SaaS in 2021: The Permanent Shift in the Startup Landscape

SaaS Startup Runway and Financial Health

A significant amount of available capital appears to have lessened the immediate concerns surrounding runway length for many SaaS startups.

Recent findings from OpenView’s annual Financial & Operating Benchmarks report indicate that only 13% of the almost 600 companies surveyed identified “excessive cash burn” as a primary worry.

Shifting Concerns and the Growing Divide

This represents a notable decrease from the 30% reported in the previous year.

The report suggests a widening disparity is developing within the B2B software sector, distinguishing between high-performing and lower-performing businesses.

This trend is particularly visible when examining publicly traded B2B SaaS companies.

Enterprise Value and Market Dynamics

Data analyzed alongside the report demonstrates that certain companies are experiencing considerably faster growth in enterprise value compared to their competitors.

The authors posit that a large market opportunity, a robust growth model, and strong unit economics are enabling leading startups to attract both skilled personnel and substantial investment.

Consequently, capital may be flowing away from companies with less impressive results.

Implications for Early-Stage Founders

What implications does this have for founders who are not yet considering an initial public offering (IPO)?

Furthermore, what key performance indicators (KPIs) can they utilize to assess their own progress?

To gain insights, discussions were held with Sean Fanning, Vice President at OpenView, and Kyle Poyar, Operating Partner at OpenView, both lead co-authors of the report.

Additional perspectives were sought from Dale Chang, Operating Partner at Scale Venture Partners, and Matt Cohen from Ripple Ventures.

Strategies for Growth and Sustainability

These conversations explored various strategies SaaS companies can implement to mirror the success of top performers.

These include approaches like product-led growth and usage-based pricing, areas where OpenView has publicly expressed strong support.

A continuing question remains, however: are the current valuation multiples sustainable in the long term?

The report highlights the importance of efficient capital allocation and strong financial fundamentals for sustained success in the competitive SaaS landscape.

Assessing Performance

Were we limited to selecting a single chart from OpenView’s report, the benchmarks table presented below would be our choice. It details several key metrics, categorized by the annual recurring revenue (ARR) reported by survey participants.

An explanatory note clarifies that each cell displays the median performance for a company, alongside the range – specifically, the bottom and top quartiles – for each metric at each ARR level. The median value is indicated in bold type, while the range is enclosed in parentheses.

The report’s authors emphasize that benchmarks should be viewed as a guide, not a definitive representation of reality. They also point out that both performance and valuation are determined by a complex interplay of multiple factors.

A startup founder operating with an ARR between $1 million and $2.5 million could find encouragement in the data, observing that a 100% year-over-year growth rate surpasses the average for SaaS companies in that ARR bracket. However, they would also recognize that leading companies achieve growth rates of approximately 300%.

Key Takeaways

• ARR Segmentation: Metrics are clearly divided based on a company’s annual recurring revenue.
• Median & Range: Each data point shows both the average performance and the spread of results.
• Context is Crucial: Benchmarks are tools for understanding, not absolute predictors of success.

Understanding these benchmarks can provide valuable insights for SaaS businesses looking to assess their own performance and identify areas for improvement. It’s important to remember that these are averages, and individual company circumstances will vary.

Focus on Expansion

The average growth experienced by SaaS businesses is impressive, often exceeding the performance of typical small and medium-sized businesses. However, the growth achieved by companies in the top 25% is particularly noteworthy, especially for those in their early stages.

Consider the following data:

The rate at which nascent companies are expanding is remarkable. Growth rates, both median and those of the highest-performing companies, have increased across most revenue ranges when compared to the previous year, with the exception of businesses generating between $20 million and $50 million in Annual Recurring Revenue (ARR).

Chang from Scale validated this acceleration in growth. “We’ve observed a general increase in growth rates across all segments,” he stated. “A particularly striking example is within the early-stage segment. Previously, the top 10% of companies typically grew from $1 million to $3 million in ARR annually (a 3x increase). Currently, these leading companies are achieving growth from $1 million to $5 million (a 5x increase) within the same timeframe.”

Shifting Investor Priorities

Given these figures, investors are prioritizing growth above all else, often overlooking profitability. OpenView noted that the “Rule of 40” – a venture capital guideline suggesting a combined growth rate and profit margin of 40% – has been largely disregarded.

Currently, OpenView suggests a new benchmark: the “Rule of 30,” emphasizing “30% top-line growth.”

Matt Cohen further confirmed this emphasis on growth. “Due to escalating startup valuations, the 40% rule is not a primary concern for investors, whether in private or public markets,” he explained. “The current focus is almost exclusively on growth, driven by low interest rates and readily available capital.”

However, it’s important to remember that venture capitalists haven’t historically demanded profitability from early-stage startups. This raises the question of whether the “Rule of 40” was ever truly a universal standard.

Chang’s data supports this perspective. Companies with ARR under $500 million generally fall short of the 40% benchmark, and those with ARR below $25 million often operate at a loss. “Nevertheless, the Rule of 40 becomes a valuable metric as a company scales and prepares for an Initial Public Offering (IPO),” Chang added.

The Growing Advantage of Product-Led Growth

Recent findings indicate a shift in the performance of companies embracing product-led growth (PLG). Initially, PLG companies demonstrated slower growth compared to their counterparts in the early phases. However, the latest data reveals they are now exceeding the growth rates of non-PLG businesses across all Annual Recurring Revenue (ARR) levels, as highlighted in an OpenView report.

Early Stage Performance

This conclusion stems from an analysis of company performance, particularly those with ARR under $1 million. The supporting data is visually represented in the following graph:

The PLG Flywheel Effect

Previously, adopting a PLG strategy often involved a trade-off during a company’s initial stages. This was until the positive effects of the PLG flywheel began to materialize, according to Poyar. However, the current availability of substantial capital and the evolution of more hybrid business models may be altering this dynamic.

Hybrid Approaches to Growth

Early successes like Atlassian and Dropbox were characterized by a predominantly self-service approach. Today, many organizations are implementing blended models. Cypress.io, a company within the OpenView portfolio offering a testing framework for developers, serves as a prime example.

Cypress.io's Strategy

Cypress.io has cultivated a strong product-led motion, attracting users through its open-source product. These users then integrate the product into their workflows. Furthermore, Cypress has strategically expanded its marketing and sales efforts.

This expansion aims to increase awareness and educate organizations about the broader advantages of adopting the product, extending beyond individual user benefits.

Synergy Between Sales and PLG

This evolving landscape explains the diminishing conflict between sales expenditure and product-led growth strategies. The report demonstrates that PLG companies achieve 1.7 times greater gross profit for every dollar invested in both sales and product development.

Justification for Continued Investment

Given these results, it’s understandable why companies are now less hesitant to invest in accelerating growth. Poyar explains that, “in the present market, where growth is highly valued, there is minimal risk associated with productive spending.”

Capital Deployment and Utilization

The actions of companies are inextricably linked to the prevailing venture capital environment. Access to unprecedented levels of funding has led to a notable increase in the median monthly cash burn rate for businesses generating between $2.5 million and $50 million in Annual Recurring Revenue (ARR) compared to the previous year.

Scale Studio employs operating income as a representative metric for cash burn due to data privacy considerations, but their findings corroborate this trend.

Increased Spending in 2021

According to Chang’s report to TechCrunch, “A higher rate of cash burn was observed in 2021, with a median operating margin of -45%, in contrast to -33% in 2020.”

This shift is primarily attributed to the cost-cutting measures implemented during the first half of 2020.

A resurgence of confidence occurred gradually in the latter half of 2020, culminating in an accelerated growth trajectory throughout 2021. Indeed, conditions nearly reverted to pre-pandemic standards.

Productive Cash Burn is Acceptable

Poyar and Fanning express no concerns regarding cash burn, provided it translates into tangible value creation for customers.

Fanning stated, “We have no objections to capital expenditure when it demonstrably benefits our customer base.”

“Sustainable cash flows, driven by genuine customer need for the product, justify such spending over the long term.”

• Cash burn is increasing for SaaS companies.
• The increase is linked to greater access to capital.
• Productive spending that benefits customers is viewed favorably.

Ultimately, the efficient allocation of capital remains a key indicator of a company’s long-term viability.

Maintaining Momentum: The Challenge of Rapid Growth

Securing funding is no longer the primary obstacle for many companies; attracting and retaining skilled personnel has become the central concern for founders. According to Poyar, companies experiencing rapid expansion benefit from increased visibility and are better positioned to recruit top talent, enabling them to further accelerate growth. Conversely, organizations that are stagnant or slow to hire may struggle to achieve key objectives.

The potential consequences of even a temporary deviation from projected growth are significant. Chang emphasizes that missing even a couple of quarters can negatively impact a company’s long-term growth trajectory due to the compounding nature of expansion. He further notes that falling below a certain growth level can diminish a company’s appeal to venture capitalists.

This pressure extends to both privately held and publicly traded companies with high valuation multiples. These businesses often have substantial growth expectations already factored into their market value, leaving little room for error. Fanning explains that they operate with minimal margin for failure, requiring precise execution and consistent delivery on promises to justify their high multiples.

This situation presents a potential risk for investors, particularly those making concentrated bets on individual stocks. However, OpenView believes these expectations are generally reasonable, stating that leading companies effectively combine a large addressable market, a strong growth model, and sound unit economics – articulating a compelling vision, achieving operational excellence, and efficiently gaining market share.

Fanning and Poyar also point to a notable trend: the total addressable market (TAM) for many established SaaS companies is considerably larger than originally estimated. As an example, Salesforce’s initial market valuation in its 2004 IPO was $7.1 billion. Currently, this figure is less than the company’s revenue, which it recently projected to reach $26.3 billion for fiscal year 2022.

Ron Miller, a tech reporter at TechCrunch, highlights that Salesforce successfully surpassed the $20 billion revenue target set by founder Marc Benioff in 2017 by adhering to the three core principles identified by OpenView.

These principles include product-led growth, substantial market capture, and effective execution. Crucially, Miller adds, Salesforce fostered a culture of community and philanthropy, prioritizing both business performance and social responsibility. He suggests that Salesforce serves as an exemplary case study for the principles outlined in the OpenView report and a benchmark for SaaS startups.

The COVID-19 pandemic also contributed to this growth in some instances, as Chang observes. The accelerated digital transformation across nearly all industries has broadened and deepened the potential markets for software solutions, potentially explaining the increased growth rates and optimistic valuations.

Considering these factors, high valuation multiples appear more justifiable. While sustaining exceptionally rapid growth presents challenges, it ultimately represents a favorable position for a company to be in.