How to Position SaaS Sales Efficiency for M&A
- Why acquirers/investors want to understand the efficiency of a SaaS company's sales & marketing efforts
- Which metrics acquirers will look at
- Why contextual positioning of these metrics is critical
Among the many aspects of your SaaS business that a prospective buyer or investor will evaluate, the efficiency of your sales & marketing efforts is near the top of the list.
While common sales efficiency metrics like LTV, Payback Period, and CAC can help summarize the performance of sales & marketing, the implications of these metrics are highly contextual. In other words, how you perform in any given sales efficiency metric is only relevant in the context of your business and your sales & marketing program.
Considering that context matters, how you both calculate and position your sales efficiency metrics is important for building momentum in a transaction and gaining credibility for your future projections. Having advised 100+ software founders through successful M&A and capital raise transactions, here is what we recommend founders understand in regards to sales efficiency and associated metrics.
Sales Efficiency as an Indicator of Profitability
Because the cost to deliver software (the COGS) is relatively small (often less than 20% of revenue), the most prevalent cost driver in a software organization is its sales & marketing program (assuming the company has passed its preliminary R&D phase). As such, the profitability of a software company is less dependent on how much it costs to deliver a product and more on how much it costs to sell a product.
Consequently, acquirers and investors treat a SaaS company’s sales & marketing program as the engine driving the company’s efficiency and will focus much of their attention on how well the sales & marketing engine turns one dollar into more dollars.
Why is understanding this paradigm important? Because even if your company is unprofitable from an EBITDA standpoint, strong sales & marketing metrics within the context of your go-to-market motion can position you for long-term success, which is interesting to buyers.
After all, one of the most attractive aspects of a SaaS business is that customers are not a one-time source of revenue but an annuity. So if you can acquire a customer for $1,000 and they generate $10,000 in revenue over their lifetime, then you should keep spending money until it costs close to $10,000 to acquire that customer.
Which Sales Efficiency Metrics to Use?
The goal of sales efficiency metrics is to help buyers/investors understand the relationships between:
- How much it costs to acquire a customer, or customer acquisition cost (CAC)
- How much that average customer pays in each period, or annual contract value (ACV)
- How long the average customer remains a customer, which, together with ACV, helps you understand a customer’s lifetime value (LTV)
The three primary metrics that encapsulate these relationships are:
- LTV:CAC ratio
- Payback period
- Sales efficiency ratio
LTV:CAC indicates what kind of return your company realizes from investing $1 dollar in sales & marketing. General wisdom suggests that LTV should be at least 2x your CAC, with +5x being ideal. Higher than 5x (meaning for every $1 spent on S&M the company generates $5+ in revenue over time) is good because that means your engine generates more per dollar invested, but it also means you’re probably leaving money on the table and should be investing more. Investing more money into a marketing engine that is already working but has capital constraints is a highly attractive and low risk acquisition/investment thesis.
The payback period represents how long it takes in order to be "paid back" the cost you incur to acquire a customer. In terms of a good length of payback period, context matters, since the average length of a customer lifetime will vary from enterprise to SMB to consumer software businesses. In cases where customers contract for at least one year, a payback period less than one year is great.
Sales efficiency ratio
The sales efficiency ratio is the ratio of sales and marketing expense to bookings (Sales & Marketing Expense / Bookings). Anything under 1 is good.
The Importance of Positioning
Note that we didn’t get too specific as to how to benchmark these metrics. The omission was intentional, as there are no universal standards for these metrics since each business and end-market is different.
For example, to calculate LTV:CAC, you might use the simple formula of 1 / churn rate to determine the average length of a customer’s lifetime. But which churn rate do you use: logo or gross revenue retention, or do you adjust to take the COGS into account? Regarding the sales & marketing expenses in the sales efficiency ratio, which expenses do you include? Do executive salaries count? The list goes on.
You may have an answer for these questions that meets your own needs, but your internal definition won’t necessarily align with how buyers/investors interpret these metrics. Considering that buyers/investors are trying to compare your company against many other potential acquisitions or investments, you need to be speaking the same language.
Then again, we mentioned previously that you need to be able to represent the metrics within the context of your business. How do you both communicate the unique dynamics of your business while also providing credible calculations buyers will understand and accept?
Perhaps we’ve arrived too strongly at a call-to-action, but the above dilemma is exactly why hiring an investment bank is a good move for founders. An investment bank is in your corner to help you lay out the nuances of the business, while at the same time positioning those nuances in a way buyers/investors will appreciate.
To be specific, below are two examples of how a technology investment bank could help you position your sales efficiency metrics.
Positioning your strategy at scale
In many cases, the product-led companies we represent perform exceptionally well in terms of sales efficiency. It’s not uncommon for us to see 10-20x LTV:CAC.
While 10-20x LTV:CAC is certainly good, every metric needs to be put into the context of scale.
For example, a small company who is spending nearly nothing on marketing but growing well through word of mouth is going to have really attractive sales & efficiency metrics. However, buyers/investors will draw into question the scalability of this approach.
Similarly, you may be performing exceptionally in a given channel or have a single rockstar account executive, but to what degree have you already exhausted the value of that resource? At what point do you start to experience diminishing returns? What risks does that create?
Under these circumstances, the key is to demonstrate how you have historically scaled the approach. Doing so will give buyers the sense that what has worked well now will work well into the future.
Positioning low-hanging fruit
In some cases you may not have advantaged yourself of certain sales & marketing tactics that, if adopted, could dramatically improve the opportunity ahead of you.
For example, maybe you never employed a channel strategy (i.e. partner program). If you can position these opportunities in the right way, buyers/investors will recognize the potential and escalate their interest.
Stay Focused on Building a Great Sales & Marketing Program
When the time comes to sell your business, one of the most important things you can do is to stay focused on the business.
Rather than cumbering yourself with the task of figuring out what buyers/investors look for in a company’s metrics, you can instead focus on improving organizational performance while your investment bank builds a narrative that accurately represents your business in a way buyers/investors will appreciate.