Kristopher Beible, Vice President at Software Equity Group, recently spoke with podcast host and CEO of RevOps Squared, Ray Rike, about the importance of the net dollar retention metric and its contribution a SaaS company’s enterprise value.
In addition to discussing the increasing primacy of net dollar retention, Kris broke down Software Equity Group’s Net Retention Wave, advised founders on when to start benchmarking metrics, and explained how metrics can better inform investment decisions. Listen to the full podcast of Metrics that Measure Up here.
Since the onset of Covid-19, potential SaaS company acquirers have elevated the priority of net dollar retention, defined as the net change in recurring revenue from existing customers over a defined time period, including upsell or cross-sell revenue, downgrades, and cancellations. As SaaS companies saw their sales cycles lengthen and momentum for new customer acquisition slow in the first half of 2020, they placed strategic priority on relationships with existing customers. Given Covid-19 and the related downturn was the first pressure test for many SaaS companies, investors and buyers have similarly focused on the existing customer base during the due diligence process, with net dollar retention playing a key role in defining valuation.
Net Retention as a Top KPI
Increasingly for investors, B2B SaaS valuation is being driven by answers to key questions such as: how existing customers are being retained and supported, how strong is the potential to cross-sell to existing customers, and how things are starting to rebound. As a result, Kris mentions, “Retention, both from a gross and net dollar standpoint, is probably the number one metric that investors and buyers are honing in on today.” Net Dollar Retention has become the top KPI that acquirers ask about in the early stages of a due diligence process , ahead of growth, LTV/CAC, and gross margin.
Net Retention and Valuation
Few metrics have a more demonstrable impact on SaaS company valuation multiples than net dollar retention. Software Equity Group recently undertook a comparison of ARR growth, net retention, and valuation for lower to middle market SaaS companies. The resulting analysis, the SEG Net Retention Wave, showed that for companies with equal ARR growth rates, the ones with 100% or more net retention commanded significantly higher valuations than those with 90% retention, and so on. All else being equal, net dollar retention has a positive correlation with valuation. This is because companies with better than 100% net retention rates are able to demonstrate growth without adding new customers by expanding the wallet share of their existing customers, creating compound interest on their existing revenue base. This is especially important in the current environment when new customer acquisition is 2 to 2.5x more costly than expanding the existing revenue base, according to RevOps Squared.
As the leader of a growing SaaS business, how can you position your business to improve net retention? One important analysis you can undertake is net dollar retention on a cohort basis. Understanding unit economics by customer cohorts, such as market segment or industry vertical, will help you focus on high value segments. In our work with SaaS companies, we often see that unit economics in one vertical may be significantly better than in others. After analyzing customers on a cohort basis, assess what it would take to get to over 100% retention, then focus resource allocation on that vertical rather than diluting sales and marketing efforts across all verticals. Achieving strong net retention provides a stable base from which to acquire new customers and accelerate growth.
Tracking Early On
For any SaaS business, we would recommend understanding and benchmarking net retention and other KPIs early on. Tracking these metrics and understanding where your company stands early on will strengthen your company overall and garner a more positive valuation. In addition, you will be more prepared to receive inbound offers on your business.
In summation, net retention is currently a top priority for potential investors and buyers. Prioritizing your core base before focusing on new customer acquisitions will help improve net retention, one of the primary drivers of valuation. To do this, evaluate metrics on a cohort basis so you can make educated investment decisions on segments driving the most growth. Finally, develop the time and discipline to track metrics earlier in the life cycle to best position your company favorably when you raise capital or sell your business.