Customer Success — The Correlation between Customer Success and Exit Valuation
“Start with the customer and work backwards.” -Jeff Bezos
While continuously acquiring new customers should certainly be part of your high growth plan, an even more important part of your high growth plan should be to retain your customers. Remember: The more you grow your business the more revenues will come from your existing customer base!
If you run a Software-as-a-Service (SaaS) business, you need to ensure that customers renew their contracts, buy more and do not churn. Aspire low customer churn (also called logo churn) and net negative MRR churn, which means that your expansion MRR (MRR deriving from up- and cross-sell activities) exceed the sum of churn MRR and contraction MRR (e.g. downgrades). If you pursue a transactional platform business model, you must ensure your customers return and transact on your platform. Aspire high GMV retention rates and net revenue retention rates across cohorts.
If customers churn or if customers do not return to your platform in order to transact, you lose out not only on the full customer potential in terms of the customer lifetime value but also on your growth and exit valuation potential. The impact churn, up- and cross-sell and referrals can have on your company growth and your exit valuation is shown in the chart below*:
The chart shows the impact of churn, expansion and referrals on the growth and exit valuation potential of a hypothetical SaaS company. This company “starts” in month 0 with €500,000 in monthly recurring revenues (MRR) and correspondingly €6,000,000 in annual recurring revenues (ARR). Each month, this company spends €50,000 on sales and marketing and acquires 50 new customers each generating €1,000 new MRR (in total €50,000 new business MRR per month).
- The green line reflects the growth of a company that loses 4% of its customer base each month. You can see that an unhealthy 4% monthly customer churn rate quickly leads to a flattening of the growth curve, because the monthly MRR churn coming from churning customers almost completely eats up new business MRR (the bigger the MRR base the bigger the MRR churn and the more MRR you need to acquire to make up for MRR churn). Correspondingly, this company ends up with only €2,000 in net new MRR in month 72 (new business MRR plus expansion MRR minus MRR churn minus MRR contraction), annual recurring revenues (ARR) of €14,500,000 and an exit valuation of approx. €72,000,000.
- Even if the same company managed to achieve a monthly 2% MRR up-sell rate, the high monthly customer churn rate of 4% would diminish the growth potential. This company ends up with €10,000 in net new MRR in month 72, annual recurring revenues (ARR) of €24,000,000 and an exit valuation of approx. €120,000,000.
- The orange line reflects a base case in which the company cannot prevent that some customers churn (1% logo churn) but cannot up- and cross-sell either. This company ends up with €22,000 in net new MRR in month 72, annual recurring revenues (ARR) of €34,000,000 and an exit valuation of approx. €170,000,000.
- The yellow line reflects a good case scenario in which the company cannot prevent that some customers churn (1% logo churn) but is able to achieve a monthly up- and cross-sell rate of 1%. The company achieves approx. €40,000 in net new MRR in month 72, annual recurring revenues of €50,000,000 and an exit valuation of €250,000,000.
- And finally, the blue line demonstrates the growth and exit potential of a hypothetical SaaS company that shows churn, up- and cross-sell and referral rates seen at some of the companies that have become unicorns. 1% is the magic number you should remember. 1% monthly logo churn rate, 1% monthly up- and cross-sell rate and a 1% referral rate (meaning that on a monthly basis new customers can be added representing 1% of the customer base). This company achieves monthly net new MRR of €90,000 in month 72, annual recurring revenues of €70,000,000 and an exit valuation of €350,000,000.
This simplified example demonstrates that the long-term health of your company, your growth trajectory and your exit valuation potential depend on achieving low customer churn, net negative MRR churn and a compelling referral rate. If you run a platform business model, the same holds true for achieving high GMV retention rates across cohorts and high referral rates.
As a side note, referrals do also reduce your average customer acquisition costs and therefore also your CAC payback period, i.e. the number of months until your customer acquisition costs have been recouped. Since some customers can be acquired irrespective of your marketing and sales spend, the referrals lead to more new customers, thereby reducing the average customer acquisition costs.
Moreover, the earlier you can recoup your customer acquisition costs, the earlier you can reinvest the respective amount in order to acquire new customers. Referrals therefore lead to higher growth, lower customer acquisition costs, shorter payback periods and ultimately less funding need and less dilution for you as the founder (more exit proceeds for you).
KEY FOUNDER TAKEAWAYS
With a company-wide focus on customer success you can achieve your growth and exit valuation goals. If you make your customers incredibly successful (great RoI and great CX), they will churn less, buy more and spread the word. Referrals will further reduce customer acquisition costs and CAC payback period. You recoup your investments quicker and can reinvest the money again in order to further fuel your growth engine. A virtuous cycle!
I will write about how to achieve customer success in a separate article. Stay tuned!
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*For simplicity reasons, I have chosen a 5x exit multiple on the annual recurring revenues in all scenarios. But it must be noted that the multiples will differ significantly in reality since the market will take into account the exit growth rate and growth potential. In fact, in reality the spread would be even wider.