Originally published August 10th, 2019 in VentureBeat
Growth at all costs: it is a narrative familiar to almost all software-as-a-service (SaaS) companies out there. But is it always the right one to follow? A few weeks ago I was speaking at London’s SaaSGrowth conference, and the room, filled with heads of sales from software companies across Europe, breathed a sigh of relief when the speaker before me started talking about the importance of not scaling too fast.
It is difficult to describe how ingrained the fast-growth-at-all-costs mindset is. In venture capital, my industry, the default growth expectation of SaaS companies is “triple, triple, double, double, double” – in other words, triple your revenue for two years, then double it for three. This is an “add fuel and push the engine to full throttle” mindset. And, while it might be tried and tested, it is just not one that suits all businesses.
Not all SaaS companies are the same
What a company sells and who it sells it to helps determine how fast it should grow at certain points. Companies that are at the scale-up stage that focus on enterprise customers, for example, grow about 50 to 150 percent a year. There is a natural limit to how fast they can grow because they are going after high-touch sales – enterprise customers that take a long time to originate, convince, and close but, once online, typically provide substantial ongoing subscription revenues.
The time, money, and effort that goes into closing these customers and, in particular the time it takes to train, onboard, and ramp a sales team to target them, highlights the problem of the triple, triple, double, double, double model for enterprise SaaS companies: If you scale before you are ready, there is a big chance you will be throwing a lot of money down the drain.
Before you can put your foot down on that accelerator, your company needs to have done three things:
1. Found product market fit. Have you found what your product should be for what market? A $3 million to $5 million annual recurring revenue is a good marker for that.
2. Created a well-defined go to market strategy. You need to know which customer segments you target, how to target them, and with what messaging.
3. Defined a repeatable process for finding leads, nurturing them, and onboarding them smoothly, as well as taking care of them once onboarded – and knowing which team is responsible for which part of that process. The litmus for this is an ability to forecast, with reasonable precision, what happens if, say, you add more salespeople, including what the implications will be for the likes of marketing spend, sales development reps, sales engineers, support, and customer service teams.
Once this clearly-defined process is in place, it’s a good idea to take one or two quarters to make sure everything is ready to scale to a greater customer base before you go into high gear.
The fallacy of missing out
I often get asked, “but doesn’t pausing to take stock run the risk of being overtaken by a competitor?” No, is the short answer. The notion that companies will lose out in one or two quarters to another player in the market doesn’t hold in the B2B enterprise space, where things simply don’t move fast enough to make running ahead necessary.
The worst case scenario for any SaaS company and its investors is that you pump fuel into an engine that can’t take it, and you get an explosion. We have all experienced it and, for me, it’s the reason I simply steer clear of the growth-at-all-costs mindset. If you’re a company, it means having, for example, more sales people than you can generate leads for, which quickly means a dissatisfied sales team as they can’t hit their targets, and then people leaving. You spend money to hire people, train, and onboard them, and then lose them because you aren’t ready to deploy them and can’t support them properly.
You’ll find yourself, having burnt through money faster than you’ve executed a plan, having to raise more in a worse position. You haven’t met your milestones from the previous round, so the new raise is likely going to be more expensive and cost more equity. This hurts founders and management – the people who need to be on-side, revved up and focused – as well as investors, who will be diluted more than they anticipated. At best, it may still be an up round, but nowhere near as good as it could have been. Scaling faster than you’re ready for is a false economy for most SaaS companies.
The sustainable growth paradigm
Investors that don’t follow the triple, triple, double, double, double default have to have a different fund model. Most funds expect six or seven out of 10 investments to fail, two or three to muddle along, and one to be outstanding and deliver 10 to 100 times the money back — enough to support the entire fund.
But with a sustainable growth paradigm, you don’t expect any of your portfolio companies to go bust; you look for a scenario ranging between and upside of 5x return and a downside of 1.5x return. In a world geared towards sprinting, this means sustaining growth for far longer and leveraging capital to get even further.
Written by Thomas Eskebaek, Investment Manager at Oxx.