When building an operating model for a software business as part of a sell-side process, how do you go about driving your revenues for the software business?
More specifically, how do you model out your new logos and upgrades from existing customers?
As far as I understand, it's unit economics driven but my understand/familiarity beyond that is quite limited.
The standard B2B vertical SaaS operating model is usually built based off two things: New bookings and upsell / downsell / churn for the current customer base.
New bookings are typically driven by sales reps. By doing a bookings analysis, you can typically glean how productive are your sales reps at bringing in new logos and what the average bookings per rep is. Typically, you will project bookings by sales rep to stay fairly in line with historicals (don't want to project massive increases in productivity), and then you will build a sales rep schedule... this will project new sales rep hires, which will include a productivity build to ramp the sales reps (can't assume a sales rep is 100% productive the day they are hired). The sales rep build will also be tied to the expense build, which will be a larger build of historical costs by department broken into headcount / non-headcount related expenses to fuel COGS / OpEx on the P&L (can get more into cost side later if you want).
New bookings should then be distributed across different tiers of contracts / lengths of contracts. Typically a sizable SaaS business will have some complexity surrounding different types of contracts / customers. For example, there may a trial 6 month contract, a 12 month contract, a 24 month contract, etc... By doing a thorough analysis of bookings, you will be able to understand what the makeup is of different types of bookings, the pricing, the retention, and you can project those out separately. For example, you may have different waterfalls to project 6, 12, and 24 month contracts, all of which could be fueled by a total bookings number that is distributed, say 20% 6 month, 60% 12 month and 20% 24 months. Different types of contracts typically have different retention metrics as well, which you can apply to these projections.
You may also have one-time revenue streams, which usually are more simple / high-level projections. For example, each logo added may have an initial $1,000 set-up fee, so that will be driven off of total new logos added, which comes from the sales rep build. If there is a marketplace / transactional element to the business, that will be more of a P x Q that could be driven off of historicals, market assumptions, page views, etc...
The next step is looking at your current customer base. You're going to want to perform retention on the customer cube to understand the business's net, gross, gross punitive, and customer retention. You're also going to want to cut it different ways (size of customer, end-market, etc.). For example, a horizontal SaaS business may have 115% net retention and 90% gross for a healthcare end-market, but only 90% net and 75% gross for a consumer end-market. You're going to want to segment the customer base to get more accurate / granular with your projections. Then, I would apply churn / downsell amounts to the current revenue base based off those retention metrics. For upsell, you either can just apply historical upsell amounts, or you can also base it off of sales reps... usually these companies will have certain reps dedicated just to upselling the current base or they will have upsell quotas. Another reason a good bookings analysis is important.
Building a good operating model for a SaaS business can be very complex and is typically very individualized to the business model itself, but I think this is a decently reliable way to frame the mode... New bookings based on sales rep productivity + new hires, and working with the customer cube to understand the current revenue base to project expected behavior moving forward.
I'm sure @SaaSChimp would have a better answer, but these are my 2 cents as a meager software IB analyst. Feel free to PM with questions or corrections!
That makes sense, thank you! (Appreciate the detailed response too!)
Very helpful! Any good resources to get up to speed on this? Also, for marketplaces, do you just mean something like leads * conversation rate then apply ARPC?
This is awesome, thanks so much for taking the time. What is the difference between gross, gross punitive, and customer retention? Assuming customer retention is logo churn
Net retention: beginning revenue (which is prior period ending revenue) + upsell + (downsell) + (churn) / beginning... typically want to see over 100%, meaning the upsell is more than offsetting any churns and downsells
Gross retention: beginning revenue + (churn) / beginning ... typically want to see over 90%
Gross punitive: beginning revenue + (churn) + (downsell) / beginning ... typically want to see over 85%
Lots of investors will focus on gross punitive, as that is probably the best way to judge how much of the current revenue base you are truly retaining moving forward
Yep very good one!
Only addition is that now he needs to bridge from bookings to billings and revenue / deferred revenue.
And as you said, add any non saas revenue such as transaction revenue, services
In COGS you have hosting costs (can be a % of revenue), technical support, customer success (both of will based on a projected FTE schedule, assume that each employee can cover x customers), licenses and transaction costs. Typically, gross margin is above 90% unless you have a reason not to.
Opex all standard based on employee schedule, office plans, insurance, marketing etc. Only thing to be wary about is whether you capitalise development costs or not on R&D
How would you bridge from bookings to billings/deferred revenue? Would it be wrong to just take a %assumption from your bookings and then apply it to get your deferred revenue balance? Would be a simplification of course but it would sort of be a blended way to capture the fact that every contract can be billed differently?
(do you mind dropping me a PM? have a specific follow up if that's ok?)
helpful
I am less familiar with marketplace models so please take what I say with a grain of salt or correct me, but I know e-commerce type platforms will often be based on GMV (gross merchandising value), and have some sort of take-rates associated with buyers and sellers on the platform. Projecting GMV will be largely informed by larger market dynamics, and then take-rates projections will have supporting KPIs to prove their validity, assuming increases.
You also could use marketing spend to fuel marketplace revenue... like typically X amount of marketing spend brings in Y amount of leads, leads have historically converted at a certain rate across different products / strategies, and go off that... this sounds overly simple and an actual operating model for this type of business would have granular builds for different products, business segments, end-markets, etc. to more accurately project than using something simple like avg. revenue / customer
Also some marketplaces will monetize through advertisements (more of an internet / media business), but I am inexperienced in operating models for that so can't speak intelligently there.
As far as resources - I have learned most of this on the job, and I am unaware of any great courses / sites specific to software modeling beyond standard LBOs / 3-statement modeling... if anyone has any please drop them!
jeez man you know a lot about software modeling haha!
Learned from the best!
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