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Changing SaaS startup benchmarks in the COVID-19 era

This morning, let's talk about SaaS growth, retention, and burn metrics in the new era.

Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.

Last week we dug into a set of benchmarks that Bessemer Venture Partners, a venture capital firm that invests in software companies among other categories, drew up to grade software-as-a-service (SaaS) startups. The performance metrics were designed to bucket SaaS startups into quality cohorts based on their performance, giving founders and other investors a measuring stick for startup results.

But the metrics were designed pre-COVID-19 and the ensuing economic shakeup of the domestic and global economies. To get a handle on what might have changed in the metrics, and their underlying expectations, since economic growth has slowed and companies large and small have laid off staff, pushing unemployment to historic heights, I spoke with Bessemer’s Mary D’Onofrio, a growth-stage investor at the firm and one of the authors of the report the metrics were originally taken from. (TechCrunch also spoke with her recently about valuing startups in a downturn.)

This morning, let’s talk about SaaS growth, retention, and burn metrics in the new era. After all, with growth concerns rising and churn itself picking up, surely the venture friendly triple-triple-double-double-double is out the window, right?

New measures of SaaS success

Kicking off, what has changed in regards to growth? As we covered Friday, Bessemer’s original growth expectations feel aggressive today as the U.S. economy heads into a recession. D’Onofrio told TechCrunch in an interview that it’s a bit early to tell how much things have changed. But while she admitted that “we don’t have enough data to have crisp benchmarks at this point,” she did have some notes to share.

For instance, anecdotal data from inside the venture capital community points to SaaS startups looking at a “30% miss to plan” in Q1 2020. That’s a steep loss of pace.

In light of new growth expectations, of course, the bar is lower making stronger results all the more impressive. “There are going to be some very solid growers,” she added, that “could still meet that 50% ‘good’ benchmark, which in this context we would consider to be even better than we would have” before COVID-19.

Yet growth expectations have slowed as the economy has dipped. The 30% decline, mind, is for Q1, not Q2. D’Onofrio isn’t certain what’s coming in the current quarter.

“All of these plans and all of these budgets are being constantly reevaluated,” she said.

In light of that uncertainty, however, the investor is not as focused on growth as she might have been a year ago. “Rather than focus exactly on the growth rate,” D’Onofrio told TechCrunch, she’s more focused on a startup’s “growth rate in the context of the burn and in the context of the capital efficiency.” So, let’s talk about burn.

Asked about a new ratio between burn (net cash loss in a period of time) and growth (ARR expansion in a period of time), D’Onofrio told TechCrunch that she doesn’t have a new metric in hand yet for the COVID-19 era, but that “as close as [a startup] can get to a one-to-one ratio between net new ARR and burn, the better.” (As some SaaS metrics look at preceding quarter spend against present quarter growth, I asked D’Onofrio about this particular ratio which is instead measuring burn and ARR growth from the same quarter.)

If you recall our discussion from last week, Bessemer differentiated churn (revenue loss), and net retention (the sum of churn and selling more to existing customers) expectations for startups based on what sort of companies they sold to. In the pre-COVID-19 era, the venture capital firm expected most startups to post positive net retention, or more simply that their existing customer base would, on balance, spend more money with the company over time. For startups targeting smaller businesses (SMBs), expectations were looser.

But with churn on the rise thanks to the pandemic and our global response to its threat, what’s changed? Startups that sell to “SMBs are going to be disproportionately affected as SMB spending decelerates and a lot of them go out of business,” D’Onofrio told TechCrunch. In Bessemer’s portfolio, she added, its strongest-performing SaaS companies that sold to SMBs posted net retention numbers over 100% before the world economy changed. “Obviously with coronavirus that is going to change,” she added, saying that many of those startups “are going to re-forecast lowest, honestly, because of their customer segment.”

Enterprise-focused startups are expected to be more resilient she added, adding that as in-person sales are kaput for a while, upsells (selling more product to existing customers) becomes more important. How much might upsells be impacted by the slowing economy? The same uncertainty that we all feel is impacting corporate budgets, according to D’Onofrio, saying that Q2 economic activity will set expectations.

“Companies may or may not feel more comfortable expanding their seats,” she added, based on what they see in the period. Regardless, she expects upsells in the enterprise to continue, if at a possibly reduced pace.

In summation: Startups are looking at around a 30% miss to plan in Q1 with Q2 itself far from settled. This has tempered investor growth expectations. But even more than raw growth figures, SaaS investors are looking for efficient growth. In Bessemer’s eyes, a 1:1 ratio of ARR add to burn is the target. It won’t be easy. Startups selling to SMBs are going to hurt worse by rising churn than enterprise-focused startups, while startups selling to larger customers may struggle with new customer adds given travel restrictions. So, enterprise-focused startups will likely lean more on upsells than new logo adds. Those will also prove difficult, even if they won’t slow completely.

Finally, what’s changed about Bessemer’s cash conversion score (CCS) expectations? Recall from Friday that a startup’s CCS helps detail “how much cash [it] has burned to generate some amount of annual recurring revenue.” This will sound familiar, as D’Onofrio told TechCrunch earlier that a 1:1 (1x) ratio of burn to new ARR was great. That’s precisely what Bessemer noted in its presentation, giving startups that managed a lifetime CCS of 1.0x or better the score of “best,” while startups that managed from 0.25x to 1.0x were awarded grades of good-to-better.

After noting that “the median cash conversion score for a public cloud company at $100 million of revenue was a 1.3x” historically, D’Onofrio said that she is “definitely expecting a dip” in how startups perform on the metric in the near-term before emphasizing the long-term nature of venture investing. Instead of betting a startup’s Q2 performance, she said, VCs have multi-year investment horizons.

Still, cash conversion scores at startups are going to fall in 2020. “We’ve already talked through churn, we’ve talked through growth rate,” she summarized for TechCrunch, adding that she “expect[s] a deceleration [in CCS] for most companies.”

Until we know more about Q2 SaaS startup growth rates, how far variable costs can be reduced to limit burn, and what churn works out across various customer cohorts it is hard to know what to expect as a future benchmark for this particular metric. But the threshold of ‘good’ has changed. Like growth rates, it’s likely a bit lower than it was in January or February. How far is the question.

So SaaS startups are, taking D’Onofrio’s notes in aggregate, entering a period in which all expectations are likely to slip; the best will stand out all the more, while weaker SaaS firms could fall into uninvestable territory. It’s up to startups to conserve cash while maintaining venture-ready performance. If that sounds like a tall order that’s because it is. And it will get harder the longer the economy is crumbling.

When we get Q2 numbers in, TechCrunch will get Bessemer’s growth team back on the phone to find out what they are seeing. For now, uncertainty and falling thresholds of good, better, best is the order of the day.

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