SAAS/Tech Unit Economics Models

Can anyone point me in the direction of a primer or resources on building unit economics models for tech companies? Everything I've found so far is pretty theoretical and hasn't been too useful in practice. I'm trying to get a better understanding on how to value public tech/SAAS companies with negative or barely positive operating margins, EBITDA, FCF, etc. I know revenue growth (and TAM) is a huge part of the story but I'm looking for something that will incorporate ARR/CAC/churn/etc and build out a valuation from there. I've done most previous valuation work using traditional financial methods (largely DCFs) so I have some experience but I can't understand how people are looking at these companies and saying one is a buy but the other isn't when they're both trading at nosebleed valuations with largely similar operating metrics. 

Also for anyone with real experience: is the end goal for these companies ever to be profitable on a GAAP basis? Right now it seems like the market doesn't care about that at all so it's not a priority but what about a few years later? 

Thanks

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Comments (7)

Feb 11, 2021 - 7:08pm

No need to value anything, just hope to sell something to someone stupider ;)

Instagram: @dickthesellsider | Substack: dicktoad.substack.com

Feb 20, 2021 - 2:30pm

lol I knew I was going to get a response like this (although I somewhat agree). I know there's egregious cases out there that're completely full of shit (Wework) but I was thinking there have to be some great businesses using these "alternative" (not sure if that's the right word) methods/metrics. 

Feb 20, 2021 - 2:37pm

Serious answer would be: value the business at its mature-state economics, hopefully a SaaS company discloses its long-term model (say, 85% gross margin, 25% operating margin) and you can assume certain % of the TAM captured by this SaaS company, and then you can derive EPS and sensitize a target price based on EPS multiple at maturity. 

The bulk of the analysis would then be to assess qualitatively whether these assumptions are achievable (and no one said assessing these things are easy, I for one am absolutely disqualified at this moment to have any confidence in identifying the next Salesforce). 

Instagram: @dickthesellsider | Substack: dicktoad.substack.com

Most Helpful
Feb 11, 2021 - 7:43pm

You're never going to be able to build out some perfect LTV/CACC model, driven by cohorts, etc., of the sort you might see at a P/E firm. There's just not enough info for most public companies. But you can get some sense of where margins are headed, which enables valuation and analysis. Below is a quick and dirty model what a successful company's margins might look like at maturity:

First let's assume your company is subscription revenue only, for simplicity's sake. If it has a professional services division, just assume it's going to run at ~0% margin, more or less.

1. You probably have churn, or a decent churn estimate, so you can thus infer gross new ARR from subscription revenue growth

2. Assume most (~90-95%) of S&M is the driver of gross new ARR, with the rest as maintenance spend. Now you've got some ratio of ARR/S&M. Given that ratio, you can back out what amount of S&M as a % of revenue is needed to keep revenue flat or up LSD, given your churn rate. That gets you your terminal S&M as a % of revenue.

3. R&D is more "finger in the wind," but it's probably going to be somewhere around a mid-teens % of revenue at maturity, maybe high teens maybe low-teens depending on the product type, quality, scale, etc.

4. G&A can go to a mid-single digit % of revenue. 

That's a really rough framework for where margins can go, but it gives you some perspective. From there it's easier to think about multiples, DCFs, etc. Another quicker way to look at terminal margins is to look at incremental margins, and see how they're developing.

Also, as for whether GAAP profitability matters: the answer is, why show GAAP profit if you can invest into customer acquisition? If LTV>CACC, put every last dollar to work. GAAP profitability is what you go for when your investment opportunities are drying up and your business is slowing to a crawl.  

  • Associate 2 in PE - Other
Feb 20, 2021 - 9:09pm

For subscriber businesses you can use things like ARR/CAC/Retention to model an NPV of the customer portfolio and use that to figure out what discount / premium you're paying for growth etc 

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