Recurring revenue growth is the key to overcoming economic headwinds

A report of more than 400 SaaS companies found 'best-in-class' startups are still growing

It’s a fact that startups, regardless of industry, face more hurdles today than they did a year ago. Driven by inflation, the war in Ukraine and other economic headwinds, recessionary fears have put a squeeze on sources of funding that were previously easily attainable.

The consequence? Drastic cost-cutting: Through late June, 22,000 workers in the U.S. tech sector have been laid off this year, according to a Crunchbase News tally.

But not every startup is hurting for capital. In a new report, Capchase, a provider of nondilutive financing tools, analyzed over 400 private software-as-a-service (SaaS) companies generating between $1 million and $15 million in annual recurring revenue (ARR).

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After comparing their performance to 42 SaaS unicorns that went public in 2020 and 2021, the firm concluded that “best-in-class” SaaS startups are still growing and that unit economics are reliable predictors of future success.

“At the current burn multiples, with current cash levels, SaaS companies of every size will find it hard to raise up rounds at the end of their runway,” Capchase CEO and co-founder Miguel Fernández told TechCrunch in an email interview. “[But] the outlook for SaaS is still incredibly strong, and those who manage to weather this storm will turn out stronger on the other side of it.”

“Net retention rate can have a similar impact on burn as growth and is usually much more efficient.” Capchase CEO and co-founder Miguel Fernández

According to the Capchase report, top SaaS companies are handily beating the “Rule of 40,” a maxim that suggests the sum of a company’s ARR growth percentage and net margin percentage (i.e., profit is generated as a percentage of revenue) should total at least 40%. Capchase suggests that successful companies achieve at least 80% and skyrocket to over 110% during the growth stage and maintain around 55% even after they go public.

“Financial discipline is key, here. This includes cutting non-performing products, decreasing R&D and general and administrative expenses, and doubling down on creative strategies to recover customer acquisition cost instantly to reduce burn associated with growth,” Fernández said. “The best-performing SaaS companies spend 40% to 55% of their revenue in sales and marketing expenses (e.g., tools, ads, salaries and commissions).”

Top early- and growth-stage startups are also notching ARR growth between 100% and 160% — more than double average performers, according to Capchase. Moreover, they’re recording gross margins of over 80%. (Gross margin equates to net sales minus the cost of goods sold.)

“It’s much easier and cheaper to sell to an existing, happy customer than to acquire a net new customer. Net retention rate can have a similar impact on burn as growth and is usually much more efficient,” Fernández continued.

Interestingly, Capchase reports that top-quartile public SaaS companies are borrowing up to 75% of revenue, as large cash balances enable leverage. On the private side, many startups that reach $5 million to $10 million in cash runway are raising another round, either venture capital or debt.

But what about the startups that have been less successful in these challenging times? The Capchase report recommends focusing “aggressively” on retention and upselling, closely monitoring the customer base and trying to anticipate churn. Simply changing the payment terms can have a major impact on growth, according to Fernández.

“Do you charge upfront to have more cash and thus your customers finance you, or do you charge monthly to reduce adoption barriers and thus you finance your customers? Not an easy choice and depends a lot on your payback, ability to retain customers and business operations,” Fernández said. “If you have more than 24 months of runway and good retention, I would suggest you charge monthly to increase conversion. Alternatively, especially if you have a long time-to-value motion, try to get upfront payment for every new customer, even at the expense of a discount.”

For VCs, Fernández suggests that they encourage portfolio companies to explore alternative lending options and pay closer attention to key performance metrics.

“Many of the people working at startups have not yet been through a downturn, and investors can often provide practical advice on how to navigate and maintain focus through such an environment — not only to the founders but also to the wider teams,” he added. “So my advice is to be as available as possible to your portfolio companies.”

Undoubtedly, there will be casualties despite companies’ best efforts. A recent PwC study found that while tech investment deal value increased between the first half of 2021 and 2022, driven by a handful of “megadeals,” volume was down roughly 37% year over year.

“Startups should think about the timing of their next round carefully,” Fernández said. “Given the depressed valuation multiples and VC funds retrenching from the market, raising a round in the coming months will be challenging as your revenue and growth will have to be much higher in order to achieve the desired valuation. So startups should be looking at ways to extend their runway to buy time for that growth to materialize.”