products, there's a lot of tech products that sales use. Not as many as how much are at marketing people's disposal. But things like Hoopla for sales motivation and engagement, where we're investors in. Things like ClearSlide for sales enablement. DocuSign, obviously, for contract management and CRM e-signatures. Then a bunch of billing software that is a requirement for almost all recurring revenue businesses. But those are generally, at a high level, things that we track pretty closely within the sales organization.
Bob: Great. I'm excited to talk about customer success. You've mentioned it a few times already. I think this is a space that you know a lot about both through companies you've invested in and the companies in your portfolio actually doing innovative things in the customer success world. Can you [inaudible 00:42:17] about this new land of customer success and why it's so important?
Karan: Sure, yeah. I think that at a high level, I'd say this term is relatively new and titles are a lot more diverse in this area than other areas. My uber comment here is that if you're a SaaS company in today's climate, customer success is not just the responsibility of a group within the company. To me, it's the company initiative and I often tell my SaaS companies, including in our conversations where I've mentioned that I wouldn't forget the second "S" in SaaS, which is "Service."
Karan: I think there's a tremendous amount of opportunity for companies that excel in this function to outperform their competitors. As you mentioned, I made an investment in this category in a company called Preact, whose mission is to help recurring revenue businesses understand and engage with the customers to reduce churn and increase up-sells.
The metrics that this group tracks is things like churn, lifetime value and [inaudible 00:43:16]. Time to value is another metric that I would say that this group is responsible for. But I'd say it's one where it's such an important initiative within SaaS businesses, understanding that the recurring revenue portion of the business needs to be nurtured as much as the new acquisition engines that are being run by marketing and sales, which is one of the reasons why this space has become so hot, leading to a lot of investments for the different companies.
We used to think that chief customer officers and VPs of customer success would be somebody that we would add much later in a company. Today, I feel like there's a lot of conversations in boardrooms and within companies and looking at the operational metrics where having customer success be front and center and much earlier on in the company is generally helpful and a differentiated advantage relative to your competitors.
The technology products that are coming up in this space range from customer success tools and platforms like Preact that generally track the individual usage of your product in your customer base and how that usage tends to be leading indicators of either up-sell opportunities or churn risk. Communication products like InnerCOM and a bunch of help desk and support products like Zendesk. I think in general, customer success is a broad initiative that takes into account all of these things and then creates the general health of your customer base and allows you to build workflows around it.
I think if you're a SaaS business and not thinking about customer success, you're at a huge disadvantage.
Bob: I think . . . yeah, go ahead.
Karan: Go ahead, Bob.
Bob: I was just going to speak to a quick example that we've seen be really successful here at RJMetrics and kind of ties back a little bit to the growth hacking that we were talking about before. This is an obfuscated screenshot of an internal tool that we have where our account managers are able to actually, through a combination of data that's coming out of Preact and also coming out of RJMetrics, keep a very close watch on the key engagement metrics that are related to the health of their own customer accounts.
That relates to all kinds of things from billing to level of frequency of people logging in, to the percentage of accounts that are actually active, to tickets coming through our customer support system, which happens to be Zendesk and the use of this technology has created, really, a drastic shift in our ability to make sure that we're spending our time in the customer success universe very efficiently and effectively and actually helping customers, which is really what matters at the end of the day.
Karan: Yeah, I completely agree and this is something that I encourage SaaS companies to . . . as you think about sort of the first slide of your board meeting with your investors talking about the health of the business, I generally recommend that all our SaaS portfolio companies create a dashboard for customer success that tells you what the revenue at risk is going into a quarter as opposed to just a historical view of what the churn was in the past quarter and I think that's where the market is headed.
One little point that I wanted to make around NPS, and I know that gets talked about a lot, and I think the Net Promoter Score is hugely important and in some ways I think the trend of the score is a lot more important than the absolute, which means that the onus is on the SaaS business to constantly get that feedback in real-time and as quickly as possible.
One thing I'd like to point out is that the NPS is extremely important, but it's not always the best indicator of customer health when you're thinking about renewals or churn. The reason I say that is NPS captures your most vocal proponents and detractors of the product, whereas in my opinion, churn often comes from the fat middle or as I like to call them, the “silent killers”, the part of your customer base that has actually given up on you so much that they don't even give you the responses that you're looking for.
So in some ways, I think the best indicator, leading indicator of customer health is actual usage and engagement of your product, which is something that I encourage companies to really think hard about both at an account level and at an individual user level.
Bob: Great. I want to spend a little bit of time also on engineering and product. Obviously, something that you mentioned in the pre-revenue to $1 million stage being very, very important from a product kind of vision perspective. I imagine it only grows in importance over time. Can you talk about the things that you are looking for in organizations when it comes to this part of the company?
Karan: Sure. I would say as you go through those stages, it's not like . . . what it was important and the 0 to 1 stops being important and the 1 to 5 or 10-plus. In some ways, the onus is even higher and the bar is even higher to make sure you're constantly innovating on product. Product is one thing that is generally front and center today with SaaS 2.0 companies. In some ways, I would say product is a huge source of lead gen. We've seen that in companies like New Relic where a lot of customers will find six-figure ACVs without ever talking to an inside sales rep. I'd say I couldn't emphasize enough the importance of product as an integral part of the success of high-growth SaaS companies.
But just diving into it a little bit, I'd say, to me, I look at products as a combination of three pillars of product value. The first pillar being functionality, which is essentially making sure that you've got the multi-tenant aspect of SaaS, the scale-out and response of infrastructure. Thinking about private versus public Cloud trade-offs. Making sure that from the very get-go, you're thinking about data collection and analytics as the key component of product that allows you to benchmark across your customer base and potentially offer second-party offerings as a competitive mode down the road. So the base of this pyramid relies on having a very robust scale of responsive infrastructure and that's part of the functionality part of the pillar.
The second piece on the product sitting above functionality, to me, is around usability. A lot of SaaS products we'll have will be functional, but just not excel that much on the usability component. What I like to say is you've got to think of design and usability of the product in parallel with architecture. It's not something that you can slap on on top of it, given the trend of most prospects wanting to test your product before they ever talk to someone. The usability, I think, is key in SaaS 2.0 and almost a prerequisite for if you're going after the mid-market and below part of the market.
The third piece which I sometimes talk about is where truly great products stand out, which is around personality. It's a little bit odd to say that in the context of product, but I feel like a lot of companies out there have functional products. Some of them have highly intuitive and usable products but very few people actually think of this. To me, I think with some of the SaaS products that folks have come to love, companies like SurveyMonkey and Flak and New Relic and RJMetrics, I think it's what makes that product memorable and uniquely yours. I encourage the best SaaS companies to really spend a lot of time thinking about this and making sure that you realize, appreciate and sort of market the personality of the product with every product decision, feature and enhancement that's congruent with that personality.
I generally like to think of product in those three pillars. There's functionality, usability and then on top of it is personality. That's something that I've been quite happy about when I've been evaluating companies as well.
Bob: That's awesome, I love that. I'm curious, we could talk all day about general operations and the many roles that exist in that world and the metrics that matter along the way. As you think about maybe just the rest of a business as a category, are there any kind of bigger picture lessons that you think people should take away when they're thinking about just growing an organization beyond just the departments we've talked about?
Karan: Yeah. Like you said, there's so many things that we can talk about. I think the one that is probably most relevant today is around hiring and I know that a lot of companies right now are struggling with getting talent and retaining talent. At the end of the day, this is a talent war. You compete based on the people that work with you and for you. I think to get the best talent, I think it's really important as a CEO and as a company to think about what inspires people to join your company and stay there. So metrics are definitely key.
But the cultural fabric that I would argue is even more important in an environment like we're in, where there's literally a dozen alternatives for people probably more lucrative or companies that have more funding. I'd say spending a lot of time thinking about recruiting and hiring and hiring based on both a skill set that would be a potential fit for the role you're looking for, but a lot more on the cultural fit as well. I like companies, specifically SaaS companies, just like you think about personality of the product, they're actually, on a company basis, thinking about the core values that are driving them and articulate their mission, vision and culture.
In some ways, I recommend that as a CEO and as founders of a company, as you're thinking about hiring and recruiting, really define what the mission or vision statement for that company is, what the core tenets of that culture are at a high level, making sure that people are actually fitting that culture as you bring people in on board. Then practicing it in every area, whether it's marketing, sales, product development, engineering.
I've said, obviously, you and I have had these conversations where you set the culture, you set the mission statement and then you sort of vocalize it, you repeat it often. You cannot say it enough within a company is what I like to say.
So I think spending a lot of time around sort of the cultural fabric that really bonds the employees, it’s as important, if not more than all the other metrics that we could potentially [inaudible 00:53:38]. That's something that I wanted to just mention.
Bob: Definitely. Thank you so much and before we jump into Q&A, relevant to what we've been chatting about here, I just want to throw in a quick plug for our next webinar which is actually just coming up in another couple of weeks here. We're going to have Shaun McAvinney and Tucker McDonald from the RJMetrics team giving just a quick 30-minute guide to SaaS analytics and the specifics around how you can actually build out some of these metrics for your own company.
So we'll give a little insight into how we do it here at RJMetrics using the RJMetrics product and more broadly, also just talk about the approach to solving the challenge of data consolidation and making sure that you're actually looking at the right role inputs to get the data you need out the other end. So I'm really excited for this webinar. I'll definitely be in the audience, so I hope to see a bunch of you there as well.
We've got just a minute or two left to do a question from the audience here. I'm seeing a lot of questions come in that are around benchmarks and that are around things like, "What's the right LTV over CAC?” “What's the right burn rate?" "What's the right month over month MRR growth?" Maybe kind of to consolidate all of those, just a meta-question for you, which is how should people go about answering their own questions that are like that? Are there particular numbers that you look to? Are there particular benchmarks that you subscribe to that you would recommend people check out? How do you know that you're on the right track when you're looking at your own data?
Karan: That's obviously the most important question and I think in general, I would caveat my answer by saying that you have to do what's right for your business for the most part. I'll also say not every business is meant for venture capital. You also have to understand and have a high degree of self-awareness about the company that you're running, the market that you're in and what the potential opportunity size is.
That said, for a venture investment, which is something that a fund like ours, which is a $325 million fund would invest in, generally, you'd want to be on a trajectory and this, again, has held the test of time for a lot of high-growth SaaS companies and best-in-class companies in our portfolio. Once you get to the $1 million in ARR, $1 million in annual recurring revenue, you typically want to think about tripling twice and doubling three times. They call it two triples and three doubles. You're on your way to filing an S-1. That's the general growth rate that you can sort of use as a reference for what the growth rates have been for best-in-class companies. If you look at sort of New Relic and a bunch of these companies that have gone public, they're generally on that track, whether it's marketing automation, finance, billing.
So again, this is not to say that if you're less than that, you're definitely not getting funded or if you're more than that, it's a slam dunk. It's just one where if you're on that trajectory, you're generally best-in-class.
Then in terms of sort of what the LTB to CAC ratio should be and the magic number should be, when we talked about magic number being as close to one as possible, I think when you're in hyper-growth mode, typically investors will take a lower efficiency ratio for the sake of growth. But understand and know and want to see that the business could become efficient on a unit economic basis. That's sort of an important part of scaling SaaS companies.
From an LTV to CAC ratio, I think if you're calculating it properly, which is you're using discretionary churn as the ratio as opposed to just regular churn, I think any business that's in the 3 to 5x ratio is generally one that feels like it would be much benefited from an incremental investment in sales and marketing.
Again, these are general numbers to keep in mind. I wouldn't use that as the Bible. But it's to essentially give you a little bit of a framework in reference of how we view best-in-class SaaS companies both from a growth rate perspective, unit economic perspective and [inaudible 00:57:50].
Bob: Great. We are just about out of time here. I see a ton of questions continuing to pour in, so I just wanted to flash this slide up one more time. You can follow myself @RobertJMoore and Karan @KMehandru on Twitter and hopefully, we'll keep an eye on this #SaaSInvest hashtag throughout the day and our team here will do the best they can to try and get us some additional answers coming out to these great questions that keep pouring in.
There's just one last order of business here which is the winner of the cupcakes and I am pleased to inform Ryan Hatch, Ryan, you are the winner today and will be taking home some [inaudible 00:58:33] for your team. Shoot an e-mail over to marketing@RJMetrics.com and we will get that all set up for you.
With that said, I want to thank Karan Mehandru from Trinity Ventures so much for his generosity with his time and insights to this webinar. We've had a record [inaudible 00:58:51] here and it's no surprise given the amount of great information that we just got to see. Karan, thanks again, I'm sure we'll chat again soon and hopefully, we can do this again sometime. This has been fantastic.
Karan: Thanks, Bob. It was a real pleasure.
Bob: Great. Thanks, everyone, for joining us and we'll see you next time.
Karan: Thanks, all. Bye-bye.