Efficiency: How efficiently are we generating growth? Flashcards
What does the “Rule of 40” measure?
Efficiency
Measures how efficiently a SaaS company is balancing growth vs. margins.
* If you add together YoY RevenueGgrowth rate and EBITDA margin and you are above 40% then that is said to be an efficiently run company
* Benefit of this metric is you can benchmark both companies with high growth rates and low growth rates and compare how they’re trading off revenue growth vs. margins against an efficient frontier of 40%
* Not as applicable to early-stage companies
* Much more relevant metric the larger and more mature a SaaS company becomes
Several ways to calculate Rule of 40:
* EBITDA or FCF margin
* Revenue and ARR growth
Calculation specifics:
* Typically calculated on an annual or LTM basis to minimize quarterly variability
* Some firms subsitute EBITDA margin with FCF margin (CF from Operations - CF from Investing) which results in a more conservative approach
* You can also substitute YoY ARR Growth for YoY Revenue Growth to calculate Rule of 40
* Calculation options based on data availability
What does the “SaaS Magic Number” measure?
Efficiency
Measures how much New ARR was driven in current period by prior period S&M spend.
Commentary:
* For every dollar spent on S&M efforts how many dollars of New ARR growth did we drive?
* Important metric for early-stage companies where LTV and customer lifetime is not yet known
* Rough measure of how efficient GTM spend is and it is easy to calculate
Many “flavors” of SaaS Magic Number:
* Gross: only includes New Logo ARR in numerator
* Upsell: includes expansion ARR in numerator to capture upsell / cross-sell ARR growth
* Time-adjusted: S&M expense is lagged vs. New ARR growth to align with sales cycle length
* Margin-adjusted: Multiply New ARR gained in numerator by subscription Gross Margin % to account for costs of deliverying solution
Calculation specifics:
* Calculated on quarterly basis (not annually)
* For margin-adjusted Magic Number you can use current period Gross Margin % or take the average GM% of both ARR periods measured in numerator
What does “Burn Multiple” measure?
Efficiency
Measures for every dollar of ARR we add, how much cash are we “burning”?
Commentary:
* The lower the Burn Multiple the better
* Burn Multiple can be negative if the company is generating positive cash flow
* Most useful for early-stage SaaS companies that are growing fast and are burning cash
* Less relevant more mature cash flow positive businesses
Calculation Specifics:
* Most common approach is to use current period FCF in numerator (CFO - CFI)
* If most of money we spend takes time to generate ARR growth, then you might consider using prior period FCF rather than current period
* EBITDA or EBIT can also be substituted as a proxy for FCF based on data availability
What does “ARR per FTE” measure?
Efficiency
Measures how much annual recurring revenue we generate per full time employee.
- Sometimes referred to as “APE”
- Point-in-time metric indicating how efficient our employees are at building recurring revenue
- Predictor of how strong long-term margins can be at maturity
- Consider using average employees at beginning and end of period if FTE count is increasing/decreasing rapidly
What does “Opex per FTE” measure?
Efficiency
Measures how much we are spending in Operating Expenses per full time employee.
- Similar to ARR per FTE, Opex per FTE is a predictor of how strong long-term margins can be at maturity
- Rough indicator of how much we’re paying employees but note that Opex per FTE metric does not include COGS
- Operating Expenses include Sales & Marketing (S&M), Research & Development (R&D), and General & Administrative (G&A)
Calculation specifics:
* Typically calculated utilizing LTM Opex
* Consider using average employees at beginning and end of period if FTE count is increasing/decreasing rapidly
* Can also be calculated at a department level: i.e., utilizing LTM S&M expense and S&M department FTE to calculate S&M Expenses per S&M FTE
