At AirTree, we’re often asked what metrics and thresholds we look for when assessing a startup for investment, e.g., “What should our monthly churn rate be for Series X?“. Our response is usually, “We don’t have hard thresholds for individual metrics. Instead, we look for signals of product-market fit (PMF)”. We know that this can be vague, so we wanted to shed some light on the signals we look for, specifically for B2B SaaS startups.

Metrics are one key part of determining if a startup is achieving the holy grail of PMF. While investors look at many metrics, some are more important than others, depending on the stage and sector. Here are the positive signals and red flags that we look for across venture investment stages.

It’s important to know that we don’t look at metrics in isolation — longer Customer Acquisition Cost (CAC) paybacks can be OK if churn is low or negative. A high churn rate can be OK in the early days if there’s strong viral growth with an ultra-low CAC.

Let’s go through a few key metrics and ratios investors look at when deciding whether to invest.

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Customer Lifetime Value (LTV) / Customer Acquisition Costs (CAC)

LTV / CAC is a widely used ratio to determine how much customer value a product provides relative to the cost of acquiring that customer.

Great startups provide a lot of value to customers — which customers typically pay for — without spending a disproportionate amount on sales and marketing (S&M). Atlassian’s Jira is a classic example of this. Software developers get daily value from Jira as it’s key to doing their job. In the early days, Jira’s customers mostly signed up on Atlassian’s website after being referred by another user or reading about Jira online. Atlassian didn’t need to spend much on a sales team because the product essentially ‘sold itself’. We refer to this as ‘product-led growth’ (PLG), and Australia/NZ is making a name for itself as a breeding ground for PLG startups.

Generally, at Series A to C, where a startup’s Go-To-Market (GTM) and unit economics are becoming more predictable, investors often look for LTV/CAC > 3. Here’s how to calculate LTV and CAC.

The LTV/CAC ratio suggests that not all companies need to be like Atlassian, which had low CAC and a low price point in its early days. A startup can spend a lot on S&M to acquire a customer (CAC) so long as its customer’s LTV is high relative to its CAC. CRM giant Salesforce is an excellent example of this. So what drives LTV? LTV is a function of:

1. Gross margin % = (Average revenue per customer (ARPC) - variable cost to service the customer) / ARPC
2. Net revenue churn %
3. Average Revenue Per Customer (ARPC) per month
4. A discount rate %

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Let’s go through what good B2B SaaS looks like for 1 and 2. Note that 3. ARPC and 4. discount rates are less relevant for benchmarking.

1. Gross Margin %

Gross margin is revenue minus the variable costs needed to service customers. Variable costs include hosting, data vendor, ongoing customer support and any other costs essential to providing your software to your customers.

2. Net Revenue Churn

Churn is measured in several ways. Firstly logo churn refers to the % of customers lost over a time period. Logo churn does not take into account revenue. Instead, net dollar or revenue churn refers to the % revenue lost from the current customer base due to the loss or contraction of their spend, plus any expansion of spend from other current customers.

When net revenue churn is negative, the expansion of spend from existing customers outpaced the loss of revenue due to the loss or contraction of other customers’ spend over the time period. Negative net revenue churn is called net revenue retention and is a strong positive signal. Here’s how to calculate logo churn and net revenue churn.

For seed and later venture rounds, the first row of the table below shows benchmarks for net monthly revenue churn. Low churn is extremely important since acquiring a new customer to replace a churned customer is often much more expensive than retaining a customer.

Some startups see customers churn (contracted spend or cancelled subscription) after only a few months but then return a few months later. This could be because customers use the product on short-term projects (e.g., building projects on Archistar or design projects on Canva) and then reduce spend between projects. This is not necessarily bad.

If you think that your startup has a similar ‘project’ customer cohort, then it’s critical to show the metrics for your different cohorts in your pitch deck, and how you measure churn, returning customers, LTV and CAC for the ‘project cohort’. High churn can be OK in such cohorts if CAC paybacks are fast or customers regularly return, resulting in attractive LTV/CAC.

Note that investors often ask for different cohorts analyses to assess monthly net revenue retention and active usage trends at a cohort or customer level as other signals of product-market fit.

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CAC Payback

CAC payback refers to how quickly a startup receives the upfront cash spent on acquiring a customer back from that customer after accounting for the variable costs of servicing that customer. Here’s how to calculate it.

If a startup spends a lot on sales and marketing to acquire a customer who only pays a small amount per month, then the startup will suffer from long paybacks and high near term cash burn. On the other hand, a fast CAC payback means a startup can recycle its cash quicker and raise less capital (and lower dilution). We discuss cash burn further below. Note that long CAC paybacks are OK if customers grow their spend (net revenue retention >100%) and therefore LTV overtime.

In the previous table, row 3 shows venture investment benchmarks for CAC paybacks. As another reference, paybacks averaged ~18 months for US IPO SaaS companies in 2020, according to OpenView Partners.

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Cash Burn and Capital Efficiency

VCs also scrutinise a startup’s Burn. Some startups fall into the trap of spending lots of cash to build complex products or quickly acquire and grow the customer base. This is OK if you have product-market fit (low churn, high repeat product usage, fast CAC paybacks, etc.) and the spend translates into sustainable revenue growth with healthy gross margins. However, it is not good if you don’t yet have PMF which doesn’t translate to sustainable growth.

At AirTree, we like to look at Burn multiple as a measure of capital efficiency.

Burn multiple = Net Burn / Net New ARR over a time period

For venture-stage startups, here are rules of thumb for burn multiples from David Sacks:

ARR Year on Year (YoY) % Growth

As alluded to above, great metrics (signals of product-market fit) and capital efficiency should translate to high, sustainable revenue growth that are the hallmarks of a future unicorn. In B2B SaaS, Annual Recurring Revenue (ARR) is the key revenue looked at. Simply, ARR = Beginning ARR + New ARR + Expansion ARR - Churn ARR. Here are SaaS benchmarks for ARR growth.

Rule of 40 or ‘R40’

R40 is another measure of capital efficiency. R40 refers to the sum of annual ARR % growth and EBITDA % margin. EBITDA is a proxy for cash profitability. If a company is growing 100% YoY and investing revenue in growth, they may still be highly unprofitable. However, once growth slows, the company needs to show that it’s approaching profitability so that it can deliver strong cash flows to investors in the long term.

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B2B SaaS Valuation

Good investors scrutinise metrics and capital efficiency as signs of product-market fit and an effective GTM. They assess those signals in the context of the startup’s team, market, product category, GTM (referrals, sales efficiency, pipeline), customer calls and other factors. SaaS startups that ‘score’ highly should be rewarded with higher valuation multiples vs their peers. This is also the case for publicly listed tech companies where the Rule of 40 is more correlated with EV/Revenue multiples vs. ARR % growth as an analogy.

If startups don’t score highly and are given a high valuation prematurely, this can cause potential cash burn and scaling pressures, and down rounds later down the road. This can be disastrous for many scaleups and their staff and investors who see the value of their equity stall or collapse (e.g., Katerra).

On the other hand, startups that show strong signs of product-market fit should receive a top quartile valuation since the revenue and value they create will see sustainable, compounding growth.

We hope that gives some clarity around the signals we look for when evaluating investments, particularly for Seed and later stages. I’d be keen to meet you if you’re 1) hitting the benchmarks, or 2) hitting some metrics, but not quite sure about others. Almost all startups will be in group 2. Got a good example? Feel free to shoot me an email.

ANDREW YEO WAS A CONTRIBUTOR TO THIS OPEN SOURCE VC RESOURCE. YOU CAN FIND HIM ON LINKEDIN AND TWITTER.