SaaS Growth Strategy: Investment vs Profit Taking

By Justin Talerico

Sep 06 2018

I was often a self-funded founder whose SaaS growth strategy needed to include profit, as that was how my co-founders and I paid ourselves. When you’re growing a SaaS in a cutthroat sector like martech, taking investment capital out of the growth machine in the form of profit must be done judiciously and intentionally. If not, growth will be slowed, research and development stunted, or employee retention will suffer. There are only so many places to pull from in a lean or bootstrapped P&L.

SaaS Profit Taking

If you’re a founder and you pay yourself a sufficient salary, you’re working within the P&L and can manage capital usage based on cash flow. If you’re living on the business’s variable success or failure, you’re forced to manage for profit. Either way, the sack of cash is no different, so in some ways it’s irrelevant. But, a lot of people manage for profit and balancing that with growth can be hard. Why? Because short-term cash in the pocket can get tempting over longer-term SaaS growth strategies.

Capital Efficient SaaS Growth Strategy

It takes discipline to keep cold, hard cash in a company as a SaaS growth strategy. It takes steady and steely belief to bet on future growth in lieu of present income. And it takes strong leadership to keep founders, executives and boards aligned in that mission. But discipline is the backbone of capital efficiency. A P&L only has so much cash in it, and using that cash wisely is the only way to keep from needing more capital from outside of the business.

Managing to the Rule of X

I’ve found that discipline in the P&L comes from planning, debate, and agreement in advance from all parties. This is especially true of high-level goal setting and profit planning. I like to manage to the sum of growth percentage and EBITDA percentage (a la ‘Rule of 40’). These are both percentages of top-line revenue and this planning typically begins with a question. For example: Can we grow at 25% and have 10% EBITDA? (That would be Rule of 35, by the way.)

Managing your SaaS growth strategy to a rule of ‘X’ satisfies everyone and helps align all incentives on keeping the P&L as lean and efficient as it can be. It forces you to edit carefully, considering every ingredient in the soup — does it help us grow? It forces you to eek out a little bit more everywhere, with reasonable increases in efficiency expectations for KPIs across the organization.

What’s the ‘Right’ Rule of Number?

First of all, don’t get caught up in the Rule of 40. Sub-scale, self-funded SaaS companies are going to have an extremely hard time getting to 40. Where in the continuum your rule of number falls depends on:

  • scale in ARR (annual recurring revenue);
  • gross profit (and inverse cost to deliver revenue);
  • product lifecycle stage (innovation means more R&D and iteration mean less);
  • CAC (customer acquisition cost/sales and marketing efficiency);
  • revenue retention and LTV (lifetime value);
  • and your ability to push, unify and inspire your organization.

Working Backwards into Your Rule of Number

Look at your P&L for the most recent complete quarter. If you’re managing for profit, look at that percentage. Or, if you’re profit is a silly high percentage, look at it through the lens of hard currency. Either way, decide what is needed in EBITDA. This gets back to discipline because what is NEEDED is not the same as what is WANTED. Everyone must align and agree on the number of what is needed in EBITDA. What’s left over is your raw material to generate growth. Let’s say your EBITDA number is 10.

Now things get a bit hairier because you get into evaluating every line in the P&L and deciding if it’s the best way to drive growth. And initially, past performance is a tempting limiter of future performance. You have to inspire your teams to blow past that preconception or the entire exercise is a waste of time. If no one can outperform and capital is consistent, then growth is limited to past performance. Forget that.

Involving the Entire Organization in Incremental Improvement

A nice side benefit of a ‘rule of’ target is that it can be unifying and inspirational. The whole point for me was to push everyone to find ways to outperform their histories. When everyone pushes just a little bit further, return on capital improves. The company does more with the same resources. That means customer success up-sells an additional 5% and reduces revenue churn by 3%; sales improves its conversion rate 10%; marketing lowers its CPL 6%; engineering holds salaries by using incentive comp instead; ops negotiates every supplier renewal to lower G&A 3%… and the list goes on and on. The point is to inspire everyone to contribute and commit to improving each quarter and each year.

When you get everyone in the boat to commit to outperform, where does that put your number on the growth side of the equation? Perhaps, before your pencil-sharpening, KPI enhancements, your predictable growth rate was 19%, which, combined with your EBITDA target of 10% would put your ‘rule of’ number at 29. And then, perhaps your KPI sharpening improved your growth rate by roughly 10% to 21%, which would give you a ‘rule of 31’ target.

Change is Good

In my experience, revisiting this balanced SaaS growth strategy process on a quarterly cadence — and sharing progress in all-hands settings — was the path to continuous improvement. And then, on an annual basis, stepping back further to take a higher-level look at everything kept those quarterly updates in line with overall strategy, market forces, and product evolution. The only thing that doesn’t change in SaaS is the pace of change. A balanced P&L — focused on both growth and profit — is no exception. Different buckets will see different emphasis (percentages of revenue) in different periods. As long as those decisions are intentional and everyone is on board — tracking back profit and investment through a balanced P&L is a path to capital-efficient success and a SaaS growth strategy that founders can live with.

 

Content by Beacon9 SaaS Business Advisory

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