4 Quick Steps to a SaaS Startup Financial Model
How can you tell if your startup is going to be successful? If you are a startup founder working on your idea full time, you have probably found yourself agonizing over this question more than once. The following guide might help you lift the curtain ever so slightly by letting you figure out how to build a simple forecast that will outline your company's expected Profit & Loss Statements alongside metrics like LTV and CAC. If you're already familiar with these concepts, scroll down straight to implementation. Otherwise, read along for additional background.
There are several ways to help you gauge how successful your company might end up.
One is simply by looking around. How impressive and hardworking are the people on your team? Are they executing on your company's vision day in and day out? When analyzing investment opportunities, many VCs will start with the team. If you've been to a pitch meeting, you've heard a partner ask "First, tell us about who's on your team." Truly, a great team is like an awesome foundation on which you can build anything you can imagine.
Another way to gauge your expected success is by looking at your product. If you're creating something truly exciting that a lot of people are asking for, odds are you are going to do well. There's no escaping building a great product if you're planning to build a great company.
While the first two dimension of what makes a successful startup are commonly addressed, there is one more that in my view is just as crucial but is still often overlooked.
And that is startup economics.
What we mean when we talk about economics is really the metrics that help us understand whether your company is going to make any money. Another way to look at is in the words of David Skok:
There are two metrics that are often used to answer this question: CAC and LTV.
- CAC = Customer Acquisition Cost
- At its simplest, customer acquisition cost is the total amount of dollars you have spent on sales and marketing in a given period divided by the total amount of new customers in that same period.
- LTV = Lifetime Value (of a Customer)
- Lifetime value of a customer tells you, on average, how much gross profit (revenue net of cost of goods sold) a customer is going to generate for your company before they churn.
There is a wealth of information on calculating CAC and LTC. If you'd like to dive into the math behind each of the metrics and learn about different approaches to calculating them, you can look here and here.
VCs tend to think about startups in terms of ratios as those provide an easy way to benchmark one company against another. While every company is different and as a result this sort of benchmarking becomes imprecise, it still gives both an investor and entrepreneur a starting point for a more detailed discussion of what's behind the numbers.
When it comes to SaaS metrics, LTV-to-CAC ratio is usually the one discussed most frequently.
There is no clear understanding for what is the ideal LTV/CAC ratio but most VCs will tell you that it should be above 3x. LTV/CAC of 3x roughly means that you make 3 times the money it costs you to acquire a user. This is a very vague benchmark and I know countless businesses that got funded at economics much worse than LTV/CAC of 3x.
However, if at this stage you are planning out how your business is going to operate and you find out that your projected LTV/CAC is near 0, it means that something is off with your thinking. Either your price needs to go up or your conversion rate needs to increase or some other assumption needs tweaking. Do keep in mind that your calculations also need to be grounded in reality, which means you need to trace your high-level thinking to real-world analysis.
To model out a good understanding for your LTV and CAC metrics you'd normally need to build a simple financial model. This can sometimes take a couple of hours if you're planning to do it in Excel or Google Sheets from scratch. The following guide uses a simple tool we've built at Finfox. We code-named it "How much cash?" because at its most basic it will tell you how much cash your company is going to burn and how much cash it's going to generate.
If you have any questions or suggestions while going through the steps below, shoot me an email to email@example.com and I'll make sure to get back to you quickly.
By the way, here's an example of what your financial model is going to look like once you're done building it with the 4 steps I outline below.
The whole process is pretty intuitive so you can just jump right in at this link and then come back to this guide later for a more in-depth reference.
4 Steps to your SaaS Startup Financial Model
Step 1: Revenue model
First of all, navigate straight to our financial model builder right here. After filling out your company name and email (email will come in handy later on when you'd want to keep track of models you created on our dashboard).
Monthly subscription price:
- This will tell us how much money you're planning to charge for your product per customer per month. Try to be realistic when you think about pricing but keep in mind this is something you will be able to adjust in your model later on after everything else is finished.
Monthly subscriber churn:
- This tells you what percentage of your user-base is going to churn every month. If you're not sure what's your churn rate, you can use 5% as a benchmark for a new startup although beware it's not going be sustainable in the long-run.
Step 2: Customer acquisition
For simplicity's sake, we are going to assume that we will only employ online advertising and content marketing as user acquisition channels. I realize this is not the entire list of available options as it excludes referrals, direct sales, and organic growth but let me know if these are the ones you tend to rely on and I'll quickly add them in the next update. Feel free to recommend what acquisition channels you use via firstname.lastname@example.org.
A. Online ads
Here's where we model out in our ad campaign.
Monthly campaign spend:
- This is the total amount of cash you plan to spend on an advertising campaign every month (this can be Google AdWords, Facebook, or any other platform). This is a pretty important number because it's going to determine how quickly you're going to attempt to grow and thus how quickly you're going to burn cash while doing that. But don't stress too much--if later on you realize you're not spending enough or spending too little, you're still going to be able to adjust that number right in your financial model.
Monthly % increase in advertising spend:
- This tells us whether your campaign expense is going to grow over time. If not, just enter a "0."
Cost per click:
- This number is going to depend on what you're targeting and on what platform. It's a highly case-by-case calculation, but for Google AdWords we can refer to this guide that provides us with some recent trends by industry. For example, if you're in finance & insurance, you'll notice that the guide suggests a (somewhat understated) CPC of $3.72.
- Equally as important is your expected conversion rate. This is something that's best gauged based on your prior experience. However, you can also refer to this guide if you're not sure where to start. The guide suggests a conversion rate of 7.19% for finance & insurance (which is probably somewhat high).
Month when campaign begins/ends:
- I recommend planning to run the campaign for the entire 12 months of the available forecasting period just to get a sense of how your company might perform in "steady state." But if you think you can get by with just a few months of campaigning, feel free to limit it to the time span you think is appropriate.
B. Content marketing
What is content marketing? I am going to get very meta and say that content marketing is essentially this, an article you are reading right now that helps you to solve a problem but also lets you know about a cool new product (by the way go ahead and learn about Finfox :). Modeling your content marketing efforts is fairly simple but getting to the right assumptions might be challenging so make sure not to overestimate on the content marketing channel.
New monthly site visits from content marketing:
- On average, how many people do you think will come to visit your blog and read the engaging content you have painstakingly written?
% Monthly increase in site visits (virality):
- Are people linking to your blog? Are your readers telling others about your content? This is an estimation of how quickly your readership is going to grow month to month.
% Content marketing conversion rate:
- This tells you how many visitors to your blog turn to paying users. Normally you get a lot of different visitors but only few of them might be interested in your product, so assume a conservative number here like 0.5%.
Monthly content marketing spend:
- Do you need to pay someone to help with your content? Are you using freelancers? If so, here's where you can incorporate that monthly cost.
Step 3: Operating expenses
Here's where you can tell the model about some of the expenses you're going to incur in the process of running your business. Note that we will add payroll in Step 4.
Monthly cost to service a customer:
- This is a very important variable because it is going to determine your gross margins which in turn will have a substantial impact on your LTV calculation. So pay attention to this one. If your SaaS business relies heavily on manual labor (like InDinero or Bench do, for example) this where you need to be realistic about how much you'll need to spend on each customer. Other costs tend to include hosting, customer service, and technical support.
- This should be pretty self explanatory but in case you don't have an office yet, a hot desk at WeWork can run you as little as $220 per month.
Other monthly costs:
- Anything goes here. Do you need to take lots of Ubers? Do you buy your co-workers lunch? Do you pay for other SaaS services like HubSpot, Salesforce, and G Suite? You can sum them up here.
Step 4: Employee details
Odds are you will need to work with other people if you're planning to make this a successful business. So here's where you can incorporate your hiring plan.
Employee annual salary:
- Keep in mind that taxes are not directly included here but feel free to incorporate them by simply adding the annualized employer tax expense per employee to the baseline salary. Same thing for benefits.
Employee start month:
- This allows you to make a hiring plan if you expect to hire new employees at future points in time. If you want to include employees who work for you already (including yourself), simply pick "1" as the start month.
Remove / add employee:
- This allows you to grow your headcount by as much as you think you might need.
Putting it all together and tweaking, tweaking, tweaking
Once you click "Submit" you will see a spinning wheel which means you were able to successfully submit your data. This is great! You're about to get your new financial model.
At this point you will be able to see how much cash your business is going to need to operate according with your assumptions. In other words, this will show you your total fundraising need for the next 12 months. In some cases, this number might be positive, meaning you will be generating positive cash flows from day one. However, this is pretty rare (otherwise venture capital industry would have gone obsolete by now). Plan to check your assumptions to make sure everything makes sense. If it does make sense, then congrats! You might be on your way to launching a cash printing press.
Most likely, your model needs tweaking. And that is fine, it is impossible to get it right from the first try. But worry not, you are going to be able to access a Google Sheet where you would be able to revisit and tweak your assumptions as much as you want. So go ahead and complete the registration to see a link to your financial model.
Once you spend enough time exploring the model and looking at the outputs (especially your LTC/CAC ratio and Cash Balance), navigate to the sheet that's called "Assumptions" where you will find all of the data you supplied previously. Feel free to change these as much as you want and don't be afraid to break the model--you will always be available to create a new for free and store both copies in your Finfox dashboard.
One piece of advice to take away from this exercise is that any financial model, no matter how good it is, is a prediction about the future and no one can tell what the future is going to be like. While your financial model may or may not turn out to be an accurate reflection of the future, treat is as a tool to help you understand the present and to work through the logic of what needs to align today (i.e. churn rates, pricing, etc) in order to make your company successful going forward.
Thanks for reading and let me know if you have any questions or advice! I can always be reached at email@example.com.