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The Angel VC: Financial planning for SaaS startups

The Angel VC: Financial planning for SaaS startups
A few people who read my recent post about financial planning asked if I could provide an example for a good financial plan, so I'd like to post one here. The plan is very similar to the one that I created in the very early days at Zendesk and re-used a few times in the meantime, but I had to make a few adjustments to make it more generic. It's a simple plan for an early-stage SaaS startup with a low-touch sales model – a company which markets a SaaS solution via its website, offers a 30 day free trial, gets most of its trial users organically and through online marketing and converts them into paying customer with very little human interaction. Therefore the key drivers of my imaginary startup are organic growth rate, marketing budget and customer acquisition costs, conversion rate, ARPU and churn rate. If you have a SaaS startup with a higher-touch sales model where revenue growth is largely driven by sales headcount, the plan needs to be modified accordingly.

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Financial planning for SaaS Startups: Q&A with Christoph Janz I quit my day job with my friend Igor I started a new company called elastic.io, a solution that helps people connect cloud API’s without programming. One of the major hurdles we faced when starting our company was how to do the financial planning for our SaaS startup. Since we thought this might be useful for other entrepreneurs, I wanted to share with you what we learned. Financial planning for Saas resources There are multiple resources that you simply HAVE to read before doing any financial planning for SaaS. After that I would recommend Christoph Janz‘ blog. In March 2012, Christoph published a couple of blog posts about financial planning for SaaS, which we studied intensely. This sample financial plan is pretty detailed and you can read it on Christoph’s blog, so I won’t go into it again, but after we studied it, we still had a few unanswered questions about it. Is a cheaper SaaS product always easier to sell? Unfortunately, according to Christoph, this is just not true.

Aart Balk, Art Director from Washington, Pennsylvania Share The Art Institutes - mobile landing page 3 Argosy University - mobile website 3 Hollywood Tans redesign comps 5 Create my tomorrow 8 Interim redesign of Art Institutes homepage 2 Mobile main marketing website for Art Institutes 9 How to estimate Lifetime Value; Sample cohort analysis In many businesses, repeat purchase behavior is a key driver of value. Many companies track % of repeat purchases as a key business metric. This is useful in steady state, but can sometimes be quite misleading if the company is showing substantial growth. By definition, growth implies many first time customers, and the mix of these new customers can distort the view into how much repeat purchase behavior is actually occuring. I prefer to try to analyze repeat pruchase behavior, and hence, estimate lifetime value, by doing cohort analysis. I’ve uploaded a spreadsheet with a sample cohort analysis, using representative but dummy data to illustrate how to do this. In this particular example, I look at a hypothetical subscription business. By averaging across the cohorts, you can get an average retention rate at the end of one month, two months and so on. If you see a pattern like this, you can extrapolate forward using the same month-on-month attrition across several years.

Startups and financial models for SAAS companies The other day I met with an entrepreneur I was advising as he prepared to raise his next round of funding. In the meeting, he wanted me to narrow in and focus on his financial model. Financial models for startups are important from a big picture perspective, but I never like to get mired in the full details as things always change in the early stages. Given my experience with SAAS based companies like GoToMyPC (Citrix Online now) and LivePerson (Nasdaq: LPSN), we also spent some time discussing key financial metrics for SAAS businesses that he should pay attention to as he ramped up his business. Deep dive: Cancellation rate in SaaS business models I wanted to expand on the practical and mathematical implementations of the cancellation rate I referred to in last week’s post. Why cancellation rate is so important As a preamble to the metrics, it’s useful to know what you’re measuring and why it’s vital. [Cancellation rate] = [product utility] + [service quality] + [acceptable price] I put in these particular elements because I did a study of the reasons people cancel at WP Engine, and these are the main reasons for cancellation. We log every cancellation – spending time running after folks to wring out the cause — so we can deduce exactly what we can do to prevent it in future. These three factors are, of course, critical to a healthy, growing startup, and yet individually they’re impossible to measure as precisely and easily as cancellation rate. Beyond the analytical breakdown, I have an emotional attachment to this number, because whenever someone cancels I think about what had to happen to get them to this point, and it kills me.

Saas Math: Customer vs. Revenue Churn As I’ve mentioned many times before: churn (the rate at which customers cancel their subscription) is the most important metric for any recurring revenue business. This should make sense. The longer a customer keeps paying you, the more valuable that customer is. In a previous post, we looked in depth at churn. Most companies when they look at churn look at customer counts: how many customers did we start the month with? How many of those did we lose? While it’s important to understand this and to look at these patterns over time on a cohort basis (i.e. for customers who joined in a given month, from a common source, or linking them via any other common attribute to find patterns), you need to also look at revenue churn. Customer churn then is a count of customers who cancel their accounts. Here is a simple example: This example looks at changes in customer count per month. - How much MRR the company had at the beginning of each month; Why? Churn by Price Plan

Emergence Capital: Profitable Lessons From Freemium Business Mod Posted by Tom Foremski - March 25, 2010 It pays to specialize. VC firm Emergence Capital Partners is doing very well by focusing on investments in the enterprise IT market, and on startups that make use of the 'freemium' business model. Freemium is not a new idea, companies have been giving away products and services for free for a long time but it is a new word -- popularized by Fred Wilson, a VC at New York City based Union Square Ventures. Chris Anderson, the editor-in-chief of Wired magazine, has also written about "free" business models. A freemium model means that you offer a free version of your online service and try to convert some of those users to premium subscribers through offering additional features and value. This business model can work very well for some companies -- especially the portfolio companies managed by Emergence Capital . David Sacks, CEO, Yammer Ivan Koon, CEO, YouSendIt Brent Chudoba, VP Business Strategy, Survey Monkey Umberto Milletti, InsideView

Saas Math: Why are you NOT spending on marketing? Often when I meet new SaaS startups they tell me proudly that they have grown their user base without “spending a dime on marketing”. While that is a great accomplishment and a testament to the quality of the product (product = marketing for great web services), it does lead me to ask why! Did the entrepreneurs not want to grow faster? Do they not want to own the market? Fast growth and market leadership are key criteria for any potential investor, especially a VC. And from my perspective as an investor you cannot optimize for growth and scale without investing in customer acquisition. With known lifetime revenue, why would you not invest in growth? This brings up a related thought: often entrepreneurs talk about one round of financing getting them to cashflow break even. Also, bear in mind that valuation is heavily influenced by the pace and scale of your revenue growth. So, if you want to approach VCs, by definition you should be going after a big opportunity and market leadership.

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