SaaS Businesses & ARR
Some Software as a Service (SaaS) Startup Founders may find themselves guilty of bragging about their ARR (Annual Recurring Revenue) figures. ARR is their latest monthly sales multiplied by 12 to get an annualised revenue figure. That is fair because SaaS businesses often keep the customers they sign on as subscribers, and their churn rate (rate of unsubscribes) should not be high.
Common Misconceptions on ARR
- Year 1: $1M A.R.R.
- Year 2: $5M A.R.R.(5X)
- Year 3: $9M A.R.R.(1.8X)
- Average growth: 300% annually
Most people think a growing ARR like the above is a great thing. After all, they did grow really fast in 3 years, at 3X per year average.
What experienced SaaS Founders and Investors see is that they grew 400% in year 2 and 0% in year 3. How?
- Year 0: $0
- Year 1: $1M (1M-0) new bookings growth
- Year 2: $4M (5M-1M) in new bookings growth (400%)
- Year 3: $0M (4M-4M) in new bookings growth (0%)
(For the sake of this point, let’s say the business is perfectly run and thus the churn for this business is 0 – so no loss of customers yearly)
Reading between the ARR: Bookings
So what do the numbers tell us? Well, although the company successfully grew revenues 3X every year on average, they had a great Year 2 but something is wrong in year 3. Zero growth indicates any of these possibilities;
- The market size has hit its limit or did not grow in year 3
- The sales team did not grow, nor have they become more efficient
- If the number of customers did go up, then perhaps the price did go down due to factors like increased competition
The 0% growth in bookings is worrying for everyone involved if it was caused by any of the above. This affects the Valuation of the business, brings up questions on the market or operations, and so on.
I would pray that the zero growth in bookings is caused by internal operational problems because the market and competition are out of our control!