With more than 80% of venture capital investments occurring in enterprise and with the public markets disproportionately rewarding SaaS companies with huge enterprise value-to-revenue multiples (median is 7.6), it’s no surprise that interest Software-as-a-Service is booming. After meeting quite a few SaaS companies, I’ve compiled a list of my ideal characteristics for a SaaS business below.
Characteristic 1: Product Is Core to the Operation of the Business The product is essential to the operation of a customer’s business. For example, Zuora enables subscription billing; Expensify manages employee expenses; ZenDesk builds customer support systems. Customers can’t function without it.
Characteristic 2: Cost/Value Proposition is Straightforward The product is either cheaper than the alternative: hiring an engineering team to build and maintain a custom implementation of the product;
Or provides network effect benefits otherwise impossible to find: LinkedIn’s network effects drive the adoption of LinkedIn’s applicant tracking system;
Or offers sophisticated technology that is difficult to replicate: Infer builds machine learning models on top of sales data to improve company performance. Not every company has ML expertise.
Characteristic 3: Finances Its Own Growth
The company benefits from negative working capital and shorter time-to-market.
Negative working capital means customers pay at the beginning of a month or quarter or year to use the product. These customers pay to improve the software over time by providing cash up front, reducing the cash needs of the business. Because customers are paying to improve the product, rather than buying a “production-ready” enterprise product, the company can go to market much earlier in their development.
At the outset, the company targets the less sophisticated SMB segment which doesn’t demand the compliance, heavy security and integration features needed by enterprise customers. This also decreasing time to market and provides revenues and product feedback in the short term.
Characteristic 4: Efficient Sales Model
The company is able to recoup its cost of customer acquisition, be it online marketing or inside/outside sales, in less than a year. Ideally, the company offers 12 month contracts and the company can be profitable on a customer before the customer has an option to churn. Hand-in-hand with this idea is strong customer retention.
Characteristic 5: Market Leadership The company is already a market leader, is on the path to becoming the market leader, or is operating in a segment with little viable competition. In SaaS, sales and marketing execution are critical to the success of the business. Competition increases customer acquisition costs and increases sales complexity.
SaaS companies can be hugely valuable and for good reason: their products are core to their customers' businesses, offer something which is unique in the market (cheaper, better), finance their own growth through efficient sales models and ideally establish market leadership.