Diving deep into B2B SaaS metrics with Michael Tam, Partner at Craft Ventures

Episode Description

In this episode of Diving Deep, Subscript's CEO, Sidharth, has an engaging conversation with Michael Tam, Partner at Craft Ventures.

Sidharth and Michael go deep into B2B SaaS metrics as they discuss:

The three categories of metrics that investors care about
B2B SaaS benchmarks to focus on when you're prioritizing efficiency
The importance of analyzing cohorted retention instead of a static retention number
Why you need to look at retention metrics segmented by customer profile
And more!

Show Notes

Follow Sidharth: https://www.linkedin.com/in/sidharthkakkar/

Follow Michael: https://www.linkedin.com/in/mtam/

Follow Subscript: https://www.linkedin.com/company/subscript/

About Diving Deep with Subscript

Diving Deep with Subscript is a video series where we dive deep and explore SaaS metrics with leading investors, CEOs, and finance leaders.

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Episode Transcript

Sidharth Kakkar
When you're looking at potentially investing in a company and you get that deck, what's the first page you flip to?

Michael Tam
The first page is that I flip to, I think it depends. If I know it's a SaaS company, then I'll look for the KPIs. We tend to prefer to invest post product launch and some revenue. So, I'll look for some summary of business to date. If it's a marketplace, then just trying to understand the business. So, typically trying to get to some quick KPI summary page would be more often than not what I quickly flip to.

Sidharth Kakkar
For a SaaS company, what’s the first - what do you hope to see in the first four to six metrics on that KPI page? Or maybe even just one? I don't know.

Michael Tam
So, the initial KPIs I would look at if it's a SaaS business, really I would start off or summarize with three categories, the first being momentum that I definitely pay attention to, the second category being retention, the third being efficiency. In terms of momentum, the couple of KPIs that really stand out, or one, just the year over your growth. A 3X year over year possibly equates to 11% compound monthly growth rates for twelve months. And then the net new ARR per month or per quarter depending on the sales cycle. And that net new ARR really being some new ARR, plus resurrected, plus expansion, minus contracted, minus churn ARR. And we look at that on a last six month period, last three months period, last twelve months, just to note any changes in trends. The second - going back to the categories, second would be retention. That's really logo and net revenue retention, which I can get into in more detail. And then the third on efficiency is, I like looking at a monthly ratio of SaaS and marketing spend, the new sales ARR as well as the burn multiple - on the former, typically a one to one ratio. And for the burn multiple, which we define as monthly net burn divided by net new ARR. Less than two is pretty compelling. So those are the three that I quickly look for if the company obviously has that data available.

Sidharth Kakkar
Yeah, do most companies? And how do you think about that when they don't?

Michael Tam,
Yeah, it varies. It's definitely case by case, as you probably often hear. Not many companies may have that quickly accessible, although there is definitely a lot more education now, content marketing around that. And so hopefully it becomes canon and everyone can sort of agree on how to define those terms and have it readily available. I definitely try to, with portfolio companies I work with, get the data hygiene set up sooner than later so we can have that available in the investor updates or in the board meetings to help drive some of the strategic decisions that we want to discuss. I'd say now it's increasingly more often than not a vendor may have some KPIs around that, whether it's presented in a manner that we would use is still kind of a case-by-case situation. But at this point, I think most SaaS operators and founders understand what those KPIs mean.

Sidharth Kakkar
Yeah, I find that with some of these numbers, it's like, possible to push them in a way that you delude yourself. And I'm wondering whether you see that and if it's maybe like, a common way in which people sort of miscalculate or mis-look at these metrics and end up deluding themselves.

Michael Tam
Yeah, I think what I'm used to seeing, or something that’s commonly seen, is presenting retention, for example, as a static number. And we like to look at that as most investors do, I think, on a monthly or quarterly cohort basis, historically speaking, and having a weighted average per month or per cohort. And I think that's pretty common in terms of like, seeing that NRR is presented in a way that doesn't actually capture per month, on a per monthly cohort basis, but that's solvable with accessing the raw data, which can also be challenged a whole other topic, but that's probably the most common one we see.

Sidharth Kakkar
On the cohort question, there's like, one thing that I often feel that I think is a misconception, and I'm wondering if you think it's a misconception, which is that if you're an annual business, like your contracts are mostly annual, you shouldn't look at cohorts on a monthly level. I disagree, but I'm wondering how you think about it.

Michael Tam
Yeah, I get the sentiment. I think it just depends on, you know, is there upsell happening within the year, the first twelve months? It depends on the pricing model. We certainly are aware of that. If that's the case, if the ACV doesn't change until month 13 or beyond, but if the pricing model is set up in a way where there is some upsell opportunity before month twelve, then we by all means look at it within the month or the first four quarters. So it really just comes down to the company pricing model, I think.

Sidharth Kakkar
Yeah. The other case I see is like maybe 80% of deals, or one year, but then maybe another 10% are six months, and then another 10% are 18 months. And I find that so much can be lost when either you're looking at one number for net retention or you're not digging into monthly or at least quarterly cohorts.

Michael Tam
Right, yeah. It's definitely an interesting point to highlight the mix of annual or the mix of the duration of the contracts. But normalizing the NRR and logo retention across historical cohorts is just a useful exercise to get to some insights quickly.

Sidharth Kakkar
Yeah. When you're in that first or second meeting with a potential Series A or Series B company and you're talking through metrics, how fluent do you expect your CEO to be in the core metrics?

Michael Tam
For Series A stage?

Sidharth Kakkar
Yeah. A or B?

Michael Tam
Yeah. So by the time we get to Series A. And this is something that I would also hope to have for polo companies at Series A leading into the Series A because we invest growth. I would hope that by the Series A especially for going out to meeting with new investors or just new stakeholders. We don't have the day to day context that we have some presentation actually, of the net new NRR per month and the historical cohort representation of our logo and NRR and the takeaways from what that data might tell us, with the understanding that these are trend lines right? These are sort of to be cemented in any way. It can be data that can be updated, but the hope is that we at least have some directional insights from presenting that data by the Series A, definitely by the serious B.

Sidharth Kakkar
Yeah. Do most folks start bringing in their finance teams into those meetings to talk about metrics, or do CEOs typically know it and how do you interpret either of those situations?

Michael Tam
I don't have a personal preference or signal. I don't draw any signal from that at all. It just depends on the founders’ bandwidth or focus area. If their backgrounds don't lend themselves to being able to be well-versed in this arena then it's not an indicator one way or the other. At least that's not for me. So as a result, just hire accordingly, depending on your strengths.

Sidharth Kakkar
Yeah. I think you mentioned using metrics to talk through board meetings and potential future fundraisers and stuff like that. How do you think that flows down to the actual operational cadence of running the companies, at least the companies you work with and for best in class, what does that mean on an operational level rather than just a board level?

Michael Tam
That's a good question. I can't say that day-to-day, in the day-to-day week with all my portfolio companies, so take this with a grain of salt. But I will say that it's a good place to be if we're able to have a conversation with key leaders in our portfolio companies, and being able to reference KPI Runner SaaS metrics and why that's driving maybe an operational initiative. Maybe it's meeting with the VP of Sales and defining how we're setting up the sales team, and why we're doing that, and why we're focusing on this particular ICP. So it's helpful to have. I wouldn't say to have an expectation to drive all decisions from this as well, because there's just a lot more daily context that we lack at the board level. And by no means are we in my mind - ultimately it's the founder and the team's decisions at the end of the day. And these KPIs are just ways for us to drive some prioritization around the day-to-day operations. So it's entered into some of the conversations with key leaders, but it definitely doesn't consume, by any means, those computations.

Sidharth Kakkar
We're recording this in June 2022 and the world is significantly different than it was in January 2022 or December 2021. And I'm curious, since so many companies are moving away from the growth at all cost mindset that has been the norm in tech for the last few years, to more understanding efficiency metrics, what is the advice that you're giving companies?

Michael Tam
Yeah, it's definitely topical. We actually have done a couple of sessions with the broader portfolio about operating during the downturn, and talking about how we got here, and what's driving it all, and going forward. What are some recommendations? We actually published one of those as well, last minute, so you can find that online. But we actually have this table out there that's circulating. You can surface it, defining the SaaS metrics that we think are great good in a danger zone, so to speak. And that would dictate default investable - being in a position where a company can still raise and be on the spender trajectory and maintaining. For example, 3X ARR. Just as a hypothetical example. Like a 3X growth in ARR while keeping your multiple less than two. Having these conversations - and that's a very high level trajectory. But being able to get into the weeds and how to work backwards from that. Meaning how do you adjust your go-to-market drivers. What are some drivers around your payroll and setting up your sales team? Moving away from experimental marketing spend to marketing spend that's driven more - tied to KPIs or conversion rates.

Michael Tam
These are conversations we're having in real time right now within our portfolio company, ultimately to get to some scenario analysis, some semblance of scenario analysis in our operating model. So we can ultimately, hopefully get everybody to a position where they have 24 plus months of runway is very relevant right now. So we're sharing what we're learning - and this is an ongoing conversation - but we're sharing what we're learning from a fundraising perspective, and what the outcomes might look like, and then working backwards from that, thinking through tactics to be able to ride through what we think is going to be a tough couple of years.

Sidharth Kakkar
I really appreciate the focus on specific benchmarks. I'm curious actually on that note, whether there's a couple of metrics that people haven't been paying as much attention to, or hasn't been as top-of-mind when it's all been about revenue growth rate that you are emphasizing. Like, you really got to know these and the benchmarks for those.

Michael Tam
Yeah, also, I touched on the burn multiple earlier. That's something that my partner, David Sacks, wrote about in 2020. And we started to see this outside of the craft portfolio companies. And that's just a measurement of how efficient the churn is. And I'm a big fan of that, big fan of capital efficiency. And that's something that we've continued to stress within the portfolio, especially in this shifting macro environment. I think CAC payback is one that people often talk about, but having just a more tighter focus on not only what it is, but the drivers to it and hopefully get into sub-12 months CAC payback period, is definitely something that we're working on with our portfolio companies. And I think sales efficiency is a big one, especially given that there are a lot of controllable drivers that dictate that measurement. As an example, as I said earlier, the one-to-one ratio of sales and marketing spend per month or per quarter to new sales ARR in that same time period. And I'm a big fan of that just because it's just a very simple measurement and there are, as I said, adjustable levers that drive that metric.

Michael Tam
And so I would say those are the - burn multiple and sales efficiency are definitely KPIs that we focus on to make sure that we're moving toward the growth metrics that venture investors may still be focused on while maintaining some efficiency levels.

Sidharth Kakkar
I have a sort of randomly nuanced question about sales efficiency. When I was building my last business, the main thing that everyone looked at was magic number, and sales efficiency wasn't quite like - within quarter on people's radar, but they're really the same thing. The question is whether you offset the new revenue by a quarter. I've also seen people offset by two quarters or three quarters. And I'm curious, like, what do you think of as the role of the set of metrics where they're all sort of calculating sort of the same thing except just which time period you're using the spend, and which time period you're using the net new ARR. I'm curious like, how you think about that, or if you have advice on how businesses might want to pick one or another as the main one that they think about?.

Michael Tam
We have a pretty simple framework for this, and it's really just tied to company sales cycle. We're big fans of companies with self-serve product-led growth. So if you're acquiring that customer within 30 days, then we simply align the numbers within that month. If you have a 30 plus-day sales cycle, then we'll do that as we'll adjust to the matching of the spend to new sales ARR. So it's really just dictated in our minds by the sales cycle.

Sidharth Kakkar
Yeah, that makes it sense. So how much your offset when you get the new revenue is sort of directly defined by what your average sales cycle is.

Michael Tam
Right. And again, going back to your earlier question around how in the weeds or close to the operating kind of day to day are these KPIs? If it's a net new company that we're meeting, this isn't by any means a precise exercise for us as well. We're coming at this as outsiders, so that's a quick way for us to normalize this. If it were a portfolio company, perhaps there's more detailed ways, but I'm mostly speaking to this from the net new perspective.

Sidharth Kakkar
Yeah, right. How has the current environment impacted the way that you're evaluating companies that are pitching you?

Michael Tam
Yeah, good question. So I don't think that our benchmarks that we're seeking have really shifted. We're still at the Series A, broadly speaking, hoping for three acts year over year. The threshold of ARR is a million or less, and there's a sliding scale there as you increase. We're still looking at high gross margin, 70, 80% plus NDR in 120 plus and CAC payback period less than twelve months, and all of that with a burn multiple of hopefully less than two. So that was something that we were always hoping to invest in in terms of the companies we partner with. If I had to call out anything that may have shifted, I would say maybe more a focus on the quality of the revenue or durability of your customers. If you're selling predominantly to startups or SMB, just trying to understand the potential retention of those companies going forward, as I think there's going to be a lot of headwinds around spending. For example, if you're a startup sign to another startup is one example anecdote that has come up in the last couple of months. So that's one thing that I would say may be a recent shift, but other than that, in terms of the KPIs, not really.

Sidharth Kakkar
That makes no sense in an ideal world. Are there ways that you would want management teams to be able to go a level deeper into metrics, whether it's sort of like slicing and dicing things or being able to see things at a more granular level, like the example with retention and cohorts, ways that you wish that or management teams wish that they could go deeper and that you think would be really beneficial?

Michael Tam
Yeah, so it's a topic that I think about often for the portfolio I'm on the board of. And one thing that I think is interesting is thinking about retention across customer profile, and that's dictated by the nuances of your business. But a very straightforward example would be SMB mid market or enterprise, especially if you have a sales motion that may be self-serve and you see a certain kind of customer profile coming through that, and then as well as pairing that with the top down sales motion. And so understanding the logo and NRR across customer profile can be interesting, historically speaking, because that may dictate refinement in the pricing model. Let's say as an example. A small percentage of your ARR is driven by SMB. And you're finding that you're dedicating a lot of upfront costs to onboard and close this SMB. Which is sort of a sales-assisted self-serve motion. And perhaps the way the product is structured, a premium model for that cohort might make more sense. And when you cut the NRR logo retention for the tiers that are more expensive. It's even more outstanding and it might make more sense strategically to introduce a premium model to capture the SMB cohort based on what you've identified from segmenting out your attention metrics by customer profile.

Michael Tam
So that's one example off the top of my head, but I think it's a relevant topic around, especially every board meeting for SaaS company where we're discussing SDP and our go -to-market and all these levers that we can work on to be able to identify or speak to the retention metrics in a more nuanced way across our customer base.

Sidharth Kakkar
That makes a ton of sense. Yeah, I think at the end of the day, no matter how you segment your customers, there's going to be groupings of some sort, and those groupings are going to behave at least somewhat differently. And knowing the answer to what is happening there is probably quite critical to making sure you know where to invest. So that makes so much sense to me.