By: Diamond Innabi, Senior Associate, on May 18, 2018
“How much ARR is your existing customer base going to generate this year? How does that translate into revenue?”
“What is your ‘go-get’ ARR?”
“Is there any seasonality to sales?”
These are questions our clients hear on daily basis from private equity firms and strategic buyers, alike.
Though many software founders and executives have a deep understanding of their businesses, we find many are still learning the terminology frequently used by the majority of SaaS investors and buyers.
First, let’s take a step back and define some key terms:
- ARR is annual recurring revenue from subscriptions.
- MRR is monthly recurring revenue from subscriptions.
- A booking is when a customer signs a contract and is considered “won”.
- ACV is annual contract value (AKA: booked ARR).
- A billing is when a booked customer begins paying (typically at the go-live date).
- Revenue is when the billings are recognized. To keep it simple, let’s assume revenue and billings are the same… meaning all billings are monthly and there is no deferred revenue.
The key terms above are crucial to understanding the difference between calculating ACV, ARR, and revenue. For example, if a company wins and bills a new customer in January worth $1 of MRR, this would translate to $12 of ACV, $12 of ARR, and $12 of revenue for the year. Easy, right? Not exactly…
Sales flow into the pipeline, are booked, and are billed consistently throughout the year. Unless you can book all your new customers in January and start billing those customers immediately, your revenue recognition and projections will be affected. On that note, due to the time it takes to recognize revenue from a new booking, the more MRR a company bills during the beginning of the year, the higher the end of year revenue.
Now let’s say the company books $12 of ACV in July and there is a 3-month time from booking to commencing monthly billings (i.e., time for implementation, etc.). This translates into $12 of ACV in July, $12 of ARR in October, but only $3 of revenue at the end of December. Perhaps a table makes it clearer.
|ACV||$0||$12||$12||$12||$12||$12||$12||Total ACV = $12|
|MRR||$0||$0||$0||$0||$1||$1||$1||Total MRR = $1|
|ARR||$0||$0||$0||$0||$12||$12||$12||Total ARR = $12|
|Revenue||$0||$0||$0||$0||$1||$1||$1||Total Revenue = $3|
These factors can make a huge difference in explaining a company’s performance. A company with strong customer sales that presents ARR instead of ACV will lose the opportunity to show-off, and possibly get credit for, the new customers yet to be billed.
Software Equity Group is committed to providing unparalleled M&A advisory services to emerging and established software companies worldwide. We often provide informal strategic guidance and advice to business owners in the years preceding a liquidity event. Please contact us with any questions or to learn more.