Dynamics of SaaS Investing — Growth, Retention, and Profitability

What makes software exciting?

  • a considerable degree of predictability as a result of recurring revenue
  • high gross profits due to the absence of a fixed physical asset
  • marginal costs to produce a piece of software to an additional customer is zero because software is packaged lines of code
  • long product cycles in B2B
  • high retention
  • low capex with most of it being on IT spending
  • opportunistic exit environments

Power of Retention

The numerator will consist of the net difference of all expansion and upsells minus the contractions and churn. (MRR + Expansion Revenue + Upsell — Contraction Revenue — Churn)
Cohorts are established based on the month of subscribing
  • <90% NRR → not as strong
  • 100% NRR → benchmark
  • >110% NRR → very strong
Annual Expansion % - Annual Lost % - Annual Contraction % = Net difference from 100% NRR
If churn + contractions + expirations = expansion, NRR = 100%
Provided by Software Equity Group (SEG)
Notice how an NRR < 100% results in net contraction, while an NRR > 100% results in net expansion
Notice how the GRR punishes cohorts with higher churn or contractions

Retention vs. Growth

Leaky Bucket — 25% of the business is lost every year

Path to Profitability

g = acquisition growth rate, BE0 = Break-Even Time with 0 churn. ACS = Average Cost of Service. Formula from Chaotic Flow

Accelerating Profitability

  • Implement expansion revenue strategies (upsell, cross-sell, or price increases) to increase revenues without increasing costs
  • Lower total costs of delivering service to the customer by the vendor through economies of scale and cost-efficient alternatives
20% upsell amongst all customers




Summer Analyst at J.P. Morgan

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Shubhang Jani

Shubhang Jani

Summer Analyst at J.P. Morgan

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