Dr SaaS Demo

I want to walk through an example of getting a diagnosis for Dr SaaS, to show how easily you can do this for your SaaS business, and what sort of analysis you can expect to get out of it.

To get some numbers to use for this, I’m using the Demo Company which is available in Xero (if you’d like to play along at home, log into Xero and look at the bottom of your My Xero page for a link to your own copy of the Demo Company).

For the purposes of this demo I’ve changed two of the accounts to better match the sort of expenses you might have in a small SaaS business: “Subscriptions” is now “Staff Costs” and “Rent” is now “Hosting”, otherwise the data is straight out of the box.

Step 0: Getting Started

Visit http://drsaas.md and click the big orange button on the homepage:

step0a

Enter your name and email address, and you’re underway:

step0b

Enter your company name and select the period you wish to analyse. In this case I’m going to use the details for the last quarter ending Sept ’14:

step0c

Step 1: Revenue

This step collects details about subscribers and revenue, and calculates growth, churn and average revenue values.

We will need to make up the subscriber numbers, as there are no details about this in Xero. When you’re doing this yourself, you can get your subscriber numbers from your customer database or billing system.

Firstly, enter the number of subscribers you have at the end of the period. This should include both free and paid subscribers, if you have both. We will say 598 subscribers at 30 Sept.

Secondly, enter the number of new subscriber you acquired during the period. This should count every new subscriber who joined during this time, even if they have already cancelled. We will say 186 new subscribers between 1 July and 30 Sept.

Thirdly, enter the number of cancellations during the period. We will say 98 cancellations between 1 July and 30 Sept.

At this point we already have our first metrics calculated, showing the growth rate, churn rate and average tenure:

step1a

Finally, enter the amount of revenue received during the period. To get this you need to open Xero and run the Profit & Loss report:

step1b

The revenue number is shown at the top. If you have other revenue you should only count recurring revenue from subscribers at this stage (other revenue will be entered separately in Step 3 below).

In our example, there are sales of $13,733 showing in the P&L, so we enter that value here.

This then calculates the fourth metric on this page, the ARPU or average revenue per user. This is the amount you earn on average from each subscriber each month:

step1c

Already we have some useful information – the growth rate is 4.91% per month, which is okay, but churn is 6.41% which is very high and means that on average each new subscriber only sticks around for just under 10.5 months, on average we earn $8.05 per subscriber per month, which doesn’t leave a lot to play with.

Step 2: Profit

This step collects details about how much we spend acquiring and servicing subscribers, and calculates our cost of acquisition, cost to serve and also profit margin.

Before you can complete these inputs you need to split the various costs showing on the P&L report into three categories:

  1. Acquisition costs – i.e. all sales and marketing costs, commissions, discounts and related staff costs.
  2. Service costs – i.e. all support and hosting costs, payment processing and related staff costs.
  3. Operating costs – i.e. everything else! (note: we will enter these costs in Step 3 below)

In our example, we will treat “Advertising”, “Entertainment” and “Printing & Stationary” as acquisition costs, and “Hosting” and “Telephone & Internet” as service costs. We will also split the “Staff Costs” into thirds and say one third of this amount is spent on acquisition and one third on servicing subscribers. It can help to get out your highlighter at this point, to keep track of which expenses you have entered:

step2a

Those add up to $2209 and $1531 respectively, so we enter those values here:

step2b

You can see from the bubbles at the bottom that we’re currently spending $11.88 to acquire each new customer and 90c per month to service them, which leaves a profit margin of 74%, which isn’t bad. But, again, the problematic value which is highlighted is the cost of churn, which is the effective amount spent each month to overcome churn – i.e. we currently spend 9.45% of all of the revenue we earn each month to acquire new subscribers to replace those subscribers who churned.

Step 3: Runway

This final step collects the remaining details about expenses, and also how much cash is available to cover these expenses, to calculate a burn rate, breakeven target and cash runway.

Firstly, we enter the details of other revenue and other expenses not already included above:

step3a

From this we can see that the calculated breakeven target is 118. This shows how many subscribers are required in order to cover all of the operating costs and other costs, given the current business model. In our example, this is good news as we already have more subscribers than this.

However, we have not yet considered the other costs which are not included in the P&L, such as capital expenses, capital raising costs, and tax as well as foreign exchange movements. To get these we will need to look at the Cash Summary report in Xero, which shows that during the period we spend $1652 on computer equipment, so we enter that here.

Finally, we need to look at the cash on hand in the Balance Sheet report in Xero.

In our example, the bank account has $16,666 at 30 Sept:

step3b

At this point we get the calculated burn rate and runway. In our example the burn is negative, so the runway is effectively infinite, but assuming you’re not yet making a profit these values will show how much cash you burn each month and how many months you have left assuming current burn rates.

Step 4: Diagnosis

That’s it. We’re done!

The final page shows the summary diagnosis:

step4a

This graph can be a bit confusing at first, but is actually simple. It shows the lifetime value per subscriber.

The green revenue bar, on the left, shows the total amount of revenue you can expect to earn from a new subscriber on average. In our example, this is $84.29. The value is based on the average tenure of a new subscriber (derived from churn rates) and the average revenue per subscriber.

The two red bars in the middle show the cost to acquire and cost to serve, again over the lifetime of the subscriber. In our example these are $11.88 and $9.40 respectively.

The bar on the right shows the remaining gross profit – i.e. revenue less costs. If you have a profitable business model then this bar will be green, as in the example above. Otherwise this will be red, meaning you are effectively losing money on every new subscriber!

Below this is a brief description of your unit economics. This will be customised to the values you have entered:

step4b

The second part of the diagnosis highlights specific metrics which are relevant to your situation. In our example, it shows the gross profit value of $63.02 and growth rate of 4.91%, which are both positive, and also highlights the high churn rate of 6.41%. Again, the metrics that are displayed are different for each company, depending on the values that have been entered and the things you should be focussing on.

From this page you can choose to save the diagnosis, which allows you to share details with others on your team, enter multiple months to keep track of the full history, and setup a goal for one of your metrics that needs focus. You can also enter values for multiple businesses and switch between them easily – great for people like me who spread their time across multiple companies.

Please, try it out for yourself now: http://drsaas.md

We’d love to hear how you get on.

Enjoy!

 

Dr SaaS

Make your appointment now

How do you know if your SaaS business is healthy?

You need to start with the unit economics, which are the key to understanding how you will (or won’t!) make money.

At Southgate Labs we’ve had the opportunity to work with a number of growing ventures, and one thing they all have in common is that keeping on top of the maths is hard work – the calculations are confusing, it’s hard to even find a consistent formula, and a lot of what is written about this stuff is pretty dense and academic, plus there is a long list of different metrics to calculate.

All of this makes it hard to know if the business is growing well or not. So, we decided to build a tool to try and make this all easier. It’s called Dr. SaaS, and you can find it here:

http://drsaas.md

It asks you to enter some information about your subscribers, revenues and expenses, and then does all of the maths for you. All of the details are explained in plain English, so you can get started quickly and easily. And, once you’re done, a diagnosis is generated based on the information you enter, highlighting healthy areas, and also areas where there’s room for improvement. It gives you an honest assessment – if things are not healthy this will help you identify the problems early and make the changes that are needed. And, once done, you can also share the details online and invite others to view the diagnosis – it’s a good way to quickly share a snapshot of your progress with your team, your advisors and your investors.

For example, check out this diagnosis of the mythical Dobalina Inc, as an example.

We’ve been using Dr. SaaS ourselves, in various forms, for a while now, so it’s good to finally launch it for you to start to use today.

Please try it out, recommend it to others, and let us know what you think so we can make it better.

How does this work?

To understand your unit economics you need to answer three questions about your venture:

1. How much does each customer pay?
2. What does it cost to get a new customer?
3. What does it cost to provide your product or service?

Then, once you know those values, you can think about what it would take to have a profitable venture:

4. How many customers are needed to cover your fixed costs? (the break-even point)
5. How much cash do you need to get to that point?

In a traditional business model this is all reasonably straight forward – when you make a sale the revenue and the costs of goods sold are normally obvious, so all you are left to do is divide the amount spent on sales and marketing by the number of sales made to get an average cost of acquiring a customer, and you already have a pretty good picture of the health of the business.

However, with a software-as-a-service business model, where customers are paying a monthly or annual subscription, it quickly gets much more complicated. In order to calculate the revenue from a new customer, you need to know not only how much they pay, but also how long they are likely to remain a customer. Likewise, to determine what it costs to provide the service, you need to consider the total cost over the whole time they are a customer.

To complicate this even more, there is a long and confusing list of metrics used:

ARPU = average revenue per user (or customer!), normally per month or per annum
Churn = the rate at which your existing customers cancel their subscription (sometimes also expressed in terms of tenure, or life expectancy of a customer)
CAC = average cost of acquiring a new customer, ideally including all sales and marketing staff costs
CTS = average cost to serve, again ideally including all customer support staff costs (sometimes also called COGS or cost of goods sold), normally per month or per annum
LTV = expected lifetime value of a customer
Burn = the amount of cash you spend each month
Runway = the amount of time you have left before you run out of cash, given your current burn rate

Dr SaaS has been designed to cut through all of this. You only need to enter your subscriber numbers (i.e. how many subscribers you have, how many new subscribers you added in the last month and how many subscribers cancelled?) and some details from your accounts about how much you earned and how much you spent (i.e. how much did you spend acquiring new customers, how much did you spend supporting existing customers and how much did you receive from them in subscription revenue?) We even help with suggestions about where you look to find these numbers.

With those details we can calculate the amount of money you can expect to earn from each new subscriber. The graph will look something like this:

Average Lifetime Value per Subscriber

This shows the total revenue you will earn from the subscriber over their lifetime as a customer (the big green bar on the left), less the amount you spent acquiring them as a customer (your sales and marketing costs, including staff costs) and the amount you will spend supporting them while they are a customer (your operations and support costs, including staff costs). What’s left is your gross profit per customer the (hopefully!) green bar on the right. If you spend more to acquire and service customers than you earn from them then the gross profit will be a red bar.

Every SaaS company is different, and there is not one right answer with this stuff, but it is important that you know your numbers and then think about what you need to do to improve those as you grow.

Good luck!

Magic Dust

Realising that nobody else knows the secret formula for your venture is an important and valuable thing to learn.

Sadly, I don’t have any magic dust that I can sprinkle on any given start-up to make it successful. Nor does any potential advisor, mentor or investor, even if they promise otherwise. Not even if they have worked on something successful in the past – indeed, this often seems to create a bias, where we incorrectly assume the things we did will also be relevant to your situation.

To have any chance of contributing much of value, I would need to dig-in for a long period of time, and really get to know you and your business, and to understand your current circumstances and constraints.

This will take longer than one coffee meeting (but, thank you for the invitation).

If you think you need some help with the thing you’re starting, but don’t even know what that is, look for somebody who knows you, believes in what you’re doing and is prepared to work with you for years to make it happen. And, before you even ask them, make sure that’s true for you too.

Or, if you think there is something specific I can do to help you, please ask.

Track Record

Early-stage investment is a dark art.

Very few investors are forthcoming about their results, and so there is a lot of misunderstanding about what is “normal”.

The common belief seems to be that you just need to invest in ten companies and one of them will be a winner. I actually don’t think those sort of results are typical. My observation is that most investors have a selection bias which skews their returns significantly in one direction or another.

Either way, I thought it might be helpful to others to consider my own experience to date.

My first early-stage investment post Trade Me was Xero, in March 2007. It was a relatively easy decision, as I was also joining the team ahead of the IPO later that year. With the benefit of hindsight, I probably should have stopped after that, and I could now claim a 100% hit rate!

Instead, in the seven years since then I’ve made fifteen further direct investments. I’ve also made follow-on investments in six of these.

In total I have invested just over $4m so far.

This is the list in chronological order 1:

Sonar6 is the only real exit to date, after they were acquired by Cornerstone On Demand in April 2012. As an investor in their later rounds, that represented a ~2x return for me.

Four are sold or confirmed dead (in a couple of those cases there were very small amounts returned to investors, but only cents on the dollar so more of a gesture than something that should be considered a return) and one other is missing presumed dead, so 31% by count or circa 16% by value invested have resulted in a loss of the money I invested. That compares favourably with the 40% figure that Fred Wilson has written about although, as he says, that’s maybe just a signal that I’m not taking enough risks.

Thankfully, I’ve invested larger amounts in the companies which have been successful thus far. This is partly good luck and partly, I think, a function of the approach I take – typically investing a small amount at a reasonable valuation initially and then more later, once the company has proven they can execute and start to scale and as a result have significantly reduced the risk.

Xero is clearly the biggest success on that list at this point. The small portion I’ve sold has repaid my initial investment several times over, and the majority that I retain is worth more than all of the others combined, even after the recent share price correction. I remain very long and patient.

I’m also very optimistic about Vend and Timely, which take a large chunk of my time today. I am chairman at Vend and a director at Timely.

Atomic, Revert and Respondly are three recent investments, so far too soon to tell, but I’m very excited to be working with all of them too.

And, the jury is out on a few of the others – I’m hopeful there may be a couple more winners in that list too.

Overall, the portfolio doesn’t owe me anything at this point.

On top of that I’ve also gained some useful scars from the early failures. This is what I mean when I say get started and be prepared to suck for a bit. I suspect that is actually the only option, if this is something you’d like to be good at.

Some of the biggest lessons, so far:

I’ve learned it’s better to invest in the best companies, not the most companies. As the list gets longer I feel less and less inclined to do more and more.

I’ve learned that investing passively from the sidelines doesn’t provide much personal satisfaction, even if it goes well for the company, so my recent investments have been in ventures where there is an opportunity to get involved in some capacity in addition to investing cash 2. The downside with this approach is that time is finite. At the moment I have my hands full to overflowing with the things I’m already invested in and working on, so I’m focussed on those rather than looking to add anything new into the mix (and, as I have to constantly remind myself, focus means saying no or, aspirationally, having an assistant to say no on your behalf).

I’ve learned that you can achieve a lot more if you’re not worried all the time about who gets the credit, but if you take that approach you have to assume that you won’t get the credit and be comfortable with that.

I’ve learned that as a potential investor aimless networking, coffee meetings and events are a black hole, and you can spend all your time there, but it doesn’t really help you to find the best investments or contribute much of value to the companies you’re already working with.

Time will tell how this goes.

It will be interesting to look back at this list in another seven years and see whether the companies that I think are the possible winners now actually worked out that way, or if there were any surprises. And, who knows if there will be more names to add to the list which at the moment are nothing more than an idea.

I continue to make it up as I go. No doubt there are many more lessons to come.

Perhaps this post will prompt other local early-stage investors to talk more openly about their own results and experiences too. If so, please add a link in the comments below.


 

Notes:

  1. There are a few things excluded from this list, where my investment was a token amount. I have excluded the projects I’ve worked on with the team at Southgate Labs, such as Triage. They are not material to the calculation because my investment there has been predominantly time rather than cash. I’m also a small investor in the latest Movac fund, however it would be generous to count any of their investments as mine in this context so they are also excluded.
  2. In practical terms this means spending a day or so each month working with the founders on whatever they need help with, and being available in between those times via video or email to answer questions or be a sounding board – usually for things like strategy, planning, finance, legal and recruitment (or the opposite!) Ironically, these days, less and less of my time is spent on product or software development, even though being good at that was what earned me the right to be in this position in the first place, although I’ve typically invested in ventures where those skills are well represented in the team already.

Fine Words

All That Glitters


Tweet storms are fun, but I do miss blog posts. :-)

The Dark Net

NZVIF have released their latest Young Company Finance report. The report includes a list of all of the companies that raised new capital so far in 2014. It is an appallingly incomplete list. These are the companies that I know of they have missed:

I’m sure there are many others. Please add a comment to this post if you can give me more names. If you add up the amount raised by just those I’ve listed it comes to more than the $23m that is reported, meaning they miscalculate the amount of investment by at least half. No wonder officials are convinced there is a shortage of capital. They are overlooking all of the best companies who typically don’t need to resort to angel networks to raise money. This was the report on Stuff this morning: Angels give tech start-ups a good shot.

Investment in young companies by Dragons’ Den style investors topped $50 million in the year to June, according to a report by the New Zealand Venture Investment Fund (NZVIF) and the Angel Association.

Angels and Dragons, y’all. Apparently when it comes to young companies calling yourself simply an investor isn’t sexy enough. Just a thought, but maybe we should make it more about the companies and less about the investors.

UPDATED: added a few more companies and some links to media stories about these capital raises – in most cases this information is already in the public domain.

Investor Motives

When founders think about raising capital my observation is they nearly always start with the question of ‘how much?’, when they would often be better served to first ask ‘who?’

It’s useful, although rare, to try and understand the various things that might motivate different investors to be tempted by your venture at the stage you’re at, because it makes a big difference to how you might present the opportunity to them.

1. Story

Some investors are attracted by the apparent glamour of early-stage ventures. They like to be able to tell their friends and colleagues that they are investors in something that seems more exciting than their day jobs.

You need to offer these investors a role where they will get some recognition for their involvement.

2. Contribution

Some investors are looking for something to spend their time on, and prefer to be able to leverage that investment with a financial stake.

You need to offer these investors a role where they can feel they are involved and making a difference.

3. ROI

Some investors are simply looking for a return on investment – that is, at some point in the future they want you to give them back more than they gave you, plus some extra for the risk they took and the period of time that you had the benefits of their money – that could be on-going dividends or cash on exit.

You need to understand what sort of return they are expecting (this will likely depend on their personal circumstances and how early they are investing), and you need a spreadsheet which shows them the numbers to give them confidence that if things go well this is possible in your case.

4. Carry

Some investors who invest a fund on behalf of others are compensated based on the size of the fund and the overall capital gain they produce for their funders – e.g. a VC will typically receive 2% + 20%, meaning they are paid 2% of the total value of the fund they manage every year (this is used to cover the fixed costs of running the fund) and 20% of the gains. See: http://avc.com/2008/08/venture-fund-1/

You need to convince these investors that you have a chance of knocking it out of the park – because they are investing in a portfolio of companies alongside yours, there is not much difference for them between a complete failure and a mild success, so they will expect you to be swinging for the fences.

5. Uplift

Some investors who invest a fund on behalf of others are compensated based on the current value of those investments – e.g. a hedge fund will typically pay managers a bonus every year based on the increase over that time. This effectively means they buy the shares again every year.

You need to show these investors that you can steadily increase the value of your business over time and avoid any nasty shocks which could cause the value to drop from one year to the next.

So what?

Think about what sort of investor is appropriate for you, given the stage you’re at and your own ambitions for the future. It’s surprising how often there is a complete mis-match between the motivations of founders and investors as a venture grows.

If you’re just getting started and need a small amount to cover your costs while you explore the opportunity, then you’ll probably struggle to get larger investors excited, given they generally prefer to invest bigger amounts once there is an obvious way that this money can be used to remove constraints. More than this, it can actually be toxic to get a high profile investor on-board in your first round – in your next round other investors will take the lead from them, and if they choose not to continue investing, for any reason, then you’ll likely struggle.

Likewise, once you’ve proven the venture and are ready larger amounts of capital to help you accelerate, then you’re probably wasting your time if you’re still pitching investors who are mostly interested in the story or contributing their time, but who normally don’t write big cheques.

And, if you just want to create a great business that will pay a good salary for you and maybe a few friends, then you’re creating a future headache for yourself if you raise money from more institutional investors.

I’d encourage you to have the conversation explicitly in advance with potential investors. If it’s not clear which type of investor you’re talking to then take some time to understand what is attracting them to your venture.

What are the other types of investors and motivations that you’ve seen?