When Would You Run From High Churn?

May 04, 2023

by a searcher from Duke University in Westfield, NJ 07090, USA

Hi All,

I just entered into diligence with a small SEO software company (~$1M ARR) and found an interesting landmine when I finally got access to the churn data "unavailable" during our pre-LOI conversations. The software sells at a lower price point ($15-40/mo) and has a monthly churn of 6%. My experience is with much larger, higher price point software firms, but 6% monthly is very worrisome in my book.

That said, the business has been growing faster than they are losing customers, and has seen 10%-30% revenue increases each of the past few years while spending next to nothing on customer acquisition. In using the product more, I am finding that it might just not be built for long term use, which might contribute to the higher churn trend. e.g. people pay to do some keyword research a few times, and then leave once they've accomplished their goals after a few months. On one hand, this could be an opportunity if I can make the product more sticky and build for longer term usage...on the other, I could also be setting myself up for a situation where net new growth slows and the 6% monthly churn starts to catch up with me.

Curious if anyone has perspective on whether something like this could be acceptable, assuming I can validate the customers are happy with the product and are churning for the reasons I am hypothesizing...or whether I should be running for the hills. This was priced at 2.75x earnings (which felt cheap for SaaS...and now it makes more sense) and I am also wondering how to reflect this in valuation. Thanks!

P.S. Bonus question for those still reading. If anyone has perspective on AI risk on SEO and the future of Search (google search that is, not search funds/ETA lol) I'd be very interested in discussing as part of my diligence!

Reply by an investor
from University of Pennsylvania in New York, NY, USA

As painful as it will be for the time invested I would recommend passing. Not an expert but looked at an SEO recently as an add-on for a software platform. A 6% monthly churn will obviate any of the growth metrics. Additionally, growth of 10% to 30% is not actually that high for software. Another key learning was that SEO can have high churn if it becomes quickly apparent to the buyer the SEO isn't driving quality leads (i.e. the offering doesn't deliver real value).

Reply by an intermediary
from New York University in Menlo Park, CA, USA

Daniel, I agree with your initial analysis and identification of a potential opportunity to make it more sticky. I'd also look at new customers and see if they are actually repeat customers restarting a subscription. If it is a tool used by small SEO agencies, I could see a small agency canceling the subscription when the client's work is done and resubscribing when they get a new paying client. It appears as a churn but is more of a pause in the fees.

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