What SaaS Companies Need to Focus on to Survive Market Downturns
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If this is your first market decline ,, you might be confused by the conflicting advice that may result from such an event. Some people believe the sky is falling and that you should immediately change your model. Others see the pastures as green and should take advantage of the weakening landscape. Which one you are depends on what the data tells you about your business.
Right now, the data from the venture capital world can feel bleak: Global VC funding fell 33% quarter-over-quarter in Q3 2022. SaaS, specifically, has seen valuations slide since the beginning of 2022. But not all companies are the same.
The valuation decline has been the steepest for companies not focused on their data, specifically their unit economics. These unit economics will help you decide whether to stay calm and weather the storm, or attack the market to increase your dominance. Unit economics should guide your decisions.
The pendulum swing
We all benefited from larger funds and higher valuations. A rising tide lifts all ships, unfortunately, this also includes the leaky ones. Companies could still grow rapidly despite performing poorly or at poor efficiency levels due to the glut of capital. Investors pushed companies to take more risks and place greater emphasis on future growth, which could have a negative impact on efficiency and profitability.
The days of “growth at any cost” are over. Funders became more cautious about approving deals as markets fell and capital tightened. They now seek companies demonstrating the fundamentals of running a scalable SaaS company, with efficiency and a strong path to profitability as hallmarks.
The metrics that matter
To be clear, SaaS companies cannot survive without growth — dominating your space requires it. To achieve faster growth, companies must demonstrate certain fundamental metrics. SaaS companies should track dozens of metrics, but to attract investment in the current market, companies must address their efficiency metrics, especially:
Gross retention, with a goal of 90% ;
Net retention, with a goal of 110% ;
Gross margins, with a goal of 75% ;
Cost of acquisition (CAC), with a payback goal of
Achieving these efficiency metrics will help companies maintain or exceed their valuations. If you are already meeting these metrics, you can discuss increasing capital in exchange for growth. If you aren’t, slow down growth and redirect your strategy, especially if capital is scarce.
The cost of capital without efficiency
The higher cost of capital may prove incredibly expensive for companies buying time to achieve efficient growth. To reduce their downside risk, investors are placing tighter funding requirements and lower valuations on companies. They are also putting more funder-friendly structures in deals with less fundamentally sound businesses. This includes voting rights, liquidation preferences, and board control. Overly-flawed companies in later stages may not be able to obtain funding at acceptable terms. They may need to consider exiting or consolidating. But, those who are willing to persevere and take the time to achieve better metrics have many options.
What can leaders do now?
Start by scrutinizing your business fundamentals and assessing the efficiency of your core operating teams, then adjust to reduce inefficient spending.
Sales: Review metrics like pipeline-to-bookings ratio (with a goal of 4-5x ) and average seller’s quota attainment (with a goal of 65% ). This information will focus your efforts and help you find needle-moving improvements before simply growing your sales teams without correcting underlying issues.
Marketing: Focus on efficiency metrics like your cost per opportunity across every channel and over-invest in high-performing channels.
Product teams: Consider tracking efficiency based on a product productivity benchmark and monitor user-to-issues ratios. You might invest more in customer features and platform stability over new builds to increase retention and enable higher converting upsells.
Customer success: Examine retention rates across various customer segmentations to understand your customer base’s strengths and weaknesses. Optimize your business-to-customer ratios and pay attention to customer Net Promoter Scores.
As you adjust, you may need to shrink your teams and rightsize your operation. Although it’s a painful reality, you need to fill in any gaps in your organization before you renew your drive for growth. This will help you control your burn rate and give you the time to convince investors that you are on the right track to efficiency.
Where is the funding?
Valuations likely won’t reach 2021 numbers, but companies with strong fundamentals will find funding. If companies need to correct their fundamentals, and are in dire need of capital, they will find harder markets. Where else can you go? Start with your existing investor base. Venture capitalists have just as much to lose than you do. They often have “dry powder” that they can use in such situations. They may behave less aggressively because of bad valuations and increased structure. Convertible notes can be used to raise funds in the short-term, which will avoid a downround.
If equity is not an option, climbing interest rates have made debt providers more active, creating an opportunity to explore debt financing. Leveraging debt allows you to raise non-dilutive capital and gives you the opportunity to improve your efficiency metrics. The timing is important, however, as the market for debt can fluctuate quickly if monetary policies change.
The funding silver lining
Companies that rightsize their operations and control their burn for the next year might find a funding pool at the end of the proverbial rainbow. Private tech companies are being rescued by funds that have charters to invest. Funds will continue to open their doors to companies that have high efficiency metrics as the market improves.
Valuations may not have completely rebounded by then, but companies will keep raising at good multiples if they demonstrate solid fundamentals and maintain healthy efficiency metrics alongside growth rates. These companies are better prepared to ride the falling wave and catch up with the rising tide.
Frederick has been an active trader for over since 1991. After successfully navigating the market for so long, he’s finally bringing his wisdom to the masses.