Whether you are an Investor or an Entrepreneur in the Software as a Service –SaaS sector, one critical piece of information to inform the valuation of a company is the benchmark multiple from publicly traded companies. Behind the accepted methodologies for defining the valuation of a SaaS Startup and for evaluating the health of Saas Companies, we find two key indicators: The Rule of 40 and Net Revenue Retention.
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The Rule of 40
The Rule of 40 is a SaaS financial ratio combining revenue growth and profitability. It’s an at-a-glance look at the performance of a SaaS Company. The agreement from experts, based on the analysis of thousands of successful SaaS companies, states that a healthy SaaS company has a combined growth rate and profit margin of 40% or more.
Sacrificing profitability for growth is a proven SaaS startup strategy. But that doesn’t mean unsustainable growth at all costs.
The SaaS Rule of 40 gives you a benchmark to drive growth sustainably. Knowing how to calculate it helps you measure the health of your SaaS business and maximize valuation.
By combining growth rate and profit margin, the Rule of 40 is a great indicator for emerging and established SaaS Companies. If a business is not growing fast but is profitable, it is as good as a business growing super fast but still unprofitable.
Net Revenue Retention
Net revenue retention (NRR), also called Net Dollar Retention (NDR), is a metric that compares the revenue earned when a customer signed up to the revenue earned from a customer in the current period. It accounts for lost revenue from customer churn or downgrades and any increases in total revenue (annual recurring revenue or monthly recurring revenue) over a set period.
NRR is an essential metric for SaaS companies because it shows whether or not your product has value for your current customers and whether or not they’re happy advocates.
On average is ten times more expensive to acquire a new customer than to retain or upsell an existing customer; hence Net revenue Retention, combined with the Rule of 40, give you a robust assessment of the financial health of your SaaS startup.
You can see how the Rule of 40 and Net Revenue Retention are used to calculate the valuation of a SaaS company by visiting our Free Online Calculator to Define the Valuation of a SaaS Company.
Rule of 40 and Net Revenue Retention –NRR Calculation and Benchmark
This calculator, updated continuously, shows data from the US’s Top 50 Public SaaS Companies. We excluded companies such as Microsoft (MSFT), Google (GOOGL), Amazon (AMZN), and Apple (APPL), as those companies generate a large amount of their income from non-SaaS-related sources. We also excluded Telecom and Tech-enabled Services Companies. It also includes benchmark data from a representative sample of SaaS Startups in the US.
Rule of 40 and NRR formulas
Net Revenue Retention Formula for a Given Cohort of Customers
NRR = ARR1 + (ARR2-ARR1) / ARR1
Rule of 40
Rule of 40 = (Year2 Revenue – Year1 Revenue)/Year1 Revenue) + (Profit Before Taxes in Year2 / Year2 Revenue)