Building Unit Economics

Ah, Key Performance Indicators. That maelstrom of acronyms. Here at BuildGroup, we have a standard view for evaluating KPIs for B2B SaaS businesses. We are putting our methodology out there in the universe for a few reasons:

We are trying to be as transparent as possible about how we evaluate businesses. Every company - and we do mean EVERY COMPANY - that enters our deeper diligence process gets their numbers dropped into this template. We evaluate on a monthly and quarterly basis a set of SAAS metrics: LTV:CAC, Gross Margin Payback Period, and the SAAS Magic Number.

It might help you or your team as you build your business. Understanding unit economics answers the question of whether or not your business even *works*, on a fundamental level:

What is the lifetime value of your customers?

What is the cost to acquire your incremental customer?

Is the ratio of the value your customer creates over their lifetime versus the cost to acquire them comfortably high or trending in the right direction?

How long does it take you to break even on your incremental customer?
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Try Our KPI Template

To fill out this template you’ll need:

• Recurring revenue by customer by month

• Monthly gross margin

• Monthly customer acquisition costs (usually your sales &   marketing line...and sometimes more!)

A note on gross margin:

What should go into your COGS? An easy way to answer that question is asking another question: what costs do I have to incur to service the revenue?  Usually, that includes hosting costs, portions of your sales and marketing expenses, and customer success expenses.  Error on the side of caution with gross margin, it’s an important metric.  

A note on customer acquisition costs:

Go through your P&L and be honest with yourself about what your acquisition costs are. Doesn’t matter whether it’s a fixed or variable cost - what does it take to acquire a customer? Usually that’s your sales and marketing expenses, inclusive of salaries. There may be other components hiding in other line items of your P&L. 

Generally, it can be argued that Customer Success functions (in whole or in part) should be excluded from CAC. If the primary role of Customer Success is onboarding, it is usually included; if the primary role is day-to-day account support, it is usually not included in CAC.

And that’s it! Filling this out doesn’t require magical excel skills. I would import in a tab with the raw data (item #1) and then have that data flow into the data_new tab. 

Now, how to interpret the data…

Key Outputs:

1. Churn and net retention‍

• Our target businesses tend to have churn of <10% and net retention of >100%. There’s obviously wiggle room depending on your net retention profile. For example if your retention is 15% but your upsell is 30% that’s a net retention of 115%! The key takeaway is >100% net retention is great.
  

• There’s a lot of literature on churn and net retention.  BG defines churn as lost ARR from defected customers and current customers that spend less.  BG defines net retention as churn plus upsell, which is incremental ARR you sold to existing customers.  

2. Unit Economics

• LTV:CAC - the lifetime value of your customer is more than the cost to acquire the customer by x amount.  
  

• BG defines LTV:CAC as  (SaaS Bookings x Gross Margin) / churn %. We follow industry norms that >3x LTV:CAC is great.  We include gross margin because gross profit dollars are the cash that can be distributed back to the business.  Unfortunately, we all have to pay COGS.  
  

• If your LTV:CAC is sky high, you’re probably excluding something in your CAC.  Typically, we look at the entirety of sales & marketing expense as CAC, including Salaries.
  

• GMPP: how quickly can you get your customer acquisition costs back i.e. breakeven on CAC? We like businesses that have <15 month GMPP.  We love businesses that have <12 month GMPP.  
  

• SaaS Magic Number: How many dollars of SaaS booking will your company get for one dollar of S&M expense? We follow typical industry norms that SaaS Magic Number >1.0x is good.
  

• What’s a red flag? If the metrics are all over the place (not “smooth”), it means that the unit economics haven’t quite been discovered and that’s okay.  You may need to spend a few quarters proving out your metrics.

Which KPIs matter the most? Or are they equally significant?

Ultimately, these are all different ways of expressing the fundamental unit economics of your business. As a general rule of thumb, we would love to talk to you if your LTV:CAC >3.0x and your GMPP is <12 months (using our methodology).

This content does not constitute or form part of an offer of any investment advisory services of BuildGroup Management, LLC, nor does it constitute or form part of an offer to issue or sell, or of a solicitation of an offer to subscribe or buy, any securities or other financial instruments, nor does it constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment.