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Bessemer’s 10 Rules for SaaS-based Enterprises

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5. The 5 Cs of Cloud Finance 

1. CMRR, ARR, & ARRR – Committed Monthly Recurring Revenue, Annual Recurring Revenue, and Annual Run Rate Revenue. Many 1st generation cloud businesses turned to TCV (Total Contract Value) or ACV (Annual Contract Value) as their top level metric as a carry-over from the legacy software world of tracking “bookings.” In the Cloud Computing world, these metrics can be easily manipulated and are often misleading, and therefore we recommend much more focused metrics around the recurring revenue in a normalized time period. TCV and ACV are flawed for many reasons, most notably with regard to duration and services. If your renewal rates are strong, then contract duration isn’t a major variable, whereas cash collection and the size of the monthly subscription will massively impact your business (see points on Cash Flow and Churn below). Therefore, a focus on TCV has a tendency to encourage sales professionals to focus on longer term (often multi-year) deals to push up TCV, instead of pushing on the more important elements of monthly subscription value and cash pre-payments. ACV does help to reduce this over-emphasis on duration by just focusing on the first year of the deal, but shares the second major flaw that TCV is also burdened with, which is an over-emphasis on services revenue as part of the “contract value.”

For example, here are two deal options, which would you pick?Deal A: 6 month prepaid contract; renews monthly; $10k monthly subscription; $10k services. (TCV: $70k,ACV: $130k, CMRR: $10k)

Deal B: 3 year contract; 3 months prepaid; $5k monthly subscription; $80k services. (TCV: $195k, ACV: $140k, CMRR: $5k)

Despite lower TCV and ACV, Cloudonomics says you should pick Deal A every time. Deal A will gross ~$370k of revenue over 3 years, whereas Deal B will only gross ~$260k. Deal A will also likely be much higher gross margin given the lower services ratio. In fact, there are only two reasons to even consider Deal B and they are related to Churn Risk and Cash Flow, but we also attempt to correct those misconceptions later in this paper. In almost every case, CMRR is the single most effective metric.

CMRR: This single metric gives you the purest forward view of the “steady state” revenue of the business based on all the known information today. The monthly focus also tends to drive many positive behavioral changes within a team in- cluding a monthly sales and development cadence, better sales compensation plan and cash flow alignment, reduced customer price sensitivity, and heightened awareness around small MRR changes. Many leading cloud companies therefore use CMRR as the basis for everything from the financial model to the sales commission plan. This is the single most important metric for a cloud business to monitor, as the change in CMRR provides the clearest vis- ibility into the health of any cloud business.

ARR; ARRR: For external purposes, you will likely want to highlight slightly different versions of these metrics: the Annual Recurring Revenue (ARR) and Annual Run Rate Revenue (ARRR). ARR is simply the currently recognized portion of this, multiplied by twelve. ARRR is the ARR, plus any non-recurring revenue related to items such as professional services, transactions, and implementations. These external “vanity” metrics can help drive home the run rate scale of your business, especially when used to describe the forward business model. Your current CMRR may be $1.75M and projected to grow to $2.17M at year end, so for external audiences you may get maximum impact by summarizing the business plan by saying: “As we exit this year our Annual Run Rate Revenue (ARRR) should cross $30M, which includes $26M of Annual Recurring Revenue (ARR).”2. Cash Flow – Start with Gross Burn Rate and Net Burn Rate, then hopefully turn to Free Cash Flow over time. CMRR gives you a great sense for the revenue health of the business, but can very often be disconnected from the “cash health” of the business. As any scrappy entrepreneur will tell you, a business will live or die based on its cash management in the early days, and therefore detailed cash metrics are also needed.

Gross and Net Burn Rate: (Cash flow) metrics are critical for cloud businesses because the working capital require- ments are higher and the payment terms are often back end weighted. Gross Burn Rate is all of the expenses paid for in the month including debt and finance charges. Net Burn Rate is simply all cash received during the month minus all the expenses, which nets out to the cash burned in the month. These numbers are obviously lumpy based on the timing of collections and payables, so many companies further refine this by adding a “rolling 3 month average” Burn Rate set of metrics. Cloud businesses typically show significant positive Free Cash Flow (FCF) long before they turn GAAP EBIT positive, so hopefully you will be able to flip your Burn Rate (negative cash flow) metric to a positive one as you grow, and start tracking FCF instead.

CAC – Customer Acquisition Cost Payback Period. The CAC Payback is a statement in months, of the time to fully pay back your sales and marketing investment. This is worthy of much more detail and therefore broken out further in Law #6 later in this paper.

CLTV – Customer Lifetime Value. CLTV is the net present value of the recurring profit streams of a given customer less the acquisition cost. Part of the attraction of Cloud Computing business models is that once you have repaid the initial Customer Acquisition Costs (CAC), the cash flow and profit streams from customers can be quite attractive. However, whereas the CAC ratio can at least ensure that you recover your incremental sales and marketing costs on each customer, it still doesn’t tell you if these customers are highly profitable over time. To measure this, many customers have modified the consumer internet concept of lifetime value, into a similar cloud CLTV metric.  To simplify the calculation, let’s assume that a customer generates $10,000 of annual re- curring revenue for a company with a CAC Payback ratio of 12 months, a 70% Gross Mar- gin and 10% each of R&D and G&A costs. The $10,000 of revenue will generate $7,000 of gross margin and $5,000 of profit each year ($7,000 less $1,000 of R&D and $1,000 of G&A costs). Over 5 years, this customer will generate $25,000 of profit (5 years x $5,000/ year). A CAC Payback ratio of 12 months means a $7,000 upfront acquisition cost, making the CLTV equal to $25,000-$7,000= $18,000 Obviously if the retention period is longer, and/or you benefit from net positive CMRR renewal rates that actually grow your average customer relationship over time, these numbers can be much larger.

 Churn & Renewal Rates – Logo Churn, CMRR Churn, and CMRR Renewed.

Cloud executives need to track renewal rates in detail to capture “logos lost” (lost customers) as well as the percentages of CMRR renewed and lost. The standard approach is three key sub-metrics, all related to this concept of renewal rate:

Logo Churn %: This is a percentage calculation of all your customer names (“logos”) that have churned over the measured time period. If you started the year with 500 customers and 460 of them were still paying customers at some level at the end of the year, then you have churn of 40 customers and your annual Logo Churn is 8% (40/500).

CMRR Churn %: This is a percentage calculation of all your customer CMRR that has been lost over the measured time period. If you started the year with $500k of CMRR for your same 500 customers, and the 40 customers that churned represented $30k of CMRR at the start of the year, then your Base CMRR Churn Rate is 6% annually ($30k of starting CMRR churned/$500k of starting CMRR).

CMRR Renewal %: This is a percentage calculation of the total CMRR of your renewed customers at the end of the year, divided by the total CMRR of your existing customers at the beginning of the year. Of your 460 renewed custom- ers, if they have been upsold on new products and grown in their usage of the product during the year to the point where their CMRR equals $550k in total, then your Total CMRR Renewal Rate is 110% ($550k end of year CMRR just from customers who were on board at the start of the year/$500k CMRR of all customers at start of year).

If there were a reason that customers are weary of cloud services, it's because executives of cloud companies talk like this.

Customers who live with cloud solutions should fear living with lock-in payments for perpetuity.

I miss the days when I could buy Quickbooks and be done, rather than have to pay Intuit every month.

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