Mar 27, 2023

We all know which companies are “the best,” but we don’t always take a real look into what keeps them at the top. Capchase Co-Founder & CEO Miquel Fernandez and 01 Advisors VP Kristen Clifford use data to show us what differentiates the best SaaS companies from the rest. The top SaaS companies are growing really fast, roughly at twice the rate of their peers. The top quartile companies at the 1 to $3 million ARR mark grew at 160% year over year versus 100% for the median company. At the 10 to $15 Million ARR mark, the top quartile company grew at 100% year over year versus 45% for the median. Capchase’s dataset is comprised of roughly half bootstrapped companies and half VC-backed companies, so there will be some differences in benchmarking from what you see from the VC firms. Another thing that these companies have in common is a super high gross margin. Some companies have more than 80% gross margin and this actually drives most of the value and the high valuations the SaaS companies have. This is important for two reasons. One, when you have really high gross margins, your cost base actually increases much slower than your revenue base. So signing up 100 new customers costs you more or less the same as signing one additional customer. So this is, of course, very efficient. It also means that if a company runs in trouble or needs to stop growth for a little bit, there’s a ton of cash coming through because the existing customers are very efficient. How do they achieve this? 1. They either raise prices or they don’t give discounts. Giving a discount sounds very innocuous at first, but you’re actually keeping your same cost base and you’re decreasing your top line. So gross margin decreases a lot. 2. Very few or no services at all. Services generally have a lower gross margin. So if you bundle both SaaS and services, you’re actually hurting the gross margin profile of the company. So if they actually offer services, these come at a huge premium. For example, a 24/7 SLA support that is really, really expensive to sell. 3. Most of the app sales and net retention comes from deploying software and tech-driven features that have 100% gross margin. Think about additional integrations or additional workflows. The top-performing companies achieved 80% according to the rule of 40. As a refresher, the rule of 40 is a measure of sustainable growth for SaaS companies. So the equation is profitability margin plus year over year. Revenue growth is the Rule of 40 and you want that number to be above 40% generally. Why does a Rule of 40 matter in this environment? Profitability matters more than ever, and if you look at public markets comparables for two companies with the same rule of 40, the company with the higher profitability margin will achieve a higher valuation. The best companies have the most runway and they don’t wait until their runway depletes to raise the next round. They raise money when they have cash in the bank, which means that they have much more leverage negotiating terms and getting additional funds for the company. So how do they get there? They are really, really good at forecasting. They invest in the right tools, and in the right team, to understand the impact. Not just right now, but months down the line of adding new people to a team, launching new products, acquiring a competitor, entering new geographies, etc. So they really know what’s going on in the future, and they have the levers to dial up or down. Then they really invest in recovering the CAC as soon as possible. Having a long CAC payback can actually mean that the faster you grow, the more money you burn. Ideally, the faster you grow, the more money you have, but it doesn’t always work out that way. Getting your customers to pay upfront is not always easy. Sometimes you can offer flexible payment terms to customers, but then finance part of the future payments to recover the CAC upfront and be able to redeploy the cash in the future. Diversity yields results. Within the zero one advisor’s portfolio, companies with more diverse c-suites and founding teams outperform less diverse companies. Recommendations Forecast in next-12-month increments, update your assumptions frequently, and build multiple scenarios. You should always have a base case which guides your business. That’s the case that you show to the board, and it’s the case that you execute against day-to-day. Then at a minimum, you should have an upside and a downside case, if things go better or worse than plan. There’s a common error in that people set financial forecasts only at the beginning of their fiscal period and don’t revisit them. Forecasts should be living documents that you are constantly updating. Revisit your assumptions often. When you’re making forecasts, often it’s just intelligent guesswork if your company history isn’t that old. But it’s important to be constantly plugging in new assumptions to those to make them accurate. If you need to raise venture capital, preparation is important, both in terms of process and in terms of expectation alignment. On process, there is a standard punch list of documents that most investors are going to ask for. That includes financial projections, deck, sales forecast, etc. So make sure you have those documents ready and make sure they are accurate and defensible. In 2022, investor due diligence is back, and you will get challenged on those assumptions more than you ever have. On expectation alignment, your VCs are pressure-testing you on your motivations, so it’s fair to do the same to them when you’re at the final yard line. Understand what success looks like for them because it will dictate how they want you to run your business. Finally, unit economics matter more than ever. Profitability has eclipsed growth as the primary set of metrics that investors care about. Be sure to focus on profitability and be cognizant of the fact that capital sources are not as prevalent as they used to be and consider alternative sources rather than venture capital.