Three Perspectives on SaaS Companies

Presented at Cooley Godward Kronish

October 28, 2009

CFO Perspectives

Skip Smith & Mary Korn FLG Partners

Three Perspectives on SaaS Companies

Three Perspectives on SaaS Companies

SaaS CEO/Board Issues CFO Perspective

What makes a SaaS company?

SaaS Revenue recognition primer

Multiple elements in sale

New accounting next year

Capitalization of software

State sales and use tax

Systems for SaaS companies

Three Perspectives on SaaS Companies

What makes a SaaS Company?

Key attributes:Recurring revenue streamsHosted application software often accessed via a browser

Standalone or integrated applicationsCore systems Accounting or CRMAncillary systems Travel management or paymentsMedia, gaming, analytics, etc.

Fragmented, rapidly growing companiesHard to build from a financial perspectiveValuable when turn profitable (begin generating cash)

Three Perspectives on SaaS Companies

SaaS Revenue Recognition

Multiple revenue elements:Subscription monthly, per seat or per transaction bookedImplementation/professional service fees

If bundled, determine standalone value (VSOE) and recognize over expected life of relationshipIf separately charged, then recognize when deployment is effective (if VSOE for subscription renewal exists)EITF 08-01 will somewhat liberalize VSOE requirements for new fiscal years (required for years beginning after 6/15/10)

Hardware/software combinations:Now driven by software treatment thus recognition spread over useful life of device (SOP 97-2)More up front recognition for mixed hardware (iPhone, etc.) coming in 2010 (EITF 09-3)

Three Perspectives on SaaS Companies

Rev Rec Takeaways

Get it right from the start Lock down pricing schemes Develop a standard contract to maintain consistent Ts and Cs Get auditor buy in early for recognition policy

Especially for implementation revenue treatmentRestatements are very costly in time and opportunity

Adoption of EITF 08-1 treatment will improve pricing flexibility and may accelerate revenue recognitionCalendar year companies should consider adoption of EITF 08-1 and 09-3 treatment starting in January 2010

Three Perspectives on SaaS Companies

Capitalization of Software

Capitalization of internal use software governed by EITF 98-1Essentially capitalize software costs after demonstration of technical feasibility, then amortize over useful life (3-5 years)Write off all maintenance and updates other than major rewritesTrack R&D costs carefully for GAAP, management and tax purposes (including possible R&D tax credits)

Key Takeaways:Wide ranging practice but be conservativeCosts capitalized now are a drag on earnings laterEstablish a simple timekeeping and project system early

Three Perspectives on SaaS Companies

State Sales and Use Tax

Not an income tax so nexus is much easier to achieve

States are looking for revenue a very dynamic areaExpanding tax base to include much of digital commerce Active states include Washington, NC, Texas, NY, Wisc, etc.

Taxation dependent upon local statues and tax nexusNexus can be achieved by having employees in state or visits by sales or training personnel or simply having customers in stateTax rates applied at the zip code levelMonthly filing and deposit requirements

Three Perspectives on SaaS Companies

Sales & Use Tax Takeaways

SaaS company is responsible for assessment and collection of these taxes regardless of contractual provisions otherwiseGet compliant early to avoid expensive penalties and interest

Begin with focus on larger transactionsTax issues can delay strategic transactions (FAS 5 issues)Build compliance into systems earlyReview state level changes a couple of times per year

Three Perspectives on SaaS Companies

Systems Needs for SaaS

Financial reporting system (QuickBooks, MS Dynamics, etc)Simple project capability

Database for revenue and contract management Salesforce or homebuilt that scalesManage pending implementationsFeed revenue to financial system Feed management dashboards and metrics

Key TakeawaysSpreadsheets breakBuild links from operational systems to feed financialsEstablish firm audit trails

CFO Perspectives

Operational

Three Perspectives on SaaS Companies

Operational considerations

Three Perspectives on SaaS Companies

Right from the Start

SalesBuild inside sales firstSales comp plans tied to acquisition of MRRSeparate hunters and farmersAvoid costly enterprise sales techniques

EngineeringArchitectureAlways onQA

MarketingEmbrace developersOnline marketing skillsConstantly measure the effectiveness of marketing spendDeploy guerilla marketing techniquesAnalytics

Three Perspectives on SaaS Companies

Invest in Lead Generation

Marketing = lead generationMeasure lead generation conversionUse tools to generate leads & accelerate sales cycles inexpensivelyPractice guerilla marketing tactics

Offer demo accounts and start up kitsFrequent e-marketing initiatives

Explore segmented marketing Evangelize customer references

Three Perspectives on SaaS Companies

Sales Learning Curve

Set goal of MRR/Sales HC before hiringUse MRR to determine when to hire

Restrict sales hiringUse MRR vs fully burdened cost of sales to assessAccelerate sales hiring only MRR justifies

Commission plans direct behavior$1 of commission for $1 of MRR = 8.3% rate Inside sales

Inside salesRequire $60K-75K MRR

Field salesRequire $80K-100K MRR

Stay local

Three Perspectives on SaaS Companies

Develop an API Strategy Early

Adopt an open API strategy from Day One Use APIs to drive integration strategyAPIs can drive adoptionRight API strategy can lead to new channelsEntice developers to create extensions to enhance your product lineView developers as a channel

Three Perspectives on SaaS Companies

How to Measure and Monitor Performance

Three Perspectives on SaaS Companies

Critical Internal Systems & Processes

Allocate funds for internal investmentHave nimble & smart internal systemsBilling system that supports recurring billingBe flexible & able to process secure paymentsBe aware of changing regulatory environmentReporting databasePartner/developer tracking databaseCampaign manager tool setStandard contracts

Customize only for large accounts

Three Perspectives on SaaS Companies

Build Programs to Encourage & Track Usage

Analytics rule!Know exactly how customers are using your productMeasure user adoptionTest new featuresSpot potential problem areasCustomize your marketing programsFocus product feature roadmap

Three Perspectives on SaaS Companies

How to Measure

Product design & architectureReporting systemDatabases

Code & customer account / usageReporting and metricsBilling

BI toolsTo report, track & measure

Analyst resourcesTo assess & compareInternal compass

Three Perspectives on SaaS Companies

What to Measure Part I

MRR: monthly recurring revenue *CLTV: lifetime value of a customerChurn Rate: the % of customers who end their relationship in a given periodRetention rate: 1- churn rateRenewal rateUpsellSelling costsValue by year acquired

What does this tell you about the customer?

Three Perspectives on SaaS Companies

What to Measure Part II

Deferred revenue: revenue that cannot yet be recognized on the I/SLife cycle of deferred revenue: how long DR hangs out on the B/SBacklog: off balance sheet tracking of undelivered elements

Professional services, training, customization

GPM: gross profit marginCPNC: cost per new customer

Go ahead if CPNC < CLTV

Three Perspectives on SaaS Companies

What to Measure Part III

CAC: customer acquisition costMany ways to measure

Change in revenue/S&M spendChange in GM/S&M spend

Bessemer & Hummer Winblad have published their formulasPrograms should permit you to track

By marketing activityEven by individual customer

Three Perspectives on SaaS Companies

The Ideal Dashboard

Three Perspectives on SaaS Companies

What Matters

MRR *CLTVChurn RateRetention rateCACCashValue of installed baseValue of plan to come from new business

Deferred revenueLive cycle of deferred revenueBacklogAvg seats/customerAvg price/seatCustomer growthOther marketing costs

SEO, PPC, CPA, CPM

Three Perspectives on SaaS Companies

Projecting and Conserving Cash

Three Perspectives on SaaS Companies

Vulnerability of Fixed Costs

Major spend areasHeadcountFacilitiesMarketingDelivery costs

Fixed costs of operations providing response, reliability, security are hard to cutKnow your data center costs

Colo, rack space, power, bandwidth, maintenance, hands-on adminPublic SaaS companies have long climb to profitability

Major cause of losses was high S&M expenseWatch marketing effectiveness & manage sales team costs

Three Perspectives on SaaS Companies

Cash Management 101

13 week rolling forecastInflowsOutflowsCash flows from operating activities

Annual budgetForecast cash flow through end of fiscal yearSaaS may consume $30M before CFBE occurs

RunwayKnow when it ends at current spendKnow what to do about it

Three Perspectives on SaaS Companies

CFO Pers