You have +20 years of experience as an entrepreneur and 15 years as full-time investor with companies such as Klevu, MariaDB and DealDash in your investment portfolio. What is your best SaaS experience thus far, and which one have you learned the most from?
Ari: It’s tough to say. After all, one of the best qualities of SaaS companies is their predictability and relatively stable development compared to many other business models. I’ve invested in companies in extremely narrow and well-defined markets that have grown into dominant positions in their niches, and resilient companies with steady long-term growth towards their vision.
Perhaps the best – to mention one – is Paytrail where I was among the angel investors and the chair of the board until the exit. The company succeeded in creating a then-novel business model that combined subscription and transactional fees. Thus, their interests became aligned with their customers, enabling them to earn significantly when their customers throve. Nowadays, this model is more common, and I presume it to become mainstream among SaaS entrepreneurs in the upcoming years.
About the biggest learnings: I’d say Severa, my first angel investment in which I also served as the chairperson. By the time I invested, SaaS as a concept wasn’t too popular but software was still purchased as large and expensive on-premise solutions. At one point, however, things changed and more and more companies – even large enterprises – started to favor SaaS. We didn’t raise any VC funding – there were hardly such opportunities available for Finnish SaaS companies back then! – but were able to grow the company steadily to a successful exit.
The most important metric for a founder is always growth – it’s the one single factor that has the biggest impact on the value of your business.
Which are the most effective SaaS growth engines you have experience from?
Ari: It’s impossible to generalize since everything always depends on the company, product and category. It seems that everybody would like to grow virally and, undeniably, that’s a strong and lucrative strategy when it works! However, it’s not for everyone nor for all situations. You should always understand your core metrics and what they tell about your growth engine – like the strength of your viral effect. Virality can also be counter-productive if applied wrongly. In Komartek, we aimed at gaining viral effect by attaching our logo in every invoice our customers sent via our service. The outcome of this was eventually detrimental – invoices tend to spark negative emotions among their receivers so it’s no good to have your logo as the first thing in sight!
How to choose the right growth engine as a founder? Share us an example.
Ari: This is a great question and, unfortunately, there is no single right answer. In the beginning, you must start validating your hypothesis. Typically, it makes sense to experiment several growth engines to find the most suitable for your product and market.
It’s important to keep in mind that your growth engine is never ready. You can and should optimize it constantly, and typically the most suitable engines evolve or even change when the company grows. Based on my experience, in a more mature stage, the best strategy is often a mix of a few different models that is constantly tuned to yield even better results.
After you have made your first hypothesis, it’s crucial to start measuring your efforts in detail. You must measure key assumptions and growth factors for every channel on a cohort basis. In other words, you need to understand the variance of your results between different channels and their development in time. This is the only way to gain knowledge about where to focus on. Depending on your growth engines, you may need to be ready to react and optimize very rapidly. For example, if you invest a lot in paid ads, you may find lucrative audiences that need to be captured immediately while their price is affordable. When prices change, there may not be any audiences available that would be profitable based on your LTV/CAC, and then you should rebalance your focus on different growth engines.
Fast growth justifies losses but only until a certain point. I always closely follow EBITDA to understand the costs of growth.
When it’s the right time to start investing heavily in scaling and how to do it effectively? Which metrics should be followed?
Ari: This in one of the key questions I’ve discussed with probably every company I’ve invested in. In principle, your core metrics will tell you when you’re ready to scale. As long as LTV/CAC, churn and your core channel-based metrics stay lucrative in cohort-based analysis regardless of growing volumes, you can and should invest more. Given that your technology and operations can handle rapid expansion, you should put your best effort to tap into a growth opportunity when you have one. It may not be up for grabs for long.
That being said, I don’t believe in growth at all costs. I always closely follow EBITDA to understand the costs of growth, preferably divided between organizational functions to understand how much is invested in R&D and S&M, and how much the other costs are. A great tool I often use is Rule of 40. It is computed by adding EBITDA percentage (as % of revenue) yearly revenue growth percentage. The metric measures the discrete balance and trade-off between growth and profitability: faster growth always eats profits, and vice versa.
In my opinion, growth companies should always reach at least 40% in Rule of 40 analysis, top-of-the-class firms often hitting 50% or even 60%. Fast growth justifies losses but only until a certain point. Growth at all costs often means to me that the company hasn’t found a well-functioning growth engine and/or they don’t have product-market fit. Also, Rule of 40 gives signs when growth starts to stall or becomes inefficient. Then, it’s needed to alter the product, target market or growth engine or consider optimizing for profitability.
Another important topic to consider is the amount of funding you raise in each round. The cost of equity funding is obviously significant, and too big a cash buffer may cause inefficiencies. Strong cash balance enables increased spending to customer acquisition and, as a consequence, may hide problems with business fundamentals for additional 18 months. When the cash in the bank dries up, you may find yourself in a suboptimal market with an unoptimized product or growth engine, making it hard to reach top-of-the-class Rule of 40 or sales efficiency metrics anymore.
Churn is another metric I carefully follow in every company I work with. In my opinion, it’s important to understand churn based on very granular cohorts – on a monthly basis but also based on product categories, sales channels and geographies. However, that’s such a vast topic that another post is needed!
To sum up, the most important metric for a founder is always growth – it’s the one single factor that has the biggest impact on the value of your business. As an entrepreneur you should always strive for rapid growth; it’s the only way to build a sustainable and highly successful business.
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