SaaS/Software modelling

To build a bottom-up operating model for a SaaS business, here’s a structured approach based on the most helpful WSO content:

1. Revenue Modeling:

   • Start with ARR (Annual Recurring Revenue): This is the cornerstone of SaaS modeling. Break it down into:
     • New ARR: Revenue from new customers.
     • Renewals: Revenue retained from existing customers.
     • Upsells/Cross-sells: Additional revenue from existing customers upgrading or purchasing additional services.
   • Churn: Account for customer churn (percentage of customers or revenue lost). This will reduce your ARR.
   • Net Retention Rate: Combine churn, renewals, and upsells to calculate the net retention rate, which reflects the overall growth or decline in ARR from the existing customer base.

2. Customer Metrics:

   • Customer Growth: Model the growth in customer base, factoring in new customer acquisition and churn.
   • CAC (Customer Acquisition Cost): Estimate the cost of acquiring each new customer.
   • LTV (Lifetime Value): Calculate the value of a customer over their lifetime, which is critical for understanding profitability.

3. Cost Structure:

   • Sales & Marketing (S&M): This is typically the largest cost for SaaS businesses. Model it as a percentage of revenue or based on productivity metrics like ramp time for new reps, quota attainment %, and sales force efficiency.
   • R&D (Research & Development): Often done in sprints, this cost is crucial for product development and innovation.
   • G&A (General & Administrative): Include overhead costs like HR, legal, and finance.

4. Deferred Revenue and RPO (Remaining Performance Obligations):

   • SaaS businesses often recognize revenue over time. Use billings (cash collected) and RPO (future revenue commitments) to model deferred revenue and ensure accurate revenue recognition.

5. Margins:

   • Gross Margin: SaaS businesses typically have high gross margins (70-90%). Model this based on cost of goods sold (COGS), which includes hosting, support, and other direct costs.
   • Operating Margin: Factor in S&M, R&D, and G&A to calculate operating margins.

6. Scenario Analysis:

   • Build scenarios to test different assumptions for churn, customer acquisition, and upsell rates. This helps in understanding the sensitivity of the business to key drivers.

7. Key Metrics to Track:

   • Net New ARR: The growth in ARR from new customers and upsells minus churn.
   • Gross/Net Retention Rates: Indicators of customer satisfaction and stickiness.
   • CAC Payback Period: Time it takes to recover the cost of acquiring a customer.
   • Recurring Revenue Percentage: The proportion of revenue that is recurring, which is a key indicator of stability.

For additional resources, you might find TheSaaSCFO (www.thesaascfo.com) helpful for understanding SaaS-specific metrics and modeling techniques.

Sources: PE recruiting technical questions (software specific), L/S SaaS Modeling, SaaS LBO, ECB Hikes, Markets Respond | The Daily Peel | 7/22/22, PE recruiting technical questions (software specific)