Jun 16, 2018
OK, SaaS companies, I think we get it… You have to spend money to make money!
And when looking to build scalable growth, there are a few areas where you should be directing resources. Just ask the Fast Growers in Edison’s 2018 Growth Index!
Fast Growers would never dream of under-investing in sales and marketing—their most critical growth levers—even if it meant recording higher expenses.
Rather, Fast Growers are adept at finding ways to grow and spend responsibly.
At first blush, the go-to tactics for hanging on to cash, like cutting budget for sales, product and people, can make sense. In fact, the concentration of companies in this year's Growth Index that were profitable last year had all reduced their headcount. However, a closer look at our Fast Growers reveals they spent more across all categories and, in turn, they were best at increasing and sustaining high-quality growth.
So, if you’re looking for the quick and dirty playbook for preserving cash without squandering growth, you’ve come to the right place. Here are 4 quick tips:
1. Make sure hiring follows growth, not the other way around
When thinking about headcount, it seems logical that more hires brings more growth. After all, Fast Growers grew headcount by 55%. However, we found that hiring followed growth—it didn’t create it. Given that growth rate is derived from GAAP revenue—a trailing metric—we believe that Fast Growers’ hiring efforts followed visibility into bookings, customer retention and other growth leading indicators.
You may ask: What happens when the rapid bookings trend starts to slow down? Companies can balance rapid hiring with a responsible OPEX structure by establishing measurable tripwires to triangulate topline, bottom-line and headcount growth. Department heads are always going to need one more person to help carry the workload, but make sure the company is meeting its organizational goals before overloading payroll expense.
2. Watch out for creeping G&A expenses
We know from the Growth Index that Fast Growers also spend more in all categories, so it was no surprise to see higher G&A spend. Digging in one layer deeper, we saw that personnel comprised approximately half of G&A. The next top three G&A categories were rent, technology and professional services. The combination of these expenses comprised 77% of total G&A, or 29% of revenue. Shockingly, slower growers, on average, spent more on these four G&A buckets than on Sales & Marketing combined. The lesson here is to find ways to limit expenses that don’t directly impact revenue.
Not surprisingly, many of the Fast Growers are true software companies, primarily SaaS companies emphasizing software product revenue over lower-margin service revenue.
Companies with higher-than-70% (SaaS-level) margins are also those incurring more hosting costs than COGS-related labor costs—their customers are paying for technology, not people.
Our advice for companies is to automate as many tasks as you can, like offering tech support via live chat. Continually assess your tech needs like hosting and customer data storage requirements. And track utilization rates of current staff to ensure the company is deploying and servicing customers as efficiently as possible—helping to limit the need for professional services.
3. Get the full picture on your per-employee cost
Employees are a giant expense. Yet Fast Growers drove up revenue per employee three times higher than slower growers! And this is despite faster hiring. Stated differently, with Fast Growers, revenue growth outpaced headcount growth for the year.
And if you were interested in the playbook within the playbook (we’re getting super meta…), here are four steps to make sense of revenue per employee:
· Set goals—general guidance is $200K per employee
· Set expectations for average cost per employee
· Estimate the ratio of employee to non-employee expense
· Run the numbers – use our handy calculator to get the complete picture on how your business is scaling as each hiring decision is made
4. Don’t sweat the losses
Yes, it’s true. Fast growers incurred significantly higher losses than slower growers (133% vs. 53% EBITDA as a percentage of revenue.) And yes, part of those losses came from higher spend on hiring and G&A. Still, higher spending—and even higher losses—can be acceptable... if you’re a Fast Grower.
The common sanity check to ensure the company is growing responsibly is the Rule of 40. The combination of growth rate and EBITDA margin should exceed 40%. So if a company grew 100% and had an EBITDA margin of (50%), their Rule of 40 score is a positive 50 and we have found ourselves one hot startup!
While the Rule of 40 punishes companies for poor EBITDA margin, not all losses are viewed the same – remember there’s a difference between GAAP losses and cash burn (working capital being a primary driver).
There’s no sleight of hand here. Fast Growers share a tried-and true set of characteristics, practices and best-in-class methods, having executed their go-to-market model with excellence along with showing superior financial discipline and investment. And it’s probably not a stretch to say they enjoy Pizza Fridays as much as anyone else. Some frivolities are just worth the extra sweat.