I had an enjoyable lunch meeting with a general partner in a leading Bay Area VC firm and during the discussion he wanted to compare notes on the way I evaluate a good SaaS company. I thought that my answer may be of general interest for employees or investors in the space- so here goes…
- Look for company that makes something 10x better: I learned this one from Jason Lemkin, the CEO of EchoSign. Webex is 10X better than travel with your laptop for a meeting, eFax is 10X better than feeding papers into your old fax machine and EchoSign is 10X better than having a customer telling you he will sign the contract when he gets back to the office next week.
- Look for success limitations that new money or management can fix: take Intaact for example. It grew very slowly for 8 years starving for cash and a good management to put the money to work. In 2007 the company got new investors, new CEO and all of a sudden it is growing like crazy, taking names of new customers and leading partners from its competitors.
- Back to basics: Customer Lifetime Value: marketers always calculated Customer Lifetime Value as a way to evaluate marketing spend. SaaS is no different: Look at the annual payment of each customer, multiple by the average life of a customer (e.g. 5 years with 20% churn rate) and you got the number. Now, if cost of acquiring the customer (sales and marketing) are more than 1/3 of this value, you may want to start asking questions about the viability of the model.
- Renewal revenue+upsell should be >100%: here is an easy formula- in SaaS, customers are renewing their service periodically, usually once a year. Every SaaS company has some churn due to economic situation, companies that change ownership, different business needs or satisfaction issues (on premise companies suffer from it as well but they tend to report absolute number of customers, so you never know about it). Nevertheless, the holy grail of SaaS is that last year revenue becomes the base for next year, and new sales come on top of it. So a healthy SaaS business will have a combination of a small churn and relatively high upsell rates, so the total is more than 100% renewal value (e.g. 88% renewal rate + 15% upsell)
- Check uptime history: SaaS service needs to be up all the time (99.99 uptime for example). Nothing will put customers off more than a service that works most of the time but not all the time. I encourage SaaS companies to follow Salesforce.com and EchoSign and build “Trust” websites with automatic monitoring for uptime. Good uptime results will indicate good and responsive engineering and operations team.
- Now test the rest- happy customers, motivated employees, strong industry, high willingness to recommend and everything else you would normally test with any other company.