Metrics VCs Seek in Early-Stage SaaS Startups
SaaS are businesses that deliver tailored cloud-based software solutions for other businesses across various domains. Hence “Software-as-a-Service”. These domains can span from customer relationship management to work productivity, onboarding, analytics, accounting, and beyond. Globally the SaaS market is now touching $250bn, growing at an impressive 20% CAGR and expected to be ~$1tn by 2030.
With that growth momentum, it’s no surprise that it sees a lot of startup activity.
SaaS businesses are unique in terms of measurability as they primarily rely on a select few metrics. This blog dissects those essential Key Performance Indicators (KPIs) and outlines some benchmarks early-stage investors typically look at when considering a new investment in SaaS startups. If you are a founder in this space or considering becoming one then this read should help you in preparing for your fund raise.
So Which Metrics Truly Matter in SaaS Early-Stage?
As an early-stage SaaS startup with an ARR of about $300k or more, your business is likely already at a stage where some clear metrics provide insights into your performance and growth potential. Let’s dive into the ones that matter the most to an incoming investor:
Monthly Recurring Revenue (MRR): MRR reflects the predicted monthly revenue from active subscriptions. Remember, this is recurring revenue and shouldn’t have any one time components. Further breaking MRR components, such as expansion, churn, contraction and upgrades, provides strong insights into revenue dynamics.
Revenue growth is the ultimate proof of product-market fit and at a very early stage Compound Monthly Growth Rate (CMGR) can be a good indicator of traction. Startups aiming for Seed to Series A funding often target CMGR upwards of 15 to 20%.
Customer Acquisition Cost (CAC): This is the average expense associated with acquiring a single customer. Calculating CAC involves summing up the sales and marketing expenditures within a specific period and then dividing this figure by the number of customers acquired during that or a subsequent period (if the business has long sales cycles).
Lifetime Value (LTV): This metric reflects the average value a customer generates throughout their engagement with the company. It encompasses Customer Acquisition Cost (CAC), Dollar Retention, and Gross Margin, providing a comprehensive view of a company’s unit economics. LTV calculation is usually taken as the cumulative gross profit contribution, net of CAC, of the average customer in a cohort.
Months to Recover CAC: This metric, sometimes also referred as CAC payback, conveys how long it takes for a customer to generate sufficient gross profit to recover the Customer Acquisition Cost (CAC). Clearly lower margin products with high CAC do poorly on payback and you can significantly improve this metric if you reduce the complexity of your sales process.
CAC-to-LTV Ratio: The CAC-to-LTV Ratio metric compares the lifetime gross profit value of customers to the cost incurred in acquiring them. A healthy business typically maintains a LTV that is at least three times greater than its CAC. If the ratio is lower, it might indicate overspending, while a significantly higher ratio suggests potential missed opportunities.
Sales Efficiency: Sales Efficiency is a check on how efficiently a company’s sales and marketing efforts translate into additional revenue. A simple metric for this is New ARR (Annual recurring revenue) compared to Sales and Marketing (S&M) expenses. Ideally, New ARR should equal or surpass S&M expenses, indicating that the company is acquiring customers cost-effectively.
Retention: Effective customer retention is a cornerstone of sustainable growth in any sector, not just SaaS. Here cohort-based analysis is particularly insightful, focusing on monthly cohorts at specific milestones, such as months 12 and 24.
Within this, monitoring retention both in terms of customers and revenue, is vital to understanding and mitigating losses.
Net Revenue Retention — NRR: This metric measures how much revenue a cohort generates relative to its original size. Healthy SaaS companies aim for upwards of 120%+ NRR each year.
Logo Retention: This metric tracks the percentage of customers that remain active. It can’t exceed 100% and is typically lower than NRR. Smaller SaaS businesses target <5–7% churn rate, while enterprise-level ones aim for under 5%.
Customer Concentration: Evaluating whether growth relies heavily on a few large contracts or a broader customer base helps assess risk and sustainability.
These key metrics are usually sufficient to provide an incoming investor a basic picture of a B2B SaaS opportunity in terms of health, growth potential, and financial stability. Understanding and effectively communicating these metrics can greatly enhance your chances of securing funding.
What Additional Metrics Can Investors Consider as SaaS Companies Mature?
Beyond the primary metrics above, there exist a bunch of secondary metrics that provide valuable insights into the health and potential of a SaaS business. In deeper diligence, you could find investors delving into these to gain a more comprehensive understanding. Here are some to pay close attention to:
Qualified Marketing Traffic: While overall website traffic matters, it is important to demonstrate a distinction between returning customers and qualified marketing traffic. Returning customer analytics help prove stickiness to product. Event tracking and in-app analytics to identify qualified marketing visitors brings out the start-up’s capability to formulate actionable traffic-generation plans.
Leads by Lifecycle Stage: Lead definitions vary based on the prospect’s position in the customer lifecycle. Someone evaluating your Sales funnel could look at metrics such as Marketing Qualified Leads (MQLs) and Sales Qualified Leads (SQLs) to assess where leads may be getting stuck in the funnel and the underlying reasons for that. Understanding these lead categories could help you as a founder too in identifying opportunities for lead nurturing and guide sales follow-ups effectively.
Lead-to-Customer Rate: Lead-to-customer rate is a crucial indicator of a startup’s ability to convert leads into paying customers. This metric calculates the percentage of leads that successfully become paying customers, offering insights into the effectiveness of sales processes and lead nurturing strategies.
Adoption Rate/User Engagement : Adoption rate measures the percentage of new users actively using the product or its specific features. Investors value this metric a lot as it indicates user engagement and the potential for customer retention.
User engagement, traditionally a consumer metric, has become relevant for SaaS startups, particularly those offering free trials or freemium models. Metrics like Daily Active Users to Monthly Active Users (DAU/MAU) and Daily Active Users to Weekly Active Users (DAU/WAU) help assess user engagement levels. Futher, paid-user engagement metrics filter out noise from free users, offering a more accurate representation.
Some startups smartly convert a bunch of these metrics into a customer health score to help customer-facing teams proactively engage with at-risk customers, offering support and resources before churn occurs.
Net Promoter Score (NPS): NPS measures user sentiment and customer satisfaction. Investors value NPS as it correlates with product-market fit and helps in understanding user happiness and product usage patterns. Correlating NPS scores with product analytics can uncover valuable insights for founders. You can dig more into PMF in this blog I wrote earlier.
Cost-to-Service (CTS): Understanding the cost to service paying customers is a good way to assess a SaaS company’s efficiency & effectiveness. This metric encompasses Customer Success team costs, infrastructure expenses, and retention program costs. Smart founders recognize the importance of optimizing CTS to target ideal customers for sustainable growth.
Margins: Gross Margins indicate a company’s profitability by subtracting the cost of goods sold (COGS) from revenue. Lower Gross Margins may raise concerns about reliance on manual interventions and eventually affects scalability. Typically SaaS startups should aim for a gross margin of at least 75% to ensure sustainability and stay attractive to investors.
These secondary health metrics provide a deeper look into a SaaS startup’s operational effectiveness, customer engagement, and potential for sustained growth. To make more informed decisions or if primary metrics are not decisive, investors could engage with founders on some or all of these during detailed diligence.
What if My SaaS Startup is Still Pre Revenue?
In the very early stages when revenue metrics are yet to be fully established, attracting the attention of potential investors can be challenging. In these discussions, the focus normally shifts to specific indicators that signal potential for growth and success. Let’s explore some of those indicators here:
Problem Validation and Fit with Customer Needs: One of the first things an investor would typically assess in a pre-revenue SaaS startup is the validation of the problem being addressed and the alignment of the solution with customer needs. It’s crucial to showcase a deep understanding of your target audience’s pain points and demonstrate how your solution precisely addresses these needs. Robust market research and a strong understanding of customer pain points can be key assets in this regard.
Product Development Progress: Any incoming investor will understandably be very curious about the progress of your product development. They would want to know if you have a well-defined product roadmap, key milestones that have already been achieved, and a clear path to reaching the minimum viable product (MVP). Demonstrating that you’re on track and making progress is essential to gain investor confidence.
Pricing Strategy: While your startup may not have revenue yet, having a well-thought-out pricing strategy is critical. How exactly would the company be making subscription revenue and striking a balance between competitive pricing and profitability is a must have in your plan.
Go-to-Market Plan: Your GTM motion plays a pivotal role in any investor evaluations. Clearly outline how you intend to acquire customers once your product is ready for market. Provide data-backed insights into your distribution plan, showcasing your ability to reach your target audience effectively. Even at a preliminary stage, any strategic partnerships, alliances, or collaborations can be valuable indicators of market interest. Investors appreciate startups that have started building connections and relationships within their industry.
Traction Beyond Revenue: In the absence of revenue, pre-revenue startups can still demonstrate traction through other means. This could include user sign-ups, pilot programs with potential customers, partnerships, or letters of intent (LOIs) from clients interested in your solution. If applicable, provide user engagement metrics such as unique visitors, contacts, and leads.
Clear Use of Funds: Its always advantageous to clearly communicate precisely how the capital being raised will be used. A well-defined plan for allocating investment funds to achieve product milestones and drive growth instills confidence in investors.
Financial Projections: Even though revenue might not be present, an incoming investor would expect to see detailed financial projections. It showcases the potential for growth and improves the team’s execution capability by having a thought through business plan in hand.
Understanding Investor Thesis Building at Early Stage
Many investors may rely on a structured investment thesis to guide their decisions, especially in cases where concrete metrics are still emerging. Understanding that thought process can give you a distinct edge. Here are some elements to consider and these would generally apply to many contexts, not just early-stage SaaS:
Industry Focus: Investors are particularly interested in industries that are undergoing significant digital transformation. It’s not solely about the sheer market size but also about the growth potential within that market. They will often ask the crucial question, “Why Now?” They want to hear why your idea is poised for success in the current business landscape, taking into consideration macro trends and converging market conditions.
If your startup aligns with trends such as digital transformation, macro shifts, or untapped growth areas, you’ll be in a favorable position. It’s imperative to articulate how your solution fits into the larger industry narrative and why it’s well-timed for success.
Competitive Landscape: While competition isn’t necessarily a deterrent, exploring opportunities in less saturated markets can be strategically advantageous. To stand out, showcase how your unique value proposition shines in such an environment.
Investors often seek detailed insights into your target market’s size, growth potential, and your strategy to capture a share of it. Provide a comprehensive analysis of the competitive landscape. Explain what sets your solution apart and why customers would choose you over existing alternatives.
Sustainable Competitive Advantage: Beyond initial revenue, investors are looking for startups with a sustainable competitive advantage. This advantage can be achieved through various means, such as proprietary data, network-based advantages, or winner-take-all dynamics. It’s crucial to outline how your startup plans to maintain a strong market position over time.
Highlight the barriers to entry, defensibility factors, and long-term strategies that will protect your market share and ensure continued growth.
Team/Founder Market Fit: Investors love to see founding teams with strong expertise, experience, and execution capabilities. Complementary skill sets with industry-specific knowledge can be a strong positive. Demonstrating that your team possesses the skills and experience needed to navigate the challenges of the SaaS market significantly enhances confidence in your venture.
Aligning your narrative as applicable to these macro factors should further boost your chances of securing investor interest in funding your early-stage venture.
Wrapping Up
In the dynamic landscape of B2B SaaS startups, attracting the right type of investors requires a well-structured approach and a strong understanding of their thought process helps.
In the early stages focus more on communicating problem validation, value proposition, and a clear product development roadmap. Clarity on the revenue model, potential GTM motion, and early signs of traction would strengthen your pitch considerably.
In startups with strong MRR traction, strength of primary metrics like CAC, CLV, retention, and growth is crucial. But don’t overlook some of the secondary metrics that further convey the health and potential of your business -marketing traffic, lead conversion, user adoption, and engagement.
In all stages, clearly communicate fund use and financial projections.
Remember, the right investors are not just backers but partners in your journey. By continuously optimizing your metrics and refining your narrative, you not only enhance your chances of finding the “right” partner investor but also lay the foundation for a successful and impactful company!
