Introduction to SaaS Investing

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Introduction to Software as a Service Investing

• Educational Presentation #13

• 30.03.2025

• Property of the ESCP Alternative Investments Society (AIS)

• Sources: Pitchbook, FT, Bloomberg

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Section I: Introduction to SaaS

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I: Introduction to SaaS

What is SaaS in B2B?

• Software distribution model in which a cloud provider hosts applications and makes them available to end users over the internet

• One of three categories of cloud computing services including Infrastructure and Platform as a service (Iaas & Paas)

• VC Funds invest in SaaS companies due to their high scalability potentials while maintaining low overhead cost

Advantages for VCs

1. Users access the software application through the internet instead of installing them on their local devices

2. Software provider, as the host provides the application & data using its own servers and databases

3. Application is the accessible to any device within the network

• Subscription-based model that makes revenue streams more predictable • High gross margin due to a low marginal cost to serve additional customers • Once product is developed it can be scaled worldwide with low overhead cost • High customer retention due to high “switching costs” for customers

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I: Introduction to SaaS

The Software Stack

• The Software Stack can be considered as the engine behind every Saas-product as it makes independent components work together to support the execution of an application

• A strong and modern stack means high operational efficiency and quick scalability opportunities for VC investors

Interaction with end user

Layout and features of the user interface when opening an application

Part of the software the user interacts with directly, like buttons, menus or dashboards

Frontend (Client Side)

Handles all the logic, including processing user requests and stores data

Saves file to the server when user presses “Save”

Backend (Server-side)

Backend password check during login

Database

Destination where all the software’s information is stored and organized

Interaction with

Infrastructure

Cloud environment that powers the software and delivers it to the users via internet

When opening Netflix, the application is hosted on cloud infrastructure

hardware

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I: Introduction to SaaS

Further Terms of SaaS

Common metrics and concepts investors and operators should know

• ARR (Annual Recurring Revenue) is the foundational metric for SaaS valuation, reflecting predictable, contractbased revenue

Recurring Revenue

• Growth in MRR or ARR signals product-market fit and scalability - High ARR leads to higher valuation multiples, especially when paired with retention

• Net Revenue Retention (NRR) over 100% indicates strong expansion within existing customers

• Gross Revenue Retention (GRR) measures stability; <85% may indicate high churn risk

Retention Rates

• Retention is a better predictor of long-term value than new customer acquisition alone

• LTV:CAC ratio shows how much value is generated per dollar spent on acquisition; 3:1 is a strong benchmark

• CAC Payback Period under 12 months signals efficient growth and fast ROI

Unit Economics

• Strong unit economics suggest a scalable and capital-efficient business model

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I: Introduction to SaaS

SaaS Investing Trends over time

SaaS startups outperformed the rest of tech in Seed and Series C funding, while later-stage rounds saw sharper volatility after 2021

Series B Series C+ Series A Seed

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Section II: Main Player in SaaS Investing

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II: Main Players in SaaS Investing

Major European Saas Unicorns

​ Parameters

​ Celonis

​ Personio ​ Aircall ​ Typeform

​ Name

​ Logo

​ Founder

Alexander Rinke

Olivier Pailhes (ESCP)

Robert Muñoz

Hanno Renner

Greenoaks Capital

Deutsche Telekom

Investor

Index Ventures

83North

Partners

Capital Partners

​ Founding Year

$1 bn (Series D in 2021)

$120 M (Series D in

$135 M (Series C in

$200 M (Series E in

​ Funding Raised

2021)

2022)

2022)

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II: Main Players in SaaS Investing

Major Global Saas Unicorns

​ Parameters

​ Wiz

​ Gusto ​ Notion ​ Canva

​ Name

​ Logo

​ Founder

Assaf Rappaport

Ivan Zhao

Melanie Perkins

Joshua Reeves

General Catalyst

Index Ventures

Sequoia Capital

Investor

Sequoia Capital

​ Founding Year

$1 bn (Series D in 2024)

$275 M (Series C in

$200 M (Series F in

$200 M (Series E in

​ Funding Raised

2021)

2021)

2019)

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II: Main Players in SaaS Investing

Major VC Funds invested in SaaS - Startups

​ Parameters

​ Balderton Capital

​ Name

​ Sequoia Capital ​Andreessen Horowitz ​ Notion Capital

​ Logo

​ Region

Europe

USA

Europe

USA

Marc Andreessen & Ben

Roelof Botha

Bernard Liautaud

CEO

Stephen Chandler

Horowitz

GoCardless

Aircall

Snowflake

​ Notable Investment

GitHub

$6 bn

$42.9 bn

$500 M

$54.6 bn

​ AUM

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Section III: SaaS Valuations & Rule of 40

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III: SaaS Valuation & Rule of 40

The 3 Key Valuation Metrics for SaaS startups

• The three key drivers of valuation in the B2B SaaS landscape:

1. Growth Rate

2. Revenue Scale - ARR & MRR • ARR (Annual Recurring Revenue) is the core metric used to benchmark SaaS size • Higher ARR supports larger valuation multiples, especially with predictable and recurring income streams

3. Profitability & Efficiency • Investors look at Free Cash Flow Margin, EBITDA, and burn multiples • Profitable growth boosts valuation certainty • Efficiency ratios such as CAC Payback Period and LTV/CAC matter for cost control

• YoY ARR Growth is one of the strongest predictors of valuation multiple • Companies growing 30-50%+ annually are valued at premium multiples • Growth without efficiency, is discounted

Valuation = ARR × EV/ARR Multiple

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III: SaaS Valuation & Rule of 40

Introduction of the Rule of 40

• The Rule of 40 measures a SaaS company's ability to balance growth and profitability by adding its revenue growth rate to its profit margin, ensuring sustainable scaling and financial health

Rule of 40 = Revenue Growth Rate (%) + Profit Margin (%)

• The Rule of 40 serves as a benchmark for evaluating SaaS companies, as it highlights the trade-off between aggressive expansion and financial sustainability

Interpretation of the Rule of 40

• Rule of 40 > 40%: The company is considered financially strong, balancing growth and profitability, making it attractive to investors

• Rule of 40 < 40%: Indicates inefficiencies - either rapid growth with unsustainable losses or strong profits but slow expansion, reducing investor confidence

Further Explanation

• Investors and lenders favor companies exceeding 40% since they demonstrate scalable growth with controlled spending, making them more resilient in economic downturns

• Typically, SaaS companies with a Rule of 40 above 40% receive higher valuation multiples, while those below face scrutiny over their financial efficiency and scalability

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III: SaaS Valuation & Rule of 40

Key Components of the Rule of 40

• The Rule of 40 is made up of two performance metrics that, when combined, signal a SaaS company’s ability to scale sustainably:

Revenue Growth Rate • Measures year-over-year increase in ARR or MRR

Profit Margin • EBITDA or Free Cash Flow Margin

• Indicates a company’s ability to acquire new customers and grow market share

• Reflects how efficiently a company turns revenue into profit

• Early-stage SaaS often has high growth but negative margins due to reinvestment

• Can vary depending on growth stage and investment strategy

Benchmark

Benchmark

30-50 % = High Growth <20% = Low Growth

10% = Strong Profitability

Negative Margins = Acceptable for early stage, if growth is high

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III: SaaS Valuation & Rule of 40

The Impact of the Rule of 40 on Saas Valuation

• Investors reward SaaS companies that achieve Rule of 40 scores above 40% with higher valuation multiple

Higher Valuation

• Enterprise Value-to-Revenue (EV/Revenue) multiples are significantly higher for firms exceeding the Rule of 40 compared to those below it

Multiples for Exceeding the Rule

• According to Bain & Company, companies that consistently outperform the Rule of 40 enjoy EV/Revenue multiples up to 22x, while those failing to meet it often trade below 10x EV/Revenue​

Market Data on

the Rule of 40

• Public SaaS companies exceeding the Rule of 40 trade at a median multiple of 15-20x ARR, while those below it trade closer to 5-10x ARR

• SaaS firms exceeding the Rule of 40 are seen as scalable and capital-efficient, making them attractive acquisition or IPO candidates

Why It Matters for

Investors

• Investors view a low Rule of 40 score as a red flag, signalling either unsustainable losses (high growth, no profits) or stagnation (profitable, but slow-growing)

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III: SaaS Valuation & Rule of 40

Valuation Multiples Spectrum

The impact of the Rule of 40 on Valuation Multiples

• Higher Rule of 40 scores correspond to significantly higher valuation multiples • Investors reward SaaS companies that balance growth and profitability with premium EV/Revenue ratios

Rule of 40 Score (Growth % + Profit Margin %)

20% 25% 30% 35% 40% 45% 50% 56% 60%

Median EV / Revenue Multiples

8x 9x 10x 11x 12x 14x 16x 20x 22x

Top quartile performers

Medium quartile performers

Bottom quartile performers

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III: SaaS Valuation & Rule of 40

What Top-Performing SaaS Companies Do Differently

Operational strategies behind consistent Rule of 40 outperformance

Top-Performing SaaS = Strategic Growth Execution + Disciplined Profitability

1. Set Realistic Growth Targets: Align growth goals with market size & avoid over-spending on unrealistic expansion plans

2. Maximize Net Revenue Retention (NRR): Focus on upsell, cross-sell, and customer success & target NRR of 120%+ for strong internal growth

3. Optimize Go-To-Market Efficiency Segment customers and allocate sales resources based on ROI Use metrics like CAC payback and Magic Number

4. Build & Scale New Business Lines Quickly Incubate new product lines early to maintain momentum Support with dedicated resources and operational rigor

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Section IV: Key Performance Metrics

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Section IV: Key Performance Metrics

Growth and Profitability

• Rule of 40 is a measure of balance between growth and profitability and by extension, sustainability of the business

Rule of 40 = ARR growth + Free Cash Flow margin

• Across a firm's development, it will have to balance profitability and growth. Many use the "Rule of 40" to determine this trade-off

• The Rule of 40 states that the sum of a company's revenue growth and profitability should be greater than 40%

• In other words, a company that grows 80% year-over-year but has a -40% cash flow margin should be valued equally to a company that experiences little to no revenue growth but generates 40% cash flow

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Section IV: Key Performance Metrics

Recurring Revenue Metrics 1/2

• Why do recurring revenue metrics matter for the performance evaluation of SaaS companies?

• Since these companies operate on a subscription model, recurring revenue is the best indicator of their size and growth.

• To ensure consistency, it is typically reported on a monthly or annual basis, depending on the most common contract length among customers.

ARR (Annual Recurring Revenue) MRR (Monthly Recurring Revenue)

• Represents the recurring revenue from all subscription contracts, normalized on a monthly basis • MRR is always equal to one-twelfth of Annual Recurring Revenue (ARR) • One-time revenues are excluded to maintain a clear and consistent measure of predictable income

• Represents the recurring revenue from all subscription contracts, normalized on an annual basis • ARR is always equal to 12 times Monthly Recurring Revenue (MRR) • One-time revenues are excluded to maintain a clear and consistent measure of predictable income, as for MRR

 In practice, ARR is calculated as the previous month's MRR multiplied by 12

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Section IV: Key Performance Metrics

Recurring Revenue Metrics 2/2

The Components of Recurring Revenue

Metric Description

Retained ARR Recurring revenue that continues from existing customers from the previous period

Contraction ARR Recurring revenue lost due to customers downgrading their contracts from the previous period

New Sales ARR Recurring revenue acquired from new customers in the current period

Churned ARR Recurring revenue lost as a result of customers fully cancelling their contracts from the previous period

Resurrected ARR Recurring revenue regained from former customers who have re-subscribed

Expansion ARR Additional recurring revenue generated from existing customers compared to the previous period (Cross- or Upselling)

Recurring Revenue at the Account or User Level

Average Revenue Per Account: Measures the average recurring revenue per customer account. It can be reported monthly, quarterly, or annually ARPR ARP

Average Revenue Per User: Similar to ARPA but calculates revenue per individual user, considering that one account may have multiple users. In consumer software, ARPA and ARPU are often the same

U

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Section IV: Key Performance Metrics

Retention Rates 1/3

Introduction to Retention Rates

• Retention rates are key performance indicators that reflect product-market fit, sales effectiveness, and customer satisfaction by measuring how well a company retains customers and recurring revenue over time • Cohort analysis is used to track retention trends, grouping customers based on their signup period (e.g., month, quarter, or year) to assess retention performance over time • Further segmentation by factors like customer size, industry, or region can provide strategic insights, such as identifying stronger retention among customer segments, helping to refine sales strategies and the ideal customer profile (ICP)

Retention Rate Metrics - An Overview

Customer / Logo Retention Revenue Retention

Metric Description Formula

Metric Description Formula

# of customers remaining

Initial ARR in Cohort - Contraction ARR - Churned ARR

Logo Retention

Initial # of customers

Gross Revenue Retention

Measures how much of the initial recurring revenue remains over time, excluding expansion.

Measures the percentage of customers in a cohort who remain after a set period.

Initial ARR in Cohort

Logo Churn

Initial ARR in Cohort + Expansion ARR - Contraction ARR - Churned ARR

Tracks total recurring revenue, including expansion, minus churn and contraction. 100% - Logo Retention

Net Revenue Retention

Initial ARR in Cohort

The inverse of logo retention, indicating the percentage of customers who leave within a given period.

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Section IV: Key Performance Metrics

Retention Rates 2/3

Logo Retention and Logo Churn In More Detail

Logo retention measures the percentage of customers from a cohort who remain after a specific period. It is often expressed as a single percentage. For example, a 67% logo retention rate means the company retains 67% of its customers annually, which compounds to 45% over two years (67% × 67%)

Example of Logo Retention Analysis

A. Increasing Customer Acquisition – More new customers added each month, signaling better acquisition B. Higher Retention in Recent Cohorts – Newer customer cohorts show stronger retention rates, suggesting either more engaged customers or better retention strategies C. Retention Surge in Early 2022 – Higher retention between Dec 2021 and Jan 2022 suggests better customer targeting. D. Retention Drop After One Year – Sharp decline in months 11- 12, likely due to annual plan churn E. 67% Retained After One Year – Two-thirds of customers stay, emphasizing retention over acquisition

Source: GP Bullhound

Benchmark for Strong Retention: Enterprise clients retain >95% of customers, SMBs >80%, with continuous growth in new customer

acquisition

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Section IV: Key Performance Metrics

Retention Rates 3/3

Revenue Retention In More Detail

Gross Revenue Retention Net Revenue Retention

Measures how much of the initially acquired recurring revenue is retained over time

Measures how much recurring revenue a cohort generates over time compared to its initial revenue, factoring in retention, expansion, contraction, and churn

Key Insights:

Key Insights:

• Higher gross revenue retention than logo retention suggests strong retention of high-paying customers • If lower, it indicates a reliance on smaller, less revenuegenerating customers • For example: 76% one-year gross revenue retention vs. 67% logo retention, so the company retains higher-value customers better

• A net revenue retention of 100% or higher means the company can maintain or grow revenue without acquiring new customers • If below 100%, the company relies on new customer acquisitions to sustain revenue, indicating potential revenue leakage • High net revenue retention signals strong expansion revenue and upsell growth

Benchmark for Strong GR Retention: • >90% for enterprise clients, >80% for SMBs • Retention is spread across the cohort, not driven by a few power users

Benchmark for Strong NR Retention: • >120% for enterprise clients, >100% for SMBs • Improving retention, upsell, and contract value over time • Retention should be distributed across customers, not dependent on a few large accounts

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Section IV: Key Performance Metrics

Unit Economics 1/3

Introduction to Unit Economics

Importance of Unit Economics: • Revenue-Cost Mismatch in SaaS – Unlike traditional businesses that recognize revenue and costs immediately, SaaS companies incur costs upfront while revenue is recognized over time, making standard financial metrics like income statements and gross margins less effective for evaluating business health  Understanding unit-level growth helps assess whether a company is scaling efficiently and sustainably, providing deeper insights beyond traditional financial reports

Key Contract Size Metrics Key Unit Economic Metrics

LTV/CAC

Total Contract

Annual Contract

Customer Acquisition Cost

CAC Payback Customer Lifetime Value

(CAC)

(LTV)

Value (TCV)

Value (ACV)

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Section IV: Key Performance Metrics

Unit Economics 2/3

Introduction to Unit Economics

Metric Description Formula

Total Contract Size

TCV

Total Contract Value (TCV) - The full value of a contract at the time of sale, covering its entire duration but excluding any future upsell

ARR

ACV

# of customers

Annual Contract Value (ACV) - The revenue generated from a customer contract over a 12-month period. For example, if a $2,000 contract spans two years, the ACV is $1,000.

Since customer contract sizes differ across companies, the most useful metrics for evaluating unit economics and sales efficiency focus on customer acquisition cost and lifetime value

Unit Economics Metrics

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Section IV: Key Performance Metrics

Unit Economics 3/3

Key Unit Economics Metrics

Metric

Description Formula

S&M expenses in preceding period

CAC

# of new customers acquired in the

current period

Customer Acquisition Cost (CAC) – Measures the cost to acquire a new customer, typically calculated using the previous period's sales and marketing expenses divided by new customers acquired

CAC

CAC Payback

ARPA x Gross Margin

CAC Payback – The time required for revenue from acquired customers to cover acquisition costs, adjusted for gross margin

(Landing Contract + Upsell)

LTV

x Gross Margin X Average # of Years Lifetime

Customer Lifetime Value (LTV) – Total revenue an average customer generates over their lifetime, factoring in gross margin and contract duration

LTV

CAC

LTV/CAC Ratio – Compares revenue generated per customer to acquisition cost; a ratio below 1 means the company won’t recover acquisition expenses LTV/CAC

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Section IV: Key Performance Metrics

Burn Rate and Capital Efficiency

• These are used to understand the capital efficiency of a company and when it needs to raise additional capital

Metric

Description Formula

Gross Burn

Monthly Cash Outflows

Gross Burn – The total cash a company spends each month

Monthly Cash Outflows -

Net Burn

Net Burn – Monthly cash outflows minus the cash generated, reflecting net cash loss

Monthly Cash Inflows

Cash Burn

Runway

Net Burn

Runway – The number of months a company can operate before depleting its cash reserves; if cash flow is positive, the runway is unlimited

Net Burn

Burn Multiple – The amount of cash required to generate each dollar of new recurring revenue (ARR) Burn Multiple

Net New ARR

Benchmark for Strong Runway: Ideally >18 month runway at all times with an easy option to extend to 24 months

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Section IV: Key Performance Metrics

Sales Metrics

• Used to understand the efficiency of the sales strategy and the productivity of the sales team • The most important metric is the Magic Number:

Description Formula Metric

Net Burn - ARR preceding period

Magic Number

Net New

It calculates the output of a year’s worth of revenue growth for every dollar spent on sales and marketing, i.e. how many dollars of ARR do you create for every dollar in S&M spend

ARR

Benchmark for Great Magic Number: • Magic Number < 0.50 = Suggests some areas need to be improved (Not ready to invest in S&M) • Magic Number < 0.75 = Decent (Evaluate Investment) • Magic Number > 0.75 = Great (Ready to invest in S&M)

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Section IV: Key Performance Metrics

Venture Debt: Debt and Leverage in SaaS Companies

• Investors prioritize revenue stability and closely analyze a company's balance sheet • Liabilities Assessment – Debt providers review existing loans, repayment obligations, maturity dates, and secured vs. unsecured debt • Asset Evaluation – Key focus areas include business assets, intellectual property value, receivables (impacting retention), and cash runway

Metrics to Consider in Case of Raising Venture Debt

Metric Description Formula

Total Debt

Total Debt to ARR

ARR

Total Debt to ARR – Assesses a company's ability to repay debt based on its annual recurring revenue; a lower ratio indicates better financial health

Debt Facility Amount

Debt to Cash Equity Ratio

Debt to Cash Equity Ratio – Evaluates lending risk by comparing total debt to available cash equity; higher ratios suggest increased financial risk

Cash Equity

Benchmark for Strong Runway: • Total Debt to ARR ratio: 2x (in US), 1x (in Europe) • Debt to cash equity ratio < 80%

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Section V: SaaS Multiples

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V: SaaS Multiples

SaaS Multiples over the Years

• The Software hype is slowing down – and so are the valuation multiples:

EV/ARR Multiple

Analysis

• EV/ARR multiples peaked in 2020 - 2021, with many top-tier SaaS firms trading at 20x - 30x + ARR

• Driven by: Pandemic-fueled digitization low interest rates & a growth-at-all-costs mindset

• Since 2022, macro tightening (rates, inflation) and skepticism around unprofitable growth have caused a reset

EV/ARR Multiple

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V: SaaS Multiples

What has impacted SaaS Multiples

Effects on Multiples Explanation:

Rising Interest Rate

Higher rates increase the discount rate applied to future cash flows, lowering valuations. Growth companies (like SaaS) are more affected because much of their value lies in future earnings

Investors now favor companies that can grow efficiently and show a clear path to profitability, penalizing those with high burn and weak margins

Shift from Growthat-All-Costs to Profitability

Public Market Valuation Reset

The dramatic compression of public SaaS multiples, from over 30x to under 10x in some cases, has directly lowered private market expectations

Macroeconomic Uncertainty

Geopolitical instability, including the Ukraine war, has fueled inflation, disrupted markets, and contributed to risk-off investor sentiment, pressuring SaaS valuations