Miguel Fernandez
Move over, TAM. There’s a new essential metric in town.
Over the years, I’ve reviewed thousands of data points from growing SaaS companies and identified growth indicators beyond the “highlights” that most VC firms look at — and ones that are more relevant to today’s scrupulous funding environment. The predictability of a startup’s viability and success goes deeper than total addressable market (TAM) — way deeper.
In the heyday of VC-backed growth, startups had to lock in just two key metrics to secure funding: TAM and revenue growth; the larger the better. But the downturn of early 2022 brought another priority to the forefront: sustainable growth.
It’s tricky because it’s not a single metric — it’s more of a movement.
In many ways, sustainable growth looks different across industries and products, but for the average SaaS company, it’s underpinned by one core concept: product scalability. In SaaS, scalability is measured through several metrics, including ARR (annual recurring revenue) per employee, R40 (Rule of 40), and more. We’ll get into that soon.
First, here’s where we take a moment to acknowledge that there are exceptions to every rule. Think revolutionary technologies where astronomical cash burn without a clear path to profitability is still allowed by equity investors. Today we’re focusing on metrics and business environments that apply to most SaaS companies — not the unicorn outliers.
Core performance benchmarks for increased fundability
SaaS’s scalability and unit economics make the industry attractive to VC investors. However, the “growth at all costs” mentality and the burnout of B2B marketing channels have tested investors’ conviction that startups have what it takes to make it to profitability and scaled success.
Gross and net margins are great metrics to track. Still, investors are now looking at the fine print of these unit economics and ratios related to GTM (go-to-market) efficiency, an essential aspect of due diligence.
If you’re looking to fundraise in 2024, it’s important to know the metrics investors are assessing. These are the essentials:
- ARR per employee: This provides a clear picture of the efficiency of the business and the impact of each new employee, which becomes particularly important once the GTM team starts to scale. Here’s where AI automation of specific tasks can pay off. Success stories like Ramp, who reached +$100 million ARR with just 50 employees, show the possibilities and the high bar for SaaS companies.
- R40: The Rule of 40 is a primary predictor of success and ability to raise. While many startups in our portfolio have experienced a decline in growth velocity over the past 12 months, most have also seen an improvement in efficiency and margins. R40 — the idea that the highest-performing startups have profit margins and growth rates (profit + growth) that sum to more than 40% — is a great way to visualize those gains.
- CAC payback and LTV/CAC: Customer acquisition cost and lifetime value are long-trusted metrics for analyzing GTM efficiency. In 2023 alone, payback periods have lengthened significantly, putting stress on working capital and finance. Leaner operations help reduce the payback period and overall CAC while maintaining LTV.
- Customer and MRR (monthly recurring revenue) retention rates: These are more crucial than ever, as the cost of acquiring new customers has increased significantly. Not only are retention rates a great indicator of product-market fit, but strong customer retention is also vital to achieving strong unit economics because of the savings it creates within the GTM motion.
How VC priorities reflect a changing world
With capital becoming increasingly scarce and raises becoming less predictable, investors must ensure that companies are growing sustainably and can offer timely returns.
Traditionally, shareholder returns come from a positive cash flow. Because VC investors look at longer-term returns, they only sometimes consider earnings per share or dividends (expected in public companies). Instead, they look to founders to show strong unit economics and the ability to continuously reinvest in the business without significant external capital flowing in.
Companies presenting strong unit economics and reinvestment opportunities may have more leverage in 2024 than pre-2021 because of their impressive health: They’re burning less, have more room to breathe, and have more runway. In short, they’re growing sustainably. SaaS companies with good metrics will naturally stand out from the crowd and, in turn, have more options and potential buyers. In 2024, we will also see more companies looking for an exit, and more distressed sales, which will grant leverage to those looking to acquire.
Internal financial discipline is also more critical than ever. It’s a vital part of achieving better ARR efficiency. Interest rates remain high, necessitating the cost of capital for founders to stay top of mind. Founders can make a positive impact by improving profitability through increased internal efficiency, reducing footprint (such as office space), and using AI to improve productivity through automation of repetitive tasks.
Growing funding through key metrics
SaaS is a strong industry. It’s always been about increasing efficiency, so the field is resilient and has a good tailwind. To take advantage of this feature of the industry and raise funds in 2024, SaaS companies across sub-industries must position their products as ways to save other companies time and money while increasing sales.
In addition to the efficiency and sustainable growth measures detailed above, we’ve invested time and energy into understanding the future of SaaS, interviewing leaders from over 1,800 SaaS companies to develop a holistic picture of what’s to come. We determined that long-term success comes from strong metrics, disciplined leadership, and a razor-sharp focus on building high-quality products for new and existing customers — instead of pouring resources into new product lines that have not yet been proven.
The downturn of 2022 proved that the SaaS industry is uniquely flexible, agile, and resilient. Our research is already showing signs of recovery in the industry, and even though growth has declined, net margins have improved and companies are burning less on average. Combine this with SaaS sales picking up as well as VCs deal flow; we’re feeling cautiously optimistic about SaaS fundraising in 2024.
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