SaaS IPO Benchmark Study – “The good, the better and the best …”

04.10.21By Guy Sochovsky, Farview Investment Partner

 

Given Farview’s model of investing to help B2B technology companies on their journey towards $100M+ of revenue scale, we wanted to establish a reference set of what leading financial and operating metrics looked like at that scale.  Since the classic revenue threshold for SaaS IPO’s has long been set at $100M, we sought to build directly from IPO disclosures across 84 different company filings over the last 15+ years.  The companies that we chose are not the entire public universe, but ones we feel give a good cross section of the SaaS market.

Having burned up some research hours, cycles around classification debates and extensive chart builds – did we find anything interesting?   The insights below were the ones we found most intriguing …

 

SaaS companies are getting bigger at IPO, but not necessarily better

It is a well understood fact that the depth of equity financing and low cost of capital for SaaS companies has allowed them to grow in the private markets for longer, frequently now emerging as public companies well beyond $100M of revenue.  But do they seek public market support with stronger operating metrics given that extra time to mature?

Looking through the financial lens offered by Rule of 40 calculation, the clear impression from our data set is that greater scale and scaling windows in the private market has not produced stronger balanced growth and profit outcomes.  The data in the table largely speaks for itself …

There have of course been companies with exceptional operating metrics which have gone public in  the 2018+ cohort (we would call out Zoom, Datadog, TeamViewer, Olo all with Rule of 40 profiles ~100+), but cost of growth appears to have increased over time.  Breaking apart the Rule of 40 returns, the 2004-14 and 2018+ cohorts both delivered similar loss ratios at the EBITDA level,  but the later did so at the cost of ~10% less revenue growth …

 

Product-led companies out-perform Sales-led companies operating returns

The arrival of product-led companies into public markets is by now another well-documented phenomenon.  Looking at our selected reference set of IPO companies, within the 2004-2014 cohort over 70% were sales led, by contrast the 2018-2020 cohort saw over 75% using some degree of product-led motion.  There may of course be some selection bias in the names that we have pulled through, but the directional trend seems beyond question.

We were curious to understand the different investment return profiles between product and sales led companies.  To try and achieve that we calibrated across two metrics (i) Incremental Revenue / Sales & Marketing Cost (“NNR/S&M”) and (ii) Gross Profit / Research & Development Cost (“Return on Research Capital” or “RORC”).  Consistent with the investment emphasis that would be expected, the product-led companies across our sample showed higher sales returns but slightly lower returns on R&D, with sales-led companies being skewed to lower sales returns but with stronger yield on product development.

As the charts below indicate, there are some strong outliers across both models, but a distinct clustering of returns under the product-led profiles vs. a pronounced winners and long-tail shape to the sales-led group.

When we look again through the lens of Rule of 40 returns, the relative overweight of higher NNR/S&M returns on product led models appears to deliver stronger growth efficiency.  As a group across the entire data sample, product-led companies generated 63% median revenue growth rates at IPO vs. 45% for sales-led peers.  Both groups were equally capital consumptive at the EBITDA level though (showing -20% margins), meaning the ~20% growth differential translated into Rule of 40 returns.  At the risk of drawing conclusions from aggregated data … the implication seems reasonable that an organizational investment in product-led growth motions yields the strongest operating returns.

Interestingly, slicing the data back into chronological cohorts the drop-off in Rule of 40 returns from 2018 onwards applies across both product and sales-led growth motions.   Both motions show high teens decline in Rule of 40 outcomes between pre and post Jan 2018 cohorts, tellingly though, that decline leaves the most recent sales-led IPO companies delivering median Rule of 40 outcomes close to the mid-teens … with the drop off being the result of declining revenue growth despite a market that placed progressively more emphasis on top-line vs. profit performance.

 

Delivering into the Mid-market appears the hardest place to drive efficient growth

Another generally accepted theme … being stuck in the middle of a market frequently comes out as the hardest place to differentiate and deliver value from.   Testing the spectrum of the reference group across target segments and low-medium-high touch go-to-market motions appears to make this theme ring true.  As the median data-sets below indicate, the cost of staffing and investing medium touch models that typically orient around inside-sales led motions targeting $5-50k Average Contract Values yields the least attractive outcomes.

When debating how to classify companies into the cohorts above, we felt that some did not fit cleanly into any of low-medium-high touch groups, hence the “Blended” profile.  Looking at the companies within that group (including Slack, Zoom and Salesforce), it is clear that one of their clearest common characteristics at IPO was very high gross margins.   The drop-through profit that flows from growth for these companies appears to have let them support multiple segments and optimise their overall growth efficiency.

 

Some companies do not fit a model, others define a new model

Spreadsheets do not always capture the full story … some companies just break the boundaries and approaches that the majority follow.

Even across a group of 84 SaaS company IPO profiles, there are some metrics and returns which stand-out as absolute outliers and have led us to rely on median outcomes vs. averages due to the heavy skews they create.  Looking across all of the metric sets that we tracked the table below gives a summary of some of more pronounced outliers and some pointers around their outperformance …

 When we look for companies that have shaped operating playbooks that have been flattered by the replication of others, we think it would be relatively uncontroversial to call out names like Atlassian and Wix for their ability to deliver efficient logo acquisition through free digital channels, or to reference the reinvention of an entire product by Slack to move from freemium to enterprise end-market models, or perhaps most famously the realisation by Salesforce of SaaS customer success as a means to stop 8% per month churn killing the business … and perhaps even the idea that SaaS could work as an economic model.

The one SaaS metric we like to overweight as Farview though is the attainment of Net Revenue Retention (“NRR”).  Whenever we see anything that approaches 120% it leaves us with strong conviction about the underlying operating model of the company (noting that for SMB oriented companies anything closing on 100% is pretty darn good).  Looking across our benchmark set for the companies who disclosed NRR at close, we again see some distinct differential between product and sales led motions.  Perhaps most interesting is the breakaway leadership of the NRR pyramid by Veeva – demonstrating that being overweight professional services can be just as effective at driving customer transformation and upsell as even the best product led approaches.

 

Farview’s interpretation of best-in-class

Now that we have run the risk of applying simplified output financial metrics to help explain the core and endlessly complex operational models of 84 leading SaaS companies … we felt it was worth sticking our necks out a little more and suggesting which were the names we felt should be called out as best-in-class at the point their respective IPO disclosures.

After quite some internal debates we settled on one each across product-led, sales-led and blended growth motions.  All three qualify by exhibiting exceptional Rule of 40 returns above 125%, demonstrating both high growth and strong operating returns.  They also run the ACV spectrum and across the set show mastery from low-touch to high-touch models.  Trying not to be influenced by subsequent share price performance, our operating metrics winners would be as follows:

TeamViewer

If product-led growth is about building something that sells itself without needing a lot of human touch then TeamViewer stands out even vs. its product led peers delivering Return on Research Capital of nearly 15x against a product-led cohort with a median of 4.2x.  The efficiency of that motion also helped the company to demonstrate a Lifetime value / Customer acquisition cost ratio in excess of 30x, a significant stretch beyond anything that many would describe as best in class.  Honourable mention: Atlassian

 

ServiceNow  

Despite being one of the earliest companies to go public as a pure SaaS business back in 2012, ServiceNow demonstrated very powerful growth capabilities right at the top-end of the ACV scale and through complex enterprise accounts.  Its ‘classic’ selling model in 2012 demonstrated over 2x returns of net new revenue against sales and marketing cost, more than double the sales-led cohort median return and with just 5% churn rates helping to drive net revenue retention to 124%.  Honourable mention: Veeva

 

Zoom  

Without taking into account its stratospheric post IPO share price performance, Zoom unquestionably held stellar operating metrics when it first hit the public markets.  With a product geared to beat the competition with intuitive UI and UX and capable of delivering 80% gross profit margins, over half its $100k+ ACV accounts at IPO started as free users.   Zoom deployed $150M of incremental gross profit preceding its public market debut into driving 100% revenue growth, selling through all market segments and across low to high-touch motions.   Honourable mention: Slack

 

Closing thoughts

The exercise of building the dataset and reflecting on the drivers of success has been a really valuable one for the Farview team.  We have almost certainly failed to mention a huge number of vital factors that supported the journey to the public markets enjoyed by our selected IPO group, but we hope to have brought out a few points of interest about what it looked like when they actually got there.

Is there a single element that we would pull from the exercise and seek to reinforce in our thinking as we engage with companies at the outset of their journey towards IPO scale?   What the exercise has reinforced for us in the importance of understanding the particular dimensions that underpin a desired scaling motion (such as, product vs. sales-led / horizontal vs. vertical applications / SMB vs. MID vs. ENT segments) and optimising them to the fullest.  Picking the right top-quartile benchmark set to determine what that maximum potential could be, may well be a key part of setting up for success …

We are always looking to refine our own thinking and points of reference on what it takes to build and support companies on the path to durable growth and revenue scale.  If you would like to get in touch to debate anything we missed, or to delve even deeper into the underlying data to draw out points of interest for your company – do not hesitate to drop us a line.