Even a 1% improvement in renewals can drive significantly higher valuations for a SaaS company over time because of the compounding impact of churn.
In a recent article from Todd Gardner and team at SaaS Capital, the impact of how different renewal rates affect both total revenue and revenue growth rates is laid out clearly. They calculate that a 1% difference in churn can have a 12% impact on valuation in five years, so imagine the impact if the change in churn is 5 or more percent. Read the SaaS Capital article here.
Why do renewal rates improve, then deteriorate somewhat as SaaS companies grow?
While intuitively you’d expect that renewal rates improve as companies get better and better at their product, selling and support, they don’t always follow a perfect upward arc as the company grows. Churn benchmarks often worsen somewhat for fast growth companies in the $20M-$50M revenue range, then improve after that stage. Why is that?
Venture-backed, fast growth companies in the $20M+ range typically are hiring sales people at a very rapid rate to quickly grow market presence and drive revenue. While revenue growth rates usually increase during this period, we also see churn benchmarks increase somewhat as the company expands in new market segments, on-boards new sales people at a rate faster than may be optimal to ensure they are selling to long-term subscribers, and support and other infrastructure may lag behind growth, reducing a subscriber’s satisfaction somewhat.
So for companies in this stage, benchmarking churn, as well as modelling valuations several years out, it is important to do the modelling with benchmarks for larger companies, and do variable modelling with different assumptions for improved churn at a later stage.
Larger companies track churn more exactly
In addition, having benchmarked software and SaaS companies for almost ten years now, we also see companies go through stages in how they report churn. Early stage companies tend not to be able to track churn as exactly as larger companies since they don’t have the infrastructure or resources to do a complete analysis. Their focus is totally on new customer acquisition, fund raising, and keeping the company moving ahead. Larger companies tend to have the infrastructure, and personnel to track churn in great detail, by customer segment and cohort, in order to find areas where they can improve. Often, once you dig into churn in greater detail, you find it is a little higher than previously thought, although once identified, it is easier to rectify.
Also keep in mind that churn benchmarks correlate to average deal size
Renewal rates are impacted by both a company’s stage and business model. We consistently see lower retention benchmarks for companies selling low priced products, especially in the small and mid-sized market. Beyond the natural churn due to small business risk like bankruptcy and going out of business, companies selling a low priced product typically have short sales cycles and many competitors. A quick decision to use one product can easily be reversed to try another product, leading to churn.
On the other hand, the renewal benchmarks for enterprise SaaS products, with longer sales cycles and many decision makers in the purchase process, are among the highest. If a customer invests many months in a purchase cycle for a new enterprise system, there is little likelihood that they will quickly churn. Enterprise SaaS companies with high customer retention rates, often have net dollar renewal rates over 100%.
For more information on churn and retention benchmarks, broken out by revenue size, average contract values, and total number of customers, subscribe to OPEXEngine’s Benchmark Engine™. Find out more at www.opexengine.com