In this blog series we profile three core metrics for SaaS companies: revenue growth, churn and margin, from startup to $200 million dollar business. These metrics define a target profile that a SaaS company can use to compare their own performance.
Best In Class Revenue Growth - Using the "Mendoza Line"
For non-baseball fans, the Mendoza Line is a baseball term for the batting average below which a hitter is not worth hiring for Major League Baseball. The same term was used by Rory O'Driscoll (1) in 2018 to define the line for revenue growth below which SaaS companies would not be attractive to investors. Starting at $1m, Rory's model extended to the $100m mark, which is typically seen as the threshold at which companies can successfully go public. We extended the model through to $200m, where the company is substantially larger and is trending toward flatter growth goals, with 10% being a reasonable target.
The chart below shows the Mendoza Line from $1m to $200m, showing an ARR growth cycle of 77% decreasing over time to 10%. This is based on a desired investment standard of at least 82% growth persistence (where next years revenue growth is 82% of the current year).
With this chart, we can derive some fairly interesting go-to-market characteristics of a best in class SaaS company. First of all, taking a company public is not just a matter of reaching $100m in revenue. To return value, the company must also be able to continue to grow after its launch. Therefore, investment firms are looking for growth trends that will still provide for about 25% growth at launch.
This also means that companies don't have an indefinite window of time to go public. It is the combination of annual revenue AND sustained growth patterns that are attractive to investors. As the two are connected, the timeframe from $1m to $100m can be reasonably standardized as well - for best in class SaaS companies, that time period is about 9 years.
Therefore we can summarize that to be best in class, a SaaS company should grow from $1m to $100m in about 9 years with a continuing growth rate of about 25% at IPO launch.
Of course, this is a generalization (your mileage may vary!), but it does provide for a quick rule of thumb on how investors will look at the growth of a SaaS business. Other notable takeaways relate to where a company falls below or above the line:
Above the line before $100m, the company has the potential to be an attractive investment opportunity, but is not guaranteed based on how the company is performing in other metrics (see next two posts!)
If the company is below the line, action must be taken early to re-accelerate and regain a growth curve that is consistent with investors expectations.
After crossing the $100m mark and assuming the company was not taken public, being below the line opens up an increased potential for acquisition.
If the company is above the line and above $100m in revenue, then hopefully it has successfully been taken public!
The Mendoza Line provides only one view of the performance of a SaaS business. It doesn't help if you grow at 100% annually but lose 75% of your customers each year. The next metric we will evaluate is customer attrition, also referred to as "churn".
(1) The core data and foundations of this post are credited to Rory O'Driscoll and his excellent article "Understanding the Mendoza Line for SaaS Growth", TechCrunch, 2018.
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