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“Churn is the single most important metric in any recurring revenue business. That applies to enterprise, consumer, and SME”, said Mark MacLeod, Coach, Advisor and Investor, on SaaStock’s Dublin stage.
Just take a cohort of 100K of monthly recurring revenue, and look what happens to it over time at different churn rates.
If you’re churning at 5% a month, that very quickly goes down to nothing.
Whereas on the flip side, if you can have modest negative revenue churn, then you have a growing annuity.
Watch now:
That cohort just keeps growing in value in time, and that is when investors back up the Brinks truck and ask you how much money they can give you, because you have a really valuable asset.
Find out how to build a massive SaaS business selling to SMEs, from Mark. Watch the full video on our YouTube channel. You can also read the full transcript of this video below.👇
Transcript
Mark MacLeod
All right, good afternoon, everyone. So I’m here today to talk about scaling strategies for SaaS companies that sell to SME, so the small and midsize business market. I’ll do a very brief introduction to myself. I’m going to talk about the SME market, talk about the challenges in selling to SMEs, and some of the tactics that I’ve seen work over the years in selling to SMEs.
Okay, quick intro. My name’s Mark MacLeod. I’ve been in the venture backed startup world since the late 1990s. I spent 14 years as CFO for a number of VC backed startups, most notably Shopify and FreshBooks. I also spent three years as a general partner at Canada’s largest and most active seed stage venture fund where I was investing primarily in SME SaaS companies. You can’t tell from my accent, but I’m actually Scottish and I lived in Scotland for 11 years. So I’m really happy to be on this side of the pond again. I now run a company called SurePath Capital Partners, a boutique investment bank. We raise growth capital for companies. We exit companies. We have a very deep focus on SME SaaS companies. Our headquarters are in Toronto, Canada, and we have an office in San Francisco as well.
What I’ve seen over the years is that most of the buyers tend to be North American and the big outcomes from any part of the world at some point end up having U.S. institutional investors on the cap table. So that’s a big part of why I’m here. It’s not just for the Guinness. Just a couple of deals that we’ve closed. We’ve been closing about a deal a quarter. I won’t spend any time on that. I’ll get into SME. As I said, we have a really simple goal for our firm, which is to be the leading boutique investment bank to the global SME software market. We have very deep relationships with all the buyers of those companies and all the investors who look at those kinds of companies, and SME is the market that we love the most, which is a perfect segue into our talk. So let’s talk about SME. So this is U.S. data, but I think the breakdown here applies across geographies.
There are 30 million small businesses in the U.S. alone, 60 million in the English speaking countries, and 600 million globally. And as you can see, the vast majority of them, 91% in the U.S. anyway, tend to be pretty small, and that trend I think is similar across markets. We see a few trends that are driving. As I said, it’s already a massive market, as you can tell. 30 million businesses in the U.S. alone, but it’s actually growing a lot more in the coming years. And that’s why we’re really excited about this market. And it’s growing really for, I guess, a couple of macro trends that we see. One is a change in the nature of work. It’s increasingly rare for people to graduate from university and join some big company and go work there for the rest of their lives. People are wanting more meaning, more authenticity, more flexibility, and they’re choosing to work for themselves either in whole or in part.
The other is just a change in demographics. Again, I don’t have a European stat for this, but in the U.S., every single day, 10,000 people turn 65. That obviously spans, that’s not just entrepreneurs, that’s everyone, but what you’re seeing is that just a turnover in entrepreneurial demographics where older generations of entrepreneurs were very happy to run their businesses on pen and paper and Word and Excel, but the new generation, the people in this room absolutely will not. They’re going to look on their phone first, and if they don’t find what they like there, they’re going to look on their desktop browser. They’re going to find something and try it. And so whether it’s front office software or back office, we see just many, many categories of software that are going to go through big growth as a result of these two trends.
And the last thing I’ll say here is that unlike consumer and enterprise software, which tend to be winner takes all or winner takes most market dynamics, in SME software, it’s so fragmented that there’s always room for new players, and similarly, there’s always room to consolidate. Just one example. So prior to launching SurePath, I ran finance biz dev and corp dev for FreshBooks. We competed with Intuit. There’s 30 million small businesses in the U.S. Intuit had a three decade headstart, and they had seven million of those 30 million small businesses. So it’s not nothing, but it’s not the near monopoly that you see in other market segments. So that’s just a little bit overview of the SME market, and given that most of you in this room cater to that market, hopefully I was preaching to the choir there.
So let’s talk about some of the challenges that you see when catering to small businesses. This is from Jason Lemkin, Mr. SaaS(tr). He says that, “SMBs churn at a very high rate and so you’re usually forced to go up market finding larger customers. But if you can get the math to work, then that’s when the magic happens. And some of the biggest outcomes are in SMB.” So, that’s just setting the stage. Churn is the single most important metric in any recurring revenue business. That applies to enterprise, consumer, and SME. So this is just a really simple illustration of the impact of churn. Just take a cohort of 100K of monthly recurring revenue, and look what happens to it over time at different churn rates. If you’re churning at 5% a month, that very quickly goes down to nothing. Whereas on the flip side, if you can have modest negative revenue churn, then you have a growing annuity.
That cohort just keeps growing in value in time, and that is when investors back up the Brinks truck and ask you how much money they can give you, because you have a really valuable asset. This is what I’ve seen over the years in SMB. And here’s the thing, SMB incorporates, again, selling to freelancers and all the way up to 500 person businesses, but closer to the low end, more of the S than M. This is what I’ve seen work over time in terms of best in class unit economics, a two, two and a half percent logo churn, which equates to keeping a customer for about four years and where you pay no more than a quarter of that customer’s lifetime value on a fully loaded basis. So programs and sales and marketing bodies. So it gives you a 4X LTV to CAC ratio.
So let’s talk now about scaling strategies. These are seven strategies that I’ve seen work over time to really build a big company when you sell to SME. Product is super important, but most of the value in your startup’s journey will be created through distribution, through finding customers, through getting large amounts of revenue. And if you’re venture funded, your VCs often will push you to move up market and chase larger customers and higher ARPU. And the thing about SME is, if you can just tough it out and leverage one or more of these channels, then over time, you can build a really large business. So let’s go into each strategy. And I should mention, none of these are mutually exclusive obviously. It’s not like you pick one and that’s your strategy, but different strategies apply at either different stages in the company life cycle, different segments of the market, et cetera.
So the first one is to have a low cost of acquisition. That is usually driven by some viral loop. So companies that come to mind include Dropbox, where if you refer folks, you get more and more space. SurveyMonkey, MailChimp, you either fill out a survey or you receive an email newsletter and you think, “Hey, that’s a really cool tool. I’ll sign up.” Typeform is a more modern example of that. And what I’ve seen with these viral loop driven business models is they tend to have, there’s a period where it feels like it’s going super slow and then suddenly, boom, there’s this inflection point and it shoots up. And you see that with Dropbox user growth, where it was flat for a while, and then it just took off. And if I had a graph of LinkedIn’s network user base over time it would be the exact same pattern. So creating viral hooks in your product to turn recipients, users of your users into your users. That’s confusing. In any event, viral hooks is one strategy.
Second, and not unrelated, is freemium, and there’s two flavors of freemium. One is the product’s entirely free and it’s monetized indirectly, usually through advertisements. And then the second is where you have, again, a free base product but then there’s basically incentives. Those most engaged users are going to basically convert and become paid subscribers over time. Freemium was super hot a few years ago and then folks were like, “Hey, it’s actually really hard to make freemium work. I can’t get the math to work.” I still think it has a role to play, but there are certain prerequisites for freemium to work in my books. One, very, very large market. Second, the incremental cost to serve each of those free users is near zero. And third, a very differentiated upgrade path so that your most engaged users will just naturally become paid customers. So there’s lots of examples of companies to do that. Again, MailChimp, SurveyMonkey, DocSend, that’s here. Just a bunch of companies.
Strategy three, this is a busy slide, but cross-selling products. So the thinking here is you just tough it out for a bunch of years with one product and then get enough scale that you can either build products or buy other companies and get new products that you can cross sell to that same customer base. GoDaddy is the quintessential example and the largest probably pure SMB SaaS company that sells multiple products. You probably think of them as a domain name provider, but they do a whole bunch of other things. They are the largest reseller of Microsoft Office online globally. They have about seven different products that they resell. HubSpot was a one product company for a lot of its history, but then it had enough scale that it could build new products. It’s become an active acquirer now as well, and same thing for Zendesk.
So it’s not something you want to do when you’re just starting up because you don’t have the scale, you don’t have the resources. Not all of your customers on product one are going to buy product two so you need a big enough base that you can cross-sell. But over time, as you get bigger, cross-selling is a very viable strategy. Number four, build a channel. There’s only so far that direct response marketing goes before your incremental costs of inquiring that nth customer just becomes really high and starts to approach the lifetime value of that customer. And so you need to start thinking about building channels. And, again, if you do it really early, it’s probably tough because no one else wants to sell your product. It’s hard enough for you to sell your product. So not at the beginning, but more once your product is established, there’s clear product market fit, you’ve got some brand awareness. That’s when you start thinking about building a channel.
Again, HubSpot is an example here. They have agency partners who bring in about a third of their revenue and then the big accounting software guys like Xero. Xero’s main go to market strategy is through accountants. They go and give accountants a whole bunch of practice management tools and, “Here, run your business on Zero and then go and convert all of your clients onto Xero.” And so you’ll see for every accountant you get, you may get 5, 10, 15 fresh new customers. So a lot of leverage there. Number five, give great customer support. This is a counterintuitive one. Many companies think that they cannot afford to give great service when they sell to small business, because the customers are so small. But here’s the thing, first of all, small business owners, they’re super stretched. They have no time. They don’t have an IT department. And the other thing is, they talk to each other. So if you give great customer support, they tell their peers, they tell their friends, and that just leads to more customers.
So at FreshBooks, this is really a core part of the culture. Every single person in the company, no matter how junior or senior, introvert or extrovert, spends the first 30 days of their life as a FreshBooks employee in customer support, picking up the phone, responding to email, learning the product, learning the culture. When you call customer support at FreshBooks today, if the phone is not picked up in three rings, literally every single phone in the office will ring until someone serves that customer. So what that has bred over the years is just an insane customer first culture and a very high net promoter score at Apple level territories. And a high NPS just gives you so much leverage for your marketing because there’s just so much free love that’s coming in. So something to think about there.
Next is to add payments. So this is not going to apply to all software categories, but anything that’s, well, you see front office examples like Shopify. I’m going to run a store and now I need to collect payments. You’re going to see back office examples like Xero and FreshBooks where I send an invoice and now I want you to pay me. You see it with vertical specific applications like Mindbody where I can open up a yoga studio and collect payments online. But for a small business owner, there’s only so much they’re willing to pay for software, but the payments piece psychologically comes out of a different pocket. And so you add it together and it can actually add up to meaningful revenue. And so it’s hard to see here, but the graph at the bottom is Shopify’s quarterly revenue. And over time, the merchant services, that’s their payments offerings, is now 50% of the business, or a little bit more actually as of today.
And if they had just stuck with software, their growth really would have tapped out. But because they’ve added payments, they’re now a company that’s worth over $10 billion. So I’m not saying if you add payments you’re going to be worth $10 billion. Don’t quote me on that. But for many businesses adding a payments product is super important, and from that small business customer’s point of view, the thing they care about the most, is two things. One is finding customers, but second, getting paid on time, and so having a payments offering is actually super valuable. Strategy seven, segmentation. So remember, earlier I said there were 30 million small businesses. If you have built a product that you think is applicable to all 30 million small businesses, you’ve really built something that’s applicable to no one. No business owner just thinks of themselves as I am a small business owner.
They think of themselves as whatever industry they’re in. I’m a plumber, I’m a dentist, I’m a doctor, whatever. And so the best SaaS companies and, ironically, some of the biggest, have started out and spent a meaningful amount of their history being super narrow and focused on serving one customer or one vertical. And FreshBooks again today, I keep going back to that just because I know it well, only thinks about five verticals. And if there’s customers that come in from elsewhere, that’s fine, but when they are thinking about product decisions, thinking about messaging, thinking about marketing channels, events, whatever, they’re only thinking about it through the lens of a small number of verticals. So just some lessons learned over time from scaling SME SaaS.
The first is business owners have no time and that’s not going to change anytime soon, and I think that has implications for how you build products for SME SaaS. With AI and machine learning getting more and more reliable, I think you have the opportunity to build these black boxes that just do one thing really well and I as a business owner can just trust it, and off I go, or, on the flip side, have a complex product that is supported by services that either you provide or an ecosystem around you provides, you see that with Shopify where they have people who can build and design your stories, you see that with Squarespace, where you have website builders who can take a template and then customize it for you. The commonality there, or one extreme, pure AI or two software with managed services is still I, as the business owner, do not have to spend time in the product because I don’t have that time. So, that’s an important thing.
Second, growing super fast is actually expensive. SME is a huge market, but it tends to grow at a certain rate. There are three million new businesses started every year. Some number of those have a common set of needs. They need a domain, they need email marketing, they need accounting software, so on and so on. But if you try and grow at 2X or 3X the natural growth rate in your market then your incremental cost of acquisition goes way up. And this is the challenge, probably that many of you feel when you’re dealing with early stage VCs who want you to 3X your business every year. And I was talking to a CEO today where we agreed that, ain SME, it’s great to raise some initial capital, but then you actually have this desert you have to cross between one million and 10 million ARR where you’re not growing fast enough to be really appealing to the VCs, which is often why they try and get you to move up market.
But 10 million AR and beyond, you get into more growth stage private equity territory where, again, your business won’t grow 3X a year, but it could probably grow 50% to 75% a year, more or less in perpetuity, because many categories of SME software have been around for a long time and they’re going to be around for a long time. So thinking about the natural growth rate in your market and then thinking about how long the opportunity you have to build your company and just aligning that to the capital that you bring in, that’s really the point here. Third point really is around net promoter score. I’ve talked about that with the FreshBooks example. Do not underestimate it. I think it’s a critical metric. Invest in getting real customer love. And help your customers grow. And what I mean by this is, again, if I go back to the two things that an entrepreneur cares about most, it’s finding customers and then getting paid by those customers.
So if you have built a product that helps me save time, eh, I don’t really care. Whereas if you’ve built a product that’s going to help me grow my business, I care a lot. Last thing is, and this goes back to my point about evergreen markets, good things just take time. If you think about some of the biggest SME software companies, they’ve been around for a long time. Zoho’s been around since 1996. Basecamp and SurveyMonkey, 1999, and so on you. If you read Tech Crunch all the time and you think inside three years you’re going to sell your business for $300 million, sometimes that happens. More often than not it doesn’t, and with SME in particular, you really do have an opportunity to just hunker down and build a very meaningful business, but over decades, not years. That’s it. Thank you very much.
