In my 23 years in software, I’ve worked at companies large and small, at different stages of growth, across self-funded, angel, and Series A to C. At each company I’ve found many problems can be solved by borrowing what works well for a company at an entirely different stage. Bootstrapped/self-funded/pre-seed product companies at < $1m ARR can learn a thing or two from their VC-funded cousins. I’ve picked out 4 metrics less-used by bootstrappers that can rapidly grow their businesses.
Before we start: if your goal is to spend most of your days building things and have growth and revenue as a happy afterthought, I have big respect for that path, but this article is not for you.
It’s also not for you if you’re early in your first year. This time is all about getting that first paying customer, establishing a channel to consistently get more of them, and grow to 10s or 100s of subscribers. You just don’t have enough data to use the metrics we’ll be looking at. Churning 1 customer out of 10 is a weak, unreliable signal vs. churning 100 out of 1,000.
If your ambition is to grow your business efficiently, with or without funding, then read on, this one’s for you.
R&D:S&M spend ratio
All founders start with a hammer of skills that they’re must comfortable with and adept at using. Founders with a development background like me tend to spend most of their time building product. Those with a sales background spend most of their time selling.
As a solo or small founding team, be aware of your natural tendencies and biases: the work you’re most competent at and enjoy doing. Keeping these in check will accelerate your growth. You can use the Research & Development to Sales & Marketing (R&D:S&M) spend ratio to do so.
I frequently see founding teams spending 90% of their time on product development, trying to code their way out of problems better, or only, solvable by selling.
In the early days, spending half of your time and money on product development and half on sales & marketing is the right ratio to optimize for growth. Most developer-founded companies fail because they cannot sell or market the product. Or that no-one wants it, which is also a problem that wouldn’t have happened if the founders were trying to sell the product from day one.
This 50:50 R&D:S&M ratio holds true until a product reaches the maturity phase. You’ll know you’re in the maturity phase when you see it. Adding new features and fixing bugs does not accelerate growth as it did in the early days. You’re not losing deals to competitors or because you have product gaps. This is the point of diminishing returns from further R&D. To accelerate growth, S&M is the hammer to reach for. You can ramp up to around 70% S&M spend at this stage.
Many technical founders struggle to spend 50% of their time and budget on S&M. I hear a lot of frustration from those who don’t come from a marketing background. They say that ‘marketing doesn’t work’ and ‘it costs me too much to acquire a customer’. At the root, it’s often not knowing the right amount to spend on acquiring customers that’s the trouble. For this, you can use our next two metrics: LTV:CAC ratio and CAC payback period.
LTV:CAC ratio & CAC payback period
Your Lifetime Value (LTV) is the amount you expect a customer to pay you in total for as long as they’re a customer. You divide your Average Revenue Per Customer (ARPC) by churn rate to get your LTV.
Without knowing your LTV you don’t know how much it makes sense to spend on acquiring them. The most common mistake is spending too little. I’ve heard app devs complain about spending $150 to acquire a customer paying $25/month. Is that too much? Too little? I don’t know until I know the LTV.
For every dollar you spend on marketing to acquire a customer, your Customer Acquisition Cost (CAC) you should aim to return at least 3 dollars. That’s 3 dollars over the lifetime of the customer LTV: a 3:1 LTV:CAC ratio. In our example, if that customer paying $25/month stays for 18 months to generate an LTV of $450 we’re good to spend $150 acquiring them.
When you start spending on marketing it’s unlikely you’ll hit 3:1 LTV:CAC right out of the gate. You don’t know which channels to use, and you haven’t experimented with creative and targeting. But as a rule of thumb, if it’s less than 1:1 and you’re spending at the 50:50 R&D:S&M ratio, you should probably try another channel or campaign.
It’s all well and good saying that you can spend $150 up front to acquire a $25/month customer, but a challenge for self-funded startups can be financing that. Another metric that can help work out your cashflow and any financing needs is CAC payback period.
How long it takes to breakeven on acquiring the customer is the CAC payback period. The CAC payback period where it costs us $150 to acquire a $25/month customer is 6 months. This is excellent by venture-funded standards. A CAC payback period of 15 months is what these startups aim for.
By coupling a 50:50 R&D:S&M spend with a 3:1 LTV:CAC ratio and a CAC payback period under 15 months, you have the parameters to spend the right level of time and money to efficiently grow your company.
Successful bootstrapped SaaS companies throw out a lot of consistent and growing cash to founders. If your goal is an exit on a short to medium term, you’ll also want to reinvest to increase the valuation of your company. For this, the Rule of 40 guides how much profit you can invest in growth.
Rule of 40
The Rule of 40 says that efficient, sustainable growth is where adding gross margin to growth rate is greater than 40. If you’re growing 100% Year over Year (YoY) you can run a -60% gross margin. If you’re growing at just 20% YoY, your gross margin should be 20%.
VC-backed companies have the cash and financing on hand to afford to run a -60% gross margin to fuel 100% YoY growth. You probably can’t. Where the Rule of 40 is handy is to make sure you are spending enough on growth and not just taking profits. To increase your valuation you should reinvest profit if it drives further growth.
Before I discovered the Rule of 40, I ran my self-funded startup unknowingly at over 40 right from its early years. To minimize corporation tax, I aimed for breakeven or at a small loss every year while achieving 40%+ YoY growth.
One note of caution is to be mindful of the type of exit you are looking for when running the business in the period leading up to acquisition. If a valuation on revenue run rate is most likely, doing what I did and reinvesting all profit to drive 40%+ YoY growth is smart. If instead you will be valued on the profitability of the business, most commonly using a measure like Seller’s Discretionary Earnings (SDE), you will not be maximizing your valuation in the final 12 months if you run at breakeven or a loss. Growth does affect the multiple of these smaller acquisitions, but not as much as if you had focussed on profits in the final months.
These R&D:S&M spend ratio, LTV:CAC ratio, CAC payback period, and the Rule of 40 metrics are simple enough for any SaaS company to calculate. Yet they can have a profound effect on how fast your company grows by tracking and adjusting your time and money investment decisions based on them.