“The Rule of 40”, a metric popularized by venture capitalists Brad Feld and Fred Wilson, suggests that SaaS companies should strive to achieve 40% or greater when adding their annual ARR growth rate plus their profitability margin.
Deferred revenue refers to a payment received by a company for goods or services that have not yet been delivered or performed. The company records this payment as a liability, rather than as income, because it is obligated to deliver the goods or services in the future. This approach to revenue recognition is based on the accrual-basis accounting method and is used to reflect the company’s financial performance and position more accurately.
Important finance metrics for SaaS startups at all stages include Annual Recurring Revenue (ARR), Annual Contract Value (ACV), ARR Growth, and Gross Margin. As a SaaS startup scales, additional metrics become relevant, such as Customer Churn, Net Dollar Retention, Capital Consumption, Cash Efficiency, and Customer Lifetime Value (LTV)/CAC.
ARR measures the amount of money a SaaS startup is set to receive on an annual basis from its existing customers. It is usually calculated as the sum of subscriptions for the previous 12 months. ARR is a key indicator to investors when evaluating the potential of a SaaS startup. Recognized revenue, on the other hand, is the amount of revenue a company has earned and can be reported in the company’s financial statements. Banks and other non-equity lenders often focus on a SaaS startup’s recognized revenue to make lending decisions.
TTV stands for Time to Value. This metric measures the time it takes for a customer to get value from a purchase. In general startups want this number to be as low as possible, because it is highly correlated with churn.
3:1 or higher is considered a good LTV:CAC ratio for most SaaS startups. This is an ideal benchmark to aim for and improve over time. At a certain point, your ratio could become too high, to the point where you’re missing out on growth.
Successful SaaS companies typically see large profit margins, with averages in the mid-70s. A SaaS gross margin above 75% is generally regarded as very good or excellent.