Case 097SaaS metrics and diagnosticsHard

A difficult SaaS case: Quillonet, a sales-engagement platform, grew ARR 70% to Rs 60 crore, but NRR fell from 125% to 104%, CAC payback rose from 14 to 26 months and gross margin slipped from 80% to 72%. The Series C is Rs 150 crore at Rs 900 crore post. Diagnose what is breaking and decide.

Insight PartnersNew York · 2021

The situation

Quillonet sells software that sales teams use to send email sequences, log calls and track prospects, priced per seat. ARR grew 70% last year, from about Rs 35 crore to Rs 60 crore, and the founders lead their Series C pitch with that number.

Underneath, three metrics moved the wrong way. Net revenue retention (NRR) fell from 125% to 104%. CAC payback, the months of gross profit needed to recover the cost of winning a customer, rose from 14 to 26. Gross margin slipped from 80% to 72%. The company wants Rs 150 crore at a Rs 900 crore post-money valuation, 15x current ARR, and plans to grow 50% next year.

Your task

Diagnose what is breaking, show what the change in metrics does to the growth engine, and decide whether to invest at this price.

Quick check

Which reading of Quillonet's year is most accurate?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Quillonet's growth engine is breaking, and 15x ARR prices the old 125% NRR, not the new 104%. With the same Rs 43 crore a year of sales spend, last year's metrics would take ARR to about Rs 293 crore in three years; this year's reach about Rs 154 crore. I would not invest at Rs 900 crore. At these metrics, about Rs 472 crore post, 7.9x ARR, is where the same return holds.

Step 1Why read the three metrics together rather than one at a time?

If a shop's regulars start buying less, it has to spend more on discounts to pull in new people, and the discounts eat its margin. Each number alone looks like a small slip; together they say the shop is losing its pull. When NRR falls, payback lengthens and gross margin slips in the same year, the most likely cause is a product losing pricing power: customers buy fewer seats, new deals need more selling and discounting, and the cost to serve rises against a lower price. For a per-seat sales tool, shrinking sales teams at customers would produce exactly this pattern.

Three metrics turned at once, while the price still reads like last yearNet revenue retention125%104%last yearthis yearexisting customers barely growCAC payback, months1426last yearthis yeareach new rupee costs nearly twiceGross margin80%72%last yearthis yearcost to serve is risingSeries C askRs 900 crpost-money15x ARRon Rs 60 crorepriced on 125% NRREach tile: grey is last year, red is this year (scales differ by tile)
Retention, payback and gross margin all worsened in the same year while the Series C asks 15x ARR, a price that only fits last year's 125% retention and 14-month payback.
Step 2What does each metric do to next year's plan?

Take the 50% growth plan: ARR from Rs 60 crore to Rs 90 crore. At 125% NRR, existing customers alone would reach Rs 75 crore and new ones would need to add Rs 15 crore; at 104% they reach Rs 62.4 crore and new customers must add Rs 27.6 crore. Payback converts that into spend: new ARR times gross margin times payback in years. On last year's metrics the plan needs about Rs 14 crore of sales and marketing; on this year's, about Rs 43 crore, three times as much for the same growth.

The relationship
Spend=new ARR×GM×payback12:27.6×0.72×2612=43.1vs15×0.80×1412=14.0\text{Spend} = \text{new ARR} \times GM \times \frac{\text{payback}}{12}: \quad 27.6 \times 0.72 \times \tfrac{26}{12} = 43.1 \quad \text{vs} \quad 15 \times 0.80 \times \tfrac{14}{12} = 14.0
new ARRARR that new customers must add to hit 50% growth, Rs crore
GMgross margin
payback/12years of gross profit needed to recover acquisition cost
What it says in wordsLower retention means more new ARR is needed, and a longer payback makes each rupee of it cost more, so the two effects multiply.
Step 3What does the engine build over three years?

Hold the spend at Rs 43 crore a year. On last year's metrics that buys about Rs 46 crore of new ARR a year and existing customers grow 25%, so ARR reaches about Rs 293 crore in three years; on this year's metrics it buys Rs 27.6 crore and existing customers grow 4%, reaching about Rs 154 crore. Assume, for illustration, an exit at 6x ARR in year three and no further dilution. The Series C's 16.7% returns 1.95x on the old metrics and only 1.02x on the new: roughly the money back after three years of risk.

Same spend, two engines: what the old and new metrics build in three years0100200300todayyear 1year 2year 3ARR, Rs croreRs 293 crold metricsRs 154 crnew metrics6x ARR in year 3 returns 1.95x (old) or 1.02x (new) on the Rs 150 crore
With the same Rs 43 crore a year of sales spend, last year's metrics build Rs 293 crore of ARR in three years and this year's only Rs 154 crore, so the Series C returns 1.95x or 1.02x at a 6x ARR exit.
Last year's metricsThis year's metrics
NRR / payback / gross margin125% / 14 / 80%104% / 26 / 72%
Spend for 50% growth next year, Rs crore14.043.1
New ARR per year from Rs 43 crore of spend46.127.6
ARR in year 3, Rs crore293154
Series C multiple at 6x ARR1.95x1.02x
The same company on this year's metrics needs three times the spend for next year's plan and builds about half the ARR in three years, which halves the Series C's return at the same exit multiple.
Step 4What is the decision?

Do not invest at Rs 900 crore. To earn the same 1.95x on this year's metrics, the post-money would have to be about Rs 472 crore, 7.9x ARR, roughly half the ask. If the partners like the team, offer a lower price, or wait two quarters and ask for NRR by customer cohort, gross and net churn separately, discount levels on new deals, and what drove the gross margin drop. If the newest cohorts expand like the old ones and the drop came from a few large customers cutting seats, the picture improves. The limit of this analysis is the illustrative 6x exit multiple; change it and both returns move, but the gap between them does not.

Where candidates lose it

Candidates lead with the 70% growth and price the company on it. Growth is last year's output; NRR, payback and margin are the engine, and all three say next year's growth will cost far more.

The second miss is diagnosing each metric separately, for example calling the margin drop a hosting issue. Three metrics moving together usually share one cause, and naming that cause is what the interviewer is testing.

What the interviewer asks next

  • NRR is 104% overall but 120% for customers above Rs 20 lakh a year. How does that change your view?
  • What would you want to see in the next two quarters to invest at Rs 900 crore?
  • How would you structure a deal that bridges your price and the founders'?
  • Which of the three metrics would you fix first if you joined the board, and how?

Asked at Insight Partners, Generalist, New York, 2021 (Wall Street Oasis): Went through a difficult SaaS case, asked some tech-specific questions

Company names and figures are illustrative.