“Quality of earnings” is a standard investment analysis exercise, both for publicly-traded companies and M&A transactions involving profitable target companies.Given that we invest in private SaaS companies that generally do not have much in the way of a profit history, we don’t pay much attention to quality of earnings. That said, we do highly value the quality of high-margin, recurring SaaS revenue.This post focuses on analyzing cohort quality (the delivery mechanism of your recurring revenue).
Here’s how we go about analyzing cohorts…
First off, we focus on SaaS. We understand how recurring revenue functions and know how to measure its health in an initial-scale SaaS business.This is really all about the types of customers you have (SMB/enterprise/both), the relevant SaaS metrics to apply to them and the associated recurring revenue they deliver.Once we’ve determined your historical metrics, we’re using them to look to the future to best guess what may happen, apply an opportunity/risk rating and structure an investment that aligns with it.Results are represented in your metrics, so here are the customer metrics that matter.
Relevant Cohort Metrics:
# of customers: For SMB, we’re generally looking to see >100. For enterprise, >10.
Average age of customers: If all of your customers are new, say less than 12 months old, it’s hard for us to analyze the metrics as there just isn’t much history there, specifically in terms of churn/retention/engagement. Especially, if you’re selling enterprise SaaS and have not gone through renewal cycles. With 12+ months of history, we have a meaningful amount of data to make decisions.
Cohort metrics: How are you doing at growing and retaining your cohorts? Are they getting larger / staying longer? Are they paying more? Are cohort lifetimes lifetimes stable or increasing? What’s the associated spend (CAC) to acquire these cohorts? Is all of this becoming predictable? We like to know what you’ve learned and what you’re doing to improve your customer acquisition and retention.Check out our sample cohort reporting we use to evaluate SaaS cohorts, specifically SMB SaaS. This is a view-only Google Sheet, so when you open it just Open with Google Sheets and File–>Make a copy if you want to play around with it, laying in your cohort data.
What does this sample report surface for SaaS Revenue?
If you check out the report, you will see that the cohort data tell us that this company is doing a decent job acquiring new customers but appears to have a fundamental problem retaining them. The company may not actually have solid product-market fit (PMF). So, we need to dig into that and understand whether it’s really worth investing into customer acquisition at this time, or if core product and customer success work needs to be done and proven out to reduce churn over the coming months. We would pose this question to the Founder and get his/her take before we and he/she decide to invest into customer acquisition. We’ll continue sharing tools like this and developing our platform to support initial-scale SaaS companies with capital and operational insights. Feel free to reach out with questions.Hope you found this helpful. If so, please let us know (firstname.lastname@example.org) and check out some of our other content/tools here on our blog.