The following blog content has been updated in November 2023 to incorporate the most recent research findings.
SaaS founders must stay attuned to the shifting preferences of private equity (PE) investors and strategic buyers. By aligning your company’s strategies and performance with their evolving priorities, you can enhance your appeal in the competitive landscape of software investments and acquisitions.
Our 2023 State of SaaS M&A: Buyers’ Perspectives Report unveils the evolving priorities of top software-focused private equity investors and strategic buyers amidst economic uncertainty. In 2022, investors and buyers were keenly focused on gross revenue retention (GRR) and gross profit margin (GPM) as top metrics to target. Fast forward to 2023, these metrics’ significance as evaluation criteria remain.
Discover where these two crucial metrics stand in the minds of private equity investors and strategic buyers and learn what this means for SaaS founders.
Gross Revenue Retention & Gross Profit Margin: The Slight Shift
As of this blog’s update, we have published our 2023 State of SaaS M&A: Buyers’ Perspectives Report. This resource highlights the changes in buyer and investor preferences, including GRR and GPM, previously considered the top two metrics to consider. Now, they still hold significant value, but the latest survey results show a deeper look behind the mindsets of buyers and investors.
In 2023, 26% of private equity investors prioritized gross revenue retention. Currently, it maintains its second-place position overall, following revenue growth. Another perspective reveals that this year, 71% of investors ranked gross retention within their top three most crucial metrics overall.
Moreover, gross profit margin experienced a slight decline. In 2022, it held the third position in the priority list for PE investors. However, in 2023, it fell to fifth place yet remains crucial. We believe this shift may be attributed to the strong indicator that scale represents in terms of product-market fit and longevity, as it essentially swapped positions with total revenue. This is not to diminish the importance of gross profit margin. In fact, 37% of investors still rank it within their top three most critical KPIs.
Together, these two are associated with stable, efficient, mission-critical, recession-resistant businesses. Learn more about these two sought-after metrics.
Gross Revenue Retention: How to Calculate
Gross retention simply measures the percentage of recurring revenue retained from existing customers over time. It counts losses from customer churn or downgrades but doesn’t include gains from new business or upgrades.
A GRR rate proves revenue stability, with this highest possible rate landing at 100%. A high GRR rate often showcases strong customer satisfaction and loyalty. On the other hand, a low GRR rate may point to dissatisfaction across various aspects, including product, customer service, and so on.
A Quick Note Regarding Gross vs. Net Retention
Gross retention and net retention are both important metrics to evaluate and are often considered equal in value. However, gross retention may be a more accurate reflection of long-term stability.
A company with strong gross retention has fewer “leaks in the bucket,” so any future success only adds to its profitability rather than compensating for loss. This explains why 71% of investors we surveyed rated gross retention amongst their top three most critical KPIs.
“In an uncertain environment, if an investor is buying an asset for future revenue growth, they’re less sure that growth will materialize,” SEG Managing Director Allen Cinzori said. “They do know if the company has strong retention and is integral to the daily operations of their customers, those customers likely aren’t going anywhere. This creates a baseline for growth.”
What is a “Good” Gross Revenue Retention Rate?
SaaS companies hoping for a high valuation should aim for 90% or greater gross revenue retention. Companies can improve in this area by staying focused on their strongest customer relationships and ensuring they have a team of people dedicated to customer success.
READ MORE: Dive into our newly updated 20 Factors Whitepaper and access our exclusive metrics scorecard. Start benchmarking the KPIs that matter most to buyers and investors.
Gross Profit Margin: How to Calculate
The gross margin represents the profit percentage remaining after subtracting direct costs, which include the cost of goods sold (COGS), from the total revenue. It provides insight into how effectively a company converts sales into profits, taking into account various expenses such as hosting, support, and labor.
For software companies, gross margins assume particular importance, as they frequently enjoy high valuation multiples owing to their substantial profit margins. A strong gross margin signifies a greater pool of profits available for reinvestment in the business, underscoring its vital role as a key metric for assessing a company’s financial well-being and long-term profitability. Calculating gross margin is a simple, straightforward formula that subtracts the COGS from total revenue and then divides that number by the revenue.
“Gross profit margin is the first efficiency metric investors see on the P&L,” SEG Principal Austin Hammer said. “A high gross margin sets the table for profitability and is typically a result of healthy operating metrics.”
Many software CEOs miscalculate the cost of goods sold by failing to account for less obvious expenses such as hosting, infrastructure, third-party software, and employees working in DevOps or customer support. When you can clearly see what it costs to deliver each software license or subscription, you can better optimize those costs.
What is a “Good” Gross Profit Margin Rate?
Based on our experience working with hundreds of software companies, we see average gross margins of around 70% as the benchmark and recommend aiming for a gross margin of 75% or higher. A gross margin below 60% could indicate your software implementations are too complex, time-consuming, or costly, or your customer support processes may not be efficient.
Improving gross profit starts by understanding which types of customers or product offerings have the highest gross margin and increasing your focus on attracting more business in those areas. Finding ways to optimize costs by automating manual processes, improving delivery models, and reducing unnecessary expenses can help in this area. Regularly revisiting your pricing model is another important strategy that can help you maintain a high gross profit margin.
A Look at Today’s Key Metrics for M&A Success
The combination of high gross profit margin and high gross revenue is especially appealing to investors amid an uncertain economic environment because it indicates a strong potential for growth and stability regardless of external factors. Combined with GRR and GPM, profitability now takes the stage as a third metric buyers and investors are eager to find.
Nonetheless, various other factors influence the priorities of investors and buyers. Rest assured, our commitment remains steadfast in relaying their preferences to you. For more insights on the M&A market outlook and how you can take advantage of the ripe opportunities in today’s market, download our 2023 State of SaaS M&A: Buyers’ Perspectives Report.