This interview is taken from an episode of the Spend Culture Stories podcast. In this episode, Barry Jahansetan, CFO consultant for late stage SaaS startups, shares his learnings for what a SaaS startup needs to know before going public, including the top KPIs to take note of, when to implement technological tools, and how to scale your finance leadership team to get IPO ready.
About the Podcast:
Your company culture might attract talent, but your Spend Culture will make or break your company. Spend Culture Stories is a podcast that helps finance leaders learn the tactics, strategies, and processes to build a proactive Spend Culture. Learn how to pick the right tools, implement the most efficient processes, and how to develop the right people to transform the Spend Culture of your organization for the better.
Preparing to Take Your Late Stage SaaS Company Public
Barry Jahansetan is a seasoned CFO veteran and SaaS expert who has held the position of CFO for numerous fast-growing companies in the U.S.
Barry started his career auditing large multinationals like Prudential Financial, before working as a financial analyst at Oracle. After that, he joined his first IPO company called Castelle who went public in the mid-1990s. Shortly following, he was instrumental in the scaling and growth of many successful companies who eventually IPOed, as well as being well versed in mergers and acquisitions. Under his leadership, he’s prepared four exits, two being over $100M. Barry is very passionate about helping late stage SaaS startups drive better business decisions and building rigid financial plans that work.
In this episode, Barry Jahansetan shares his learnings for what a SaaS startup needs to know before going public, including the top KPIs to take note of, when to implement technological tools, and how to scale your finance leadership team to get IPO ready.
Speakers: Barry Jahansetan, Principal & Cofounder, The MRR Group
What kind of leadership a public company investor usually looks for when it comes to approaching an IPO?
A Strong Management Team That Can Accurately Describe Financial Performance
Barry Jahansetan[00:05:53] Public investors are looking for a management team that can accurately describe the current financial performance but also the future direction.
So, all of this comes back to this theme about predictability.
Predictability of a business is a key theme for public investors, because if the company’s performance is lumpy, that’s telling investors that the management team doesn’t know what to expect and is not in control of the results. And this will diminish valuation, you make investors skittish and diminish valuation and open the company’s stock price to volatility.
Investors are Looking for a Strong Leadership Team to Be Stewards of Their Investments
Barry Jahansetan [00:08:31] So, that’s a key part of the leadership team and work can be done prior to the IPO to create trust and respect with public investors. But of course, apart from the CEO and the CFO, investors are looking for a strong leadership in product, in sales, in marketing, to manage an ever growing revenue base to come out with new features and new products. Investors in general, they want to have good stewards of their investments.
So, that strong leadership team is key. And, of course, public investors, investors in general, they want to have good stewards of their investments.
And the leadership team, again, it goes back to the CEO and the CFO, need to really understand, they need to prove to these public investors that they really understand, deeply understand the business of the company. So, hopefully that gives you some perspective.
The Guidelines and Metrics VCs Care About
Barry Jahansetan [00:10:39] So, there are guidelines around growth. So, in terms of what is the role of the CFO in terms of the company itself in the SaaS world, there are certain guidelines, key guidelines and yardsticks that you have to follow.
So, of course, growth and getting to scale is really key for any company that wants to go public.
Mendoza Line of Growth
Barry Jahansetan [00:11:03] So, in terms of growth, there is a guideline called the Mendoza line of growth. And basically what it tells companies’ CFOs, CEOs is that after we get to ten million dollars of what is called ARR, Annual Recurring Revenue, every year, typically you’re going to grow between 80 to 85 percent of the prior year.
So, the top tier of SaaS, cloud, subscription–based companies, based on this formula, get to two hundred million dollars of ARR within five years, that’s the top tier.
Velocity – How Fast Revenue Is Growing
Barry Jahansetan [00:11:44] And with SaaS or with any business, it‘s not so much the revenue milestones that you’re going to meet, it is the velocity, how fast your revenue is growing, which affects your valuation.
Because as a VC, as a private equity investor, even as a public investor, you are looking at the internal rate of return. You’re looking at the return on investments.
So, how fast you grow is really key in SaaS, in any business. In fact, McKinsey did a study of public companies and found that the effect of growing your revenue is twice as much on your valuation, than the effect of growing your margins.
Barry Jahansetan[00:12:28] In the SaaS world, in terms of SaaS public companies, every one percent increase in net retention, so net retention in the SaaS language is how much are you expanding your revenue from the existing base less any revenue that you lose to Churn to lost customers. That’s called net retention.
The public SaaS companies, every one percent improvement, you can make in your net retention, that increases your valuation by hundred million dollars. And this was fromBessemer. So, this is studied at Bessemer, a famous VC in the valley.
Barry Jahansetan[00:13:57] Another key thing in getting ready to go public is public investors, of course, they’re going to look at your market opportunity. And of course, they want to find companies that have open and huge TAM, (total available markets).
Because if a company has a huge TAM, even if the company penetrates a relatively small portion of that TAM, still the company can become a franchise. So, TAM is very important in terms of how public company investors look at a prospective IPO.
Barry Jahansetan[00:14:39]Also the competitive landscape.If there are low barriers to entry, and if there are many companies, many competitors in your space, that is a big negative,unless perhaps you have been able to build a Moat, like through a network effect, or perhaps you are somebody like Workday and you’re taking out a dominant player like Oracle.
So that, of course, you know, comes into two, but also your products. In terms of your product, the public investors don’t want to invest in one phony kind of product company.
Cash and Profitability
Barry Jahansetan [00:16:25] In terms of another theme that the CFO, of course, has to be thinking about is cash and the public investors look at this cash and profitability.
So, public investors at IPO, they expect the company to have sufficient cash on its balance sheets to get to breakeven within a year or two without any of their IPO money. And I say a year or two, depending on market conditions whether it’s a risk–on or risk–off kind of market.
The IPO capital raised the way investors look at that is as a reserve or perhaps capital to increase growth and revenues. But the company needs a sufficient cash to get to breakeven.
Public company investors are looking for a self–sustaining business. The last thing you want to do when you go public is to go back to public markets and try to raise additional capital. That’s going to be a disaster. Right?
What is The ASC 606 and How Does it Affect Businesses?
Barry Jahansetan [00:17:34] And, of course, I said cash and also profitability. So, you may have heard, I‘m sure your audience has heard of the latest revenue recognition pronouncement, ASC 606.
Basically, for such businesses, it accounts for mismatches which is innate in a SaaS business when it comes to upfront sales and marketing expenses, and the time of delivery of services. It accounts for that.
Barry Jahansetan [00:18:07] So, for instance, you can amortize your sales commissions over the term of a subscription contract versus your expenses getting hit when you pay those commissions as an example.
The Forty Percent Rule
Barry Jahansetan [00:18:47] Another really important rule for SaaS companies is called the 40 percent rule, which means, at any point in time, if you add up how much your revenues are growing and how much you’re losing as EBITDA, when you add those two numbers up is forty percent.
So, basically, you can be growing your revenues at 100 percent and you could be losing sixty percent in EBITDA. And you’re within these guidelines.
And as you know, a lot of SaaS companies that go public, around hundred million dollars, they are still losing money. They have great, perhaps top line revenue growth but their earnings margins are weak.
And that’s one of the reasons in the SaaS world and public investors have the same expectation, we measure unit economics because the earnings margins are not there and the company is losing money,.
Cash and Profitability
Barry Jahansetan [00:16:25] In terms of another theme that the CFO, of course, has to be thinking about is cash and the public investors look at cash and profitability.
So, public investors at IPO, they expect the company to have sufficient cash on its balance sheets to get to breakeven within a year or two without any of their IPO money. And I say a year or two, depending on market conditions whether it’s a risk-on or risk-off kind of market.
The IPO capital raised the way investors look at that is as a reserve or perhaps a pool of capital to increase growth and revenues. But the company needs a sufficient cash to get to breakeven.
How can you manage growing expenses when you are scaling?
Of course, there’s always systems that you can use when you’re starting out to approve expenses, but eventually, you can also look into more elaborate systems like [Procurify] where somebody like myself or managers can approve expenses right before the employee goes out and spends the money.
Barry Jahansetan[00:36:23]Obviously, there are planning, budgeting systems. Having a strong budgetary systems, like Adaptive Insights is also key in terms of managing your expenses.
What Other Tips Do You Want to Give to Scaling SaaS Companies?
Do a Three-Year Strategic Plan with Management Team
Barry Jahansetan[00:36:44] To me, it’s really key to do a three–year strategic plan with the management team versus building out an operating plan by myself, or without having thought about, okay, what were the lessons learned in the previous year.
If we want to get to hundred million dollars of revenue in 3 years, what would that mean in terms of our average contract size? What would that mean in terms of our marketing expense? What would that mean in terms of the money we have to put into our product roadmap?
So, I always do a three-year strategic plan before really jumping into the numbers in terms of an operating plan. So, I think doing, spending the time upfront to think through, yes, we want to get to hundred million dollars of revenue but flushing that out, what are the costs, expenses for us to get there?
Having the Right Budgeting and ERP Systems
Barry Jahansetan [00:37:44] And having the right systems like a spending management system like Procurify, like a good budgeting system, like a good ERP system, like Intacct or NetSuite are key, of course.
How Can Companies Encourage a More Healthy, Proactive Spend Culture?
Recording Standard Processes Through an Employee Handbook
Barry Jahansetan [00:40:47] And then, of course, you know you need to start as the company grows and I’m a big believer in policies, maybe let’s say, the employee handbook.
I think a lot of smaller startups don’t spend the time to build their employee handbook which can be a very simple, really a management team kind of exercise whenever the company basically talks about the policies, like when an employee is travelling, this is our policy.
In the employee handbook, you can talk about your philosophy that, hey, we want to put our money into the health plans, the health insurance for employees versus perhaps throwing expensive Christmas parties.
Spend Culture and Communication with Employees
Barry Jahansetan [00:41:30] So, at the core of this is the company culture and the truths are and number one is communication with the employees. I think the employee handbook,frequent company meetings where you’re communicating to the employees at a high level,your company’s performance in terms of not just the revenues but how you’re managing your expenses, I think is key.
And I know nowadays the employees want to be involved in this kind of decision–making in terms of how much you have to spend. So, to grow this much, these are the investments you have to make to grow lower or higher the different levels of spending.