5 SAAS METRICS THAT MATTER FOR GOVTECH COMPANIES
I wrote this piece for GovTech.com but thought I'd cross-post as a lot of it applies to SaaS companies regardless of industry.
5 SaaS Metrics That Really Matter for Gov Tech Companies
Here's an excerpt and full article at https://www.govtech.com/5-saas-metrics-that-really-matter-for-gov-tech-companies
I often get asked by gov tech CEOs: “Which metrics matter most for investors?” So here we are at stage three of talking to investors about your business. In step one, we discussed five types of investors trying to buy your business. In step two, we discussed five common questions you’ll get asked at an introductory meeting.
Assuming the meeting went well, you are on step three — where investors start asking for a variety of financial and market data.
As you share data, it is helpful to understand the top five priority metrics investors care about and how to frame the numbers.
ANNUAL RECURRING REVENUE
As an entrepreneur, you are used to calculating the revenue of your business. But all revenue is not valued equally. Recurring revenue that will contractually repeat every year (in the absence of a cancellation) is valued much more highly than one-time revenue — typically project or implementation work. You will quickly be asked what “your ARR is,” i.e., how much annual recurring revenue do you have? As you run the business, it’s important to document and calculate the different types of revenue — recurring, repeat and one-time. Investors will want to know both your ARR and what percentage of overall revenue is recurring. For example, in Tyler Technologies’ November 2020 public filing, they referenced that 73 percent of their revenue is recurring.
THE RULE OF 40
The “Rule of 40” is highly valuable as it actually combines two metrics into one. As most entrepreneurs soon realize, there is a direct trade-off between your margins today and how much you are reinvesting into the business to grow it. To “normalize” this dynamic across companies with different growth and margin strategies, the Rule of 40 simply adds the year-over-year revenue growth rate plus the EBITDA margin of the business. Anything over 40 on this metric is generally considered good, but there can be several paths to get there. The business could be a fast grower at 50 percent growth but a negative 10 percent EBITDA margin (with, for example, heavy investment in sales and marketing driving both the growth and negative margin), or a more conservate grower at 10 percent annual growth but with a 30 percent EBITDA margin. Keeping track of this metric over time can help you calibrate and benchmark how effective your investments in the business are in generating the corresponding growth versus peers.
NET DOLLAR REVENUE RETENTION
One of the attractive characteristics of the government market is that customers generally remain customers for a long time if you serve them well. There are several different ways to measure the retention of customers: customer logo retention, gross dollar revenue retention and net dollar revenue retention (although you will sometimes see each of these expressed, and the corresponding reciprocals of each of these known as churn). It can also be helpful to better understand trends in your business by tracking these retention metrics in a variety of additional ways — by cohort vintage, by type of agency — which are typical analyses investors will conduct when evaluating your business. The single most important retention metric to pay attention to is net dollar revenue retention, which incorporates both the revenue that you lose over a year from existing customers canceling netted against the growth you see from your existing customers (mathematically, this is calculated as revenue at the beginning of the year — dollar revenue lost - dollars decreased + dollar expansion). At its core, it shows off the customer dollar value of contracts eligible to renew that year, or how much was renewed by those existing customers. Gov tech companies should target over 100 percent net retention (ideally[redacted]percent) as customers should expand by buying additional licenses, seats, products, pricing and capacity by more than they decrease usage or churn entirely. For example, in their 2019 SPAC filing, GTY Technology Holdings disclosed the NRR for their five business units ranging from 96 percent to 134 percent.