#69- SaaS is 2 businesses not 1
Demystifying SaaS - Part 1
Welcome to the very sporadic Siddharth’s Newsletter. I write about my learnings and experience as an early stage investor and try to demystify key items for my founder friends. If you follow me on LinkedIn or Twitter, you may realize I am long India B2B software, and my affinity will follow to this newsletter as well.
Below you can find a bunch of my notes on B2B software:
#8- How to conduct productive user interviews
#48- A primer on enterprise software sales
#51- How to determine the right sales model for your SAAS startup?
#67- BVPs 'The Rise of SaaS in India'
If you like what you’ve been reading, please consider liking, sharing, or subscribing.
Today I am starting a multi-part series on Demystifying SaaS which will help both SaaS & non SaaS folks better understand the space. If you’d like me to cover a topic, please comment below. Thanks
Why its difficult to understand a SaaS business?
If you are a SaaS founder, your P&L statement probably looks like this
Anyone who does not understand SaaS businesses will claim this is an unsustainable business. Despite high gross margins, the fixed costs in the business are too high to ever turn a profit.
And there are many items we need to infer or assume. For example, what is the pace of growth? What is the recurring revenue? How many customers are satisfied and continuing business with your company? How many customers are unsatisfied and leaving?
Two businesses in one
A regular P&L does not capture the true essence of a SaaS business. This is because a SaaS business is actually two businesses - a recurring revenue business, and a customer acquisition business.
Side note to founders: If you aren’t splitting your business in this manner, why not?
I have assumed:
Business is growing 2x a year (typical for early stage)
Customer support & service costs included in COGS
Sales & marketing costs to acquire new customers
Pro rata Tech R&D, General & admin costs across the two P&Ls
This shows you which part of the business is recurring, and creates value, and which part of the business is new, and requires investments.
What investors love is the potential of the acquisition part of the business to attain the characteristics of the recurring part of the business over time. And just like that, the P&L of next year can have $1mn in recurring revenues generating 20% operating margins.
But, it still does not give you the full picture, does it?
If this is a recurring revenue business, you want to understand how much of the revenues are recurring, how many customers are staying, what is the current rate of growth, and so on.
In my next post, I will highlight the correct way to look at revenues which can simplify life for many founders and their teams.
If you like what you read, please consider sharing.