Big Luck = Take Big Bets

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Estimated read time: 7 minutes 16 seconds

1. 7 SaaS Metrics That Matter Most

2. Big Bets = Big Luck?

Good morning and happy Monday - let's get smarter

7 SaaS Metrics That Matter Most

As technology like artificial intelligence continues to improve, more and more companies will be technology-based or use more and more technology to increase efficiency and effectiveness

IMO, more and more people will be employed by SaaS companies big and small over the next 10 years than ever before

Last Monday, we talked about employees of private companies receiving phantom equity

One thing that's important to understand is the value of the business that you are receiving options, phantom equity, or regular equity, in

This will help you figure out how much your % is worth, and if that amount is substantial enough to forgive a higher salary and higher stability at a larger company for a more risk based startup

As we have discussed, most SaaS businesses are valued as enterprise value / revenue or EV/Revenue

Simply put - they are valued based on a revenue multiple (top line), where most businesses are valued based on EBITDA their proxy for recurring cash flows

So what makes some SaaS companies more valuable than others? These metrics are a key factors to know in order to determine a SaaS companies revenue multiple

Top 7 Most Important SaaS Metrics to Track

During bull markets when VC’s have an excess amount of dollars to allocate, high-growth startups can have frothy valuation multiples like 100x revenue

When markets turn, investors tend to care more about free cash flow and other key performance indicators rather than only focusing on growth

Key performance indicators or KPIs tell you about the operational efficiency of the business

How effectively is your company managing cash flows?

What is the cost to acquire a customer and how long is the sales cycle?

Depending on what you read or who you listen to, you’ll hear about 6,000 metrics that are important and you can quickly fall into analysis paralysis

Tracking these metrics allows you to make better spending decisions, hiring decisions, control your cash flows, etc.

We have highlighted the top 7 most important metrics that the founder(s) and finance team should be following via a financial dashboard weekly and reviewing monthly:

ARR or Revenue per employee

Take your total revenue or your annual recurring revenue and divides by the number of full-time employees

The metric gives you insight into the efficiency/effectiveness of your workforce

The higher the ratio, the more effective

However - if this ratio is high due to not hiring enough staff and churning and burning your current employees, then you have a problem

Employee churn will make this ratio look better, but will be an even bigger problem

Look at this metric in connection with employee morale and compare it to other companies in your industry of your size

Cash burn

Total monthly revenue - total monthly expenses

Your cash burn looks at the rate you are burning cash and you can apply it to your cash balance to figure out your cash runway

This is where having a dashboard with variance analysis is extremely important so you can see what expenses are contributing the most to the cash burn, what drove it higher than expected

Cash runway

Total cash / cash burn

Your cash runway is the number of months you have remaining before you run out of cash based on your cash burn

Ideally, especially during more difficult fundraising items (i.e., recessions or economic slowdowns), it’s a good practice to keep 18 months of cash in the bank at least

Burn multiple

Cash burn / net new ARR or net new revenue

This metric is an efficiency metric that looks at how much revenue are you generating from every dollar of cash burn

If you raised capital, investors also like to see your burn multiple to get an understanding of how well you are allocating the capital that you raised aka how effectively are you spending investor dollars

Your target for this metric is as close to zero as possible

Gross Margin

Revenue - cost of revenues / revenue (gross profit / revenue)

Gross margin tells you the percentage of profit on revenues after factoring in the variable costs needed to generate the revenue

SaaS companies typically have gross margins around 65-75%

Your cost of revenues should include hosting services, engineering salaries, and other salaries that directly work with customers as opposed to just operations overall

CAC Ratio

Sales & Marketing Expenses / New ARR + Upsell ARR

Your CAC ratio tells you how much sales & marketing spend it takes to generate every incremental dollar of ARR of revenue either by new customer acquisition or by upsells

A CAC ratio of less than 1 is the goal

Operating Leverage

% Change in Operating Profit / % Change in Revenue

Degree of operating leverage shows you how much of every dollar of revenue or ARR is converting into profit based on your fixed and variable cost percentages

Typically, a company with a higher value of operating leverage is expected to have an increase in profitability with an increase in revenue, as higher revenue. On the other hand, a company with a lower value of operating leverage experiences little to no change in its profitability with an increase in revenue.

However, it is important to note that a company with high operating leverage is exposed to the risk of financial losses in case of a significant decline in revenue as a large portion of the cost structure is fixed in nature

Big Bets = Big Luck?

Placing big bets in life, investments, etc, is not often talked about

One of the most common similarities I see when talking to people is the the people who typically take big bets in their life also take big bets in markets

The people who play it safe and diversify in life almost always do the same in their life as well

I dig some digging on placing big bets across markets to try and understand which really is better

Here's what I found:

Stan Druckenmiller lost $3 billion in 6 weeks on one trade in the dotcom bubble

When asked what he learned?

“I didn’t learn anything. I already knew I wasn’t supposed to do that I was an emotional basket case and couldn’t help myself”

Some big name examples 👇

Stan is worth $5.6 billion and has returned 30%+ for DECADES

That’s not just hard it’s almost impossible

Peter Lynch even said you can make a lot of money being right 6/10 times

Peter Lynch averaged a return of 29.2% for his clients over decade plus

So what’s the best route then? Diversify or “bet big when you have conviction”

I explore 👇

Stan Druckenmiller: “I think diversification and all the stuff they're teaching at business school today is probably the most misguided concept everywhere”

Disney

Disney is a widely successful company by all accounts

Disney also went bankrupt

Disney produced hundreds of films that lost them a TON of $

What changed? Snow White and the 7 Dwarfs earned $8 million in 1938 and transformed Disney

So was Disney lucky or did they shoot a lot of shots and get luck on their side?

VC funds

The Disney approach reminds me a lot of VC funds

VC funds know that almost all of their investments will fail

They don’t care. They know that if 1-2 of them hit it will generate enough return to cover all of their losses AND generate a return

Again.. Taking a lot of bets and one hitting big

George Soros

George Soros took a large bet against the Bank of England in 1992 taking positions against the british pound

The result?

George Soros made $1.5bn on the trade

He had conviction, and placed a very large bet

Warren Buffett

Nobody can deny Buffett’s success. However, even his partner Charlie Munger stated that if you removed some of their largest successes their returns would be modest at best

Warren Buffett paid $2.35bn for Geico. His profit (without dividends) on the trade?

$41.6bn PROFIT. He made a return of 48,000+%

Chris Rock

Everybody who has seen his stand-up can admit he is hilarious

But most people don’t know before he goes to large venues to perform he goes to a ton of smaller venues and practices his jokes

He uses this to figure out what will hit with bigger crowds and what won’t

He places a lot of bet’s, then narrows it down

Netflix

Netflix CEO Reed Hastings said “our hit ratio is way too low. I am always pushing our content team. We have to take more risk and try more crazy things”

They fail a lot and place a lot of bets

Amazon

Amazon had an absolute DUD with the fire phone

Amazon probably has countless ideas that fail every year

Amazon Web Services didn’t fail and that one good idea can change everything

Is it luck or skill?

I think it’s both

“Tails drive everything” - Morgan Housel

If you think about a standard distribution, the outermost points are called “tails”

Tail risk: Tail risk is risk that arises when the possibility that an investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution

My opinion after reading all of these and doing some thinking myself is you don’t know how much is look and how much is skill

But placing big bets where you have skill and high conviction I believe can ultimately be what creates the impression of luck

- Dev

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.