B2B SaaS

K2 Achievements, the management consultant company I co-founded many years ago, specialized in the continued services sector. Companies in this sector usually share the same business logic and dynamics associated with acquiring and establishing a long-term relationship with their clients through subscriptions. For instance, these companies usually face the same sort of sales and operational challenges such as segmentation and targeting, continuous rationalization of the cost to serve, client loyalty and anti-attrition, monthly billing, multiple processes involving the main offering and so on.

Perhaps the most notable characteristic of continued services companies is that if they decide to stop investing in growth by not spending money to acquire new subscribers, they will rapidly become profitable.

SaaS (Software as a Service) companies are in the continued services sector. However, in a particular way. B2B SaaS businesses typically enjoy:

* High gross margins — 70%+

* High switching costs, i.e., “sticky” subscription-based models – for instance, once an ERP system is installed in a company, it becomes a nightmare to change it.

Most of the SaaS companies do not generate cash yet, but investors are believing in their stickiness potential. Moreover, if we believe that the transition to cloud is still in the beginning, the SaaS opportunity is massive (pure play SaaS companies exist for only 15 years).

These factors explain the rich valuations (high revenue multiples) of B2B SaaS companies today, which are around 15x NTM (next twelve months) revenue – in some cases, like Datadog, it is more than 30x.

There are around 75 US public pure play SaaS companies. Over the last 3 years, their average return from IPOs prices is near 5x! (source: Spark Capital). So, while IPO valuations are high (in the 8 to10x EV/revenue NTM range), their amazing public returns have made it worth to invest on them — and mainly if you invest during the Late Stage phase.

Dissecting the pre-IPO numbers from those SaaS companies (source: Spark Capital):

* They were not making profits

* They were growing over 55% year over year

* They were generating US$ 150 million of Annual Recurring Revenues (ARR)

Conclusion

EBITDA is not a good metric for a SaaS company.

Instead, the metrics that matter are ARR, ACV (Annual Contract Value) and growth.

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