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  • Mike

    I am an early stage SaaS start up trying to finalize my financial model for investors. The business is focused on service companies in the construction industry. I have been trying to find some data on conversion rates when using a freemium model and was hoping that someone out there might be able to give me some direction. Specifically I am looking for info to explain how many users covert from a free version of a program to a paid version. Does anyone know a reputable source for this kind of information and where I could find it?

  • http://www.forentrepreneurs.com David Skok

    Hi Mike, unfortunately the conversion rates for freemium businesses vary greatly from one company to another, depending on how compelling the value proposition is for the upgrade to paying. The only thing I can tell you is that in a number of successful businesses, the conversion rate has been around 3%. However, it is my guess that a lot of the businesses that try to get the freemium model working don’t get to that number, as their value proposition is not strong enough.

  • Mime

    What does SaaS stand for .

  • http://www.forentrepreneurs.com David Skok

    Software as a Service. i.e. when you are able to access software using your web browser, because it is running in the cloud. The benefits versus conventional software:
    - No need to ask IT to purchase servers, and run and manage them
    - No large upfront license fee

    - Easy to test the software before purchasing

  • Swati

    How are SaaS companies valued? What does a VC look for in a SaaS company?

  • Eugenia

    Hi David- I was wondering if you had any thoughts on whether third-party content-based (rather than first-party software based) subscription businesses (such as Netflix, Spotify) should be evaluated any differently than classic SaaS companies, given the significant differences in gross margin (driven in part by upfront investments that are fixed despite how many users convert).

  • http://www.forentrepreneurs.com David Skok

    Hi Eugenia, if you are thinking about the metrics that I suggest in SaaS Metrics 2.0, those do take into account the different Gross Margin when evaluating whether a company has good unit economics. Was that the question you were looking to have answered?

  • http://www.forentrepreneurs.com David Skok

    That’s a question that has a complex answer. Here are a few of the elements that will be evaluated:

    - Quality of the entrepreneur and executive team

    - Evidence of traction

    - Growth rate

    - Size of market

    - Unit Economics

    - Barriers to entry

    - Customer retention (which is evidence of how well the customers like the product)
    I hope this helps.

  • Eugenia

    Well, I believe your Q&A with “Z” bears closest resemblance to my question. To elaborate…

    I work at a startup whose business is to license content, where there are both upfront acquisition costs as well as ongoing, performance-based payouts. We have a subscription model for users to access this content. The first expense is fixed (unrelated to the number of users that decided to subscribe because of any piece of individual content) and the second variable (driven by the number of people who interacted with aforementioned content). This is different from software SaaS businesses where top line expenses are entirely variable (i.e. server costs).

    Accounting-wise for us (and our peers), both expenses are included when calculating gross margin. However, given that the unit economics of one expense improves with every additional subscriber (let’s say, $5K/100 subscribers versus $5K/500 subscribers) while the other maintains a direct, linear relationship ($1 per subscriber), should both be equally contributing to calculating a subscriber’s LTV? Or, should the upfront costs be contributed to the CAC while the GM only has the royalty payments deducted? Or something else?

    Hope that helps clarify!

  • http://www.forentrepreneurs.com David Skok

    Hi Eugenia, this is a more complex situation, which makes it harder to compute LTV. In answer to your question “should up front costs be contributed to the CAC” – the answer to this question depends on whether those costs are part of the customer acquisition process, i.e. sales and marketing costs, or part of the product delivery, servicing or support costs. If they are part of the sales and marketing/customer acquisition costs, they should be attributed to CAC. If part of the product delivery, servicing or support costs, then they should be attributed to Gross Margin.
    In your situation, I would be looking to try to find a way to forecast/estimate the number of people who interacted with the content, so I could predict the variable cost associated with that, and then use that as a best guess for GM for the LTV calculation.
    Best, David

  • Swati Jain

    Hi David, could you possibly throw some light on how do VCs value a SaaS business when they are looking to exit?

  • http://www.forentrepreneurs.com David Skok

    Hi Swati, the primary way to do this would be a multiple on revenues (either this year’s revenues if early in the year, or next year’s revenues if about May onwards). To determine the multiple, one would assemble a list of comparable public SaaS companies, and private SaaS companies that had recently been acquired.
    When you look at public company multiples for SaaS companies, you will see that they vary quite a bit. However if you plot those multiples against the growth rates of those companies, you will see a very high correlation: the higher the growth rate, the higher the valuation. The correlation coefficient is 0.78 (even after the recent market correction).
    Interestingly if you also graph multiples against Operating Profit (EBITDA) as a % of revenue, you don’t get a very good correlation (the correlation coefficient is only 0.04%). That tells you that even after this market correction, growth appears to still be the major driver for higher valuations.
    Other factors that matter:

    - Dollar Retention Rate – this is different to the Customer Retention Rate. (See references to Negative Churn in my ‘SaaS Metrics 2.0’ post). (This would likely be the second most important variable behind growth rate.)

    - Is the company the clear market leader?

    - Is there a clear path to profitability? (One factor here would be high Gross Margins. Average seems to be around 65-70%.)

    - Are there strong barriers to entry?

    - Quality of the team.

    I hope this helps. Best, David