How to Know If Your Tech Startup Is on the Path to Profitability -- or Not
Free Book Preview Money-Smart Solopreneur
Building a company from the ground up is a tough task. There’s an art to entrepreneurship that’s difficult to master, and can be even harder to measure. In the early stages of starting a business many entrepreneurs struggle to identify meaningful metrics they can track their growth against, when profitability may be far in the distance. For early-stage SaaS companies in particular, it’s especially challenging to determine value when the baseline for growth is so low.
That said, there are a few key metrics entrepreneurs can look at to monitor their performance and keep the train from going off the tracks as it chugs ahead. Keep these in mind as you start to scale to set yourself up for long-term success.
Lifetime value and timeline to ROI
For starters, startups offering a SaaS product have a big hurdle to clear that their peers developing physical products don’t. Their sale doesn’t end, and the company doesn’t profit, once the product is sold. Instead, these companies play the long game by offering their service through a subscription-based model. They’re banking on the customers they acquire sticking around to reap the benefits of that service for months and years to come.
For this reason, SaaS businesses need to take into consideration the lifetime value they’re getting from each sale and be able to recoup the cost to acquire a customer in a reasonable amount of time. As a guiding metric you should aim to see a return from that cost in about a year. If you can’t recoup that cost for two years or more, it will be hard to reach profitability.
The best way to demonstrate that a company has a viable product to sell is a solid growth rate. In a business’s early days this rate should be a multiple, i.e. 200-300x in a year. As a company starts to develop market share, that will naturally come down. A business that’s growing at 25 percent to30 percent as a fully formed company has solid traction and is doing well.
Make sure you can demonstrate the need for your business early on to start on your growth track, and then iterate to keep that momentum going. Many companies make the mistake of thinking that they can grow proportionally just by adding, but the things that get you to $20 million may not get you to $50 million or $100 million.
Resist the temptation to hit cruise control and settle into the growth strategies that worked in your younger days. Take a close look at what’s working and what isn’t as your business expands. You may be able to identify one or two winning strategies you should focus your efforts on -- and the one or two problem areas you should dismiss -- to get you to the next level of success.
On top of the customer acquisition challenge, young companies face the harsh reality that not all customers stick around. To overcome this you need to have a solid grasp on churn rate. Keeping a customer for two years on average is very different from keeping a customer for ten years. It’s hard to identify this number in the early growth stages, but some inverse math calculations and conservative assumptions can help provide a solid estimate on what churn will be.
Assume that 10 percent of existing customers will leave in 10 years, then trim that figure to seven or eight years to play it safe. Look at what that calculation means in terms of the number of accounts and the budget, and plan a roadmap for the future around these figures.
The overall rate of churn isn’t the only thing to consider though. As the sales team undoubtedly knows, not all customers are created equal -- or carry the same amount of cash. Growing startups must keep an eye on the size of the customers they’re losing to churn and try to minimize the larger losses.
It’s always easier to spend money than earn it, especially when you’re raking in those high-value prospects as a young business. But, entrepreneurs should stay wary of what lies ahead -- especially if it’s another round of funding. Companies that wait until they desperately need cash are more likely to be stuck in a disadvantageous situation in mediocre terms with lenders or investors.
Make sure you’re regularly monitoring your cash burn to understand how quickly you’re spending, if/when you’re going to need more and your expected ability to raise money when needed. Plan ahead and map out the amount of cash you have versus your burn rate so you can anticipate when you’ll need more funding. Have a plan so that when you’re approaching that point, you’ll be able to borrow on the best terms and will be ready to handle whatever comes your way.
Starting a company certainly isn’t easy, but if you track growth figures diligently from the start you’ll find they won’t be a roadblock later on.
Consider these metrics as your benchmarking tools to keep your well-oiled machine chugging along on the track to success. Monitor them regularly, and hone in on the details of what’s working and what’s not so you can change course if needed. It’ll be a bumpy ride -- entrepreneurship always is -- but tracking metrics from Day One will make that path to profitability a bit smoother.