Part 1: ARR Analysis - GTM Data Points You Need to Know Before Your Next Funding Round
This blog post series is to help with what kind of Go-To-Market metrics you should have in hand for potential investors or to monitor your business as a whole.
After leading 40+ SaaS M&A business diligence deals, I learned a lot about the standard metrics, analysis, and questions that investors ask. I have had to represent investors numerous times and question a business management team about their numbers and what caused them to be good or bad regarding business activity.
I will review the ARR analysis in the 1st part of this series.
ARR stands for Annual Recurring Revenue. ARR represents the money that comes in every year for the life of a subscription (or contract). More specifically, ARR is the value of the recurring revenue of subscriptions normalized for a single calendar year.
Usually, investors will ask for an ARR Analysis 1st during the diligence process to get a good foundation on the business. If this has any holes, you will get way too many questions from potential investors and could bring your valuation down or even risk not getting any investment at all.
What is in an ARR Analysis?
First, you will have to complete your ARR waterfall with the changes that have occurred to get to the ending ARR for a period, quarterly and yearly. An ARR waterfall is foundational, and investors will leverage it to understand business growth and the general pulse of the business from a GTM perspective.
Some potential waterfall components could be upsell, down-sell, cross-sell, new, churn, and product churn (churn in a product but still a current customer in another product).
What are the metrics you can calculate with your ARR waterfall?
Net Retention Rate (NRR)
NRR is a crucial metric for SaaS companies because it demonstrates the ability to keep customers and grow revenue from existing customers. NRR indicates how well a company can not only renew but generate additional revenue from its customers, "Expand and Land." NRR is also an essential component of profitability. Acquiring a new customer can be 5 - 25 times more costly than retaining an existing customer. Keeping and expanding your existing customers reduces your Customer Acquisition Cost (CAC), thus increasing your profitability in the long run.
To calculate NRR, take the recurring revenue from your current customer base, subtract any down-sell & churn, and add cross-sell & upsell. Then, divide that number by the previous period's ARR.
NRR = (Previous Period ARR + Upsell ARR + Cross-Sell ARR - Down-Sell ARR - Churn ARR) / Previous Period ARR
Best-in-class SaaS companies usually have an NRR > 110%.
Gross Retention Rate (GRR)
GRR is the percentage of recurring revenue retained from existing customers in a defined period, including down-sell and churn. Upsell and cross-sell are not included in this. GRR is the representation of your success in retaining your existing customer ARR. A high GRR indicates that your offering represents a strong value proposition for your customers. This is sometimes referred to as having a "sticky" product.
To calculate GRR, take the recurring revenue from your current customer base and subtract any down-sell and churn. Then, divide that number by the previous period's ARR.
GRR = (Previous Period ARR - Down-Sell ARR - Churn ARR) / Previous Period ARR
Best-in-class SaaS companies usually have a GRR > 90%.
Net New ARR
Net New ARR is calculated by taking the total recurring revenue from new customers in a period and subtracting any down-sells & churn.
Net New ARR = (New ARR- Down-Sell ARR - Churn ARR)
This helps investors understand whether the business is delivering more new ARR than is being lost in down-sell and churn. It takes into consideration incremental revenue and contraction revenue at the same time.
From this, you can evaluate what aspects of your business are bringing in the new revenue and which ones are driving revenue away. If you notice New ARR bookings have decreased over time, it might be time to look at your sales and marketing efforts. If churn starts to rise, this is an indicator to reevaluate your product and/or customer success team and New ARR's inability to keep up with churn.
The goal is to have a positive Net New ARR added, meaning that the amount of churned ARR and down-sell ARR is not outdoing New ARR.
Net Expansion ARR
Net Expansion ARR is calculated by taking the total recurring revenue from Upsell and Cross-Sell in a period and subtracting any down-sells & churn. Another way to understand the "Land and Expand" trend in the business.
Net Expansion ARR = (Upsell ARR + Cross-Sell - Down-Sell ARR - Churn ARR)
This helps investors understand if your product(s) are sticky enough and if you could grow your customers' share of wallet. I usually like to look at this metric with NRR as it helps me understand why Net Expansion ARR is low and what could have caused it. It could have declined because of a large down-sell in a period or for some other reason, but you can further investigate those reasons by looking at other metrics.
The goal is to have a positive Net Expansion ARR, meaning that the amount of churned ARR and down-sell ARR is not outdoing upsell and cross-sell ARR.
Also, you should see exponential growth over time in this metric as it should be easier to expand on current customers rather than bring in new customers. The biggest reason why investors love SaaS or subscription-based businesses is the expansion of existing customers can be a significant factor.
ARR Growth Rate
The ARR growth rate is calculated by dividing the current period ARR and dividing it by the ARR of the previous period and then subtracting 1. This metric helps investors understand how quickly you are growing your recurring revenue.
ARR Growth Rate = (Current Period ARR/Previous Period ARR)-1
The goal is to have a positive ARR growth rate, meaning that your business is growing, and the higher the number with consistency over time, the better it looks in the eyes of investors.
The ARR Growth Rate is also important to track because it will give you an idea if you need to increase or decrease your sales and marketing efforts. If this number starts to decline, it might be time to look into your go-to-market strategy and see what needs to be changed.
This metric is often overlayed with GM% and other profitability metrics to ensure growth and profitability are aligned and balanced for long-term success of the business.
