Metrics that matter: What tech investors are looking for? (Part 2)

In our last article, we revealed four of the key metrics that investors use to evaluate software businesses. We focused on Annual Recurring Revenue (ARR), ARR Growth Rate, Gross and Net Revenue Retention, and Gross Margin. These indicators are often the first place investors look when assessing the strength and potential of a SaaS or software business. 

This month, we’re wrapping up the series with three additional metrics that are just as critical, especially for businesses looking to scale, raise capital or attract a premium valuation.  

If you missed Part 1, you can read it here.

1. EBITDA Margin 

You’re probably familiar with this one, but it bears repeating. If you’re EBITDA positive as a software business, you’re usually either at or very close to the point of being cashflow break-even. From an investor perspective, this means you’ve probably reached the point where you’re funding yourself off your customers’ money rather than your investors’, and are unlikely to need to go need more capital unless it’s to supercharge growth. In an ideal scenario you should target a 40% EBITDA margin, particularly if you’ve hit scale, but running at low or even at a negative EBITDA margin can sometimes be ok if it is resulting in rapid growth.  

Sacrificing profit for growth has become less attractive of late, so even if you are chasing growth, it’s important to show you can quickly pivot to cashflow generation if needed. Consider creating a view of your P&L for potential investors that shows the “optional” R&D and sales and marketing spend that is chasing growth vs what is required to deliver on existing commitments, so they can see the underlying profitability of the business. 

2. Rule of 40

The rule of 40 has become a popular shorthand for investors trying to determine whether growth is sustainable. This metric is the sum of your revenue growth rate and EBITDA margin – i.e. if the business is growing at 15% per annum and generating a 30% EBITDA margin, the rule of 40 score is 45%. The rule of thumb has been that investors will look for a score of 40% or better, but this metric is only useful for software businesses that are already at scale – an early-stage business that’s doing well will often have a rule of 40 score of 75% or more as the company chases initial scale. 

3. LTV/CAC (Lifetime Value to Customer Acquisition Cost)

LTV / CAC shows an investor how efficient and effective your sales team is. This metric is the average lifetime value of a customer compared to what you spend to acquire them. This metric is a bit more challenging to calculate (and there are a few ways people do it) but as a simple example:  

• Assume your margin per customer is $10k, your churn rate is 5%, your sales & marketing expenses is $1m, and you acquire 20 customers in a period  
• LTV = gross margin per customer / churn rate, so $10k / 5% = $200k 
• CAC = sales & marketing expense / number of customers acquired, so $1m / 20 = $50k 
• LTV / CAC = $200k / $50k = 4x 

A higher number is usually better but be careful of over-optimising. An LTV / CAC that’s greater than 5 may signal to investors that either the revenue is extremely sticky, or more likely, that you’ve underinvested in sales and have left growth on the table. Aiming for 3-5x LTV / CAC usually indicates a business is creating value while not ignoring growth. 

Final thoughts – management of metrics is most important 

While this series of articles has covered off what metrics investors often look for and why they matter, we’ve left the most important piece until last: While the metrics do matter, and how you present your business in relation to them can have a very meaningful impact on pricing, the most important thing to investors will generally be how you use them.  

A great way of showing that you’re aligned is how you use the metrics day to day. Don’t just calculate them as you get ready to speak to investors and memorise them for a pitch – start measuring them now and, importantly, use them to measure and course correct the business as a normal management practice.  

If you’re considering bringing new investors into your business, looking to sell down (partially or completely) or just want to benchmark your business against what investors are looking for, reach out to Luke Harwood for a confidential discussion.