Assessing SaaS Businesses — COVID 19
I read a great article from Chirag Modi and wanted to highlight/recap some of that article as well as throw in my input on certain areas.
To kick this one off, lets jump into exactly what we all want to see.
Chirag really did a great job at breaking these KPIs out but let’s talk through it as well:
Our first thought as investors typically immediately falls on revenue performance and growth. Through COVID my outlook has fluctuated, my immediate expectation was that I’d think companies would cancel their SaaS subscriptions and look to cut back on all non-necessary costs as possible. This may still be true, but lately, empirical evidence has led me to think quite the contrary. Businesses are starting to realize WFH may be the new way of life for their organization and SaaS companies are reaping the tailwinds of both small and large businesses needing their services, so that fragmented revenue mix with a good amount of small to medium sized players and then the larger institutional contracts as well. I also believe a lot of these businesses are opting in for longer term contracts and setting up a network of services that complement each other. I touched on contract duration as a factor I don’t necessarily see as being greatly impacted but I do agree with Chirag that re-negotiations are certainly on the table and businesses will exercise this option. At a high level though, these are fantastic revenue metrics to dive further into with a prospective investment.
These are really crucial aspects to evaluate, all of Chirags points are so crucial, and to recap them quickly:
- Contraction of IT spending in certain industries (e.g. airlines, hospitality, oil and gas) that are particularly hit during the crisis.
- End-customers in these verticals are generally re-negotiating their existing software subscriptions to restructure their cost base. In the worst cases, customers have stopped paying software providers due to liquidity constraints.
- SaaS businesses in these verticals will be severely affected and their recovery will be dependent on the recovery in the respective end markets.
- Horizontally integrated providers will survive but be hit hard by the decrease in budgets: ex. marketing automation tool; marketing budgets being slashed.
Touching upon this real quick, companies with a shorter sales cycle and ultimately a product that is easy to implement will have success in the current environment. This is naturally true outside of covid as well but companies with lengthier sales processes and products that require in-person pitches or setups is a lot going to be a lot harder to sell at the given moment.
Ultimately here we are again going to see companies that aren’t essential to the WFH vertical having difficulty in selling their product, especially to major clients. In contrary, mission critical WFH software like Zoom, and business collaboration tools have reaped the positive tailwinds of WFH. It’s also been a prevalent theme that corporations begin to cut back on shelfware they no longer view as necessary.
Great context from Chirags article:
“ Furthermore, customers will reassess the budget spent on under-utilised software (shelfware), which will lead to churn or increased payment renegotiation. Henry Ward, CEO of Carta, sums up the typical cost reduction strategy at firm level in his recent note: “once we modeled a slower growth rate in 2020, the first things we looked at reducing were non-headcount related expenses like non-essential software, AWS, travel, real-estate costs, and so on.” “
The financial metrics is pretty self explanatory, based on the factors above, there will be a clear impact to top line revenue and subsequently margins. Focusing on targets with strong unit economics will be even more of an emphasis now.
Standard valuation applies, with my emphasis on seed/growth investing the valuation metrics in Chirags diagram are not quite applicable yet.