SaaS Framework
A differentiated point of view for analysis of SaaS companies
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Key takeaways
• Analyzing SaaS companies requires unique metrics and a
differentiated point of view. This framework seeks to provide
a comprehensive lens through which to view these companies.
• The framework assesses businesses across five categories:
the company’s solution, sales and marketing, revenue, path to
profitability and balance sheet. Investigating product market
fit, total addressable market, customer acquisition costs and
the company’s financing history serves as a starting point for
complete company analysis.
• SaaS business models are well-positioned for future growth.
The proliferation of SaaS businesses was driven by the
business model’s asset-light nature and ability to generate
recurring revenue, and the influx has only been perpetuated
by a number of large VC exits in the space over the past few
months, paving the way for more investment activity.
Published on July 5, 2018

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Credits & Contact
Analysts
CAMERON STANFILL Analyst
cameron.stanfill@pitchbook.com
DARREN KLEES Data Analyst
darren.klees@pitchbook.com
Contact PitchBook
RESEARCH
reports@pitchbook.com
Contents
Key takeaways
1
Introduction
2-3
Solution
3-4
Sales and marketing
4-7
Revenue analysis
7-8
Path to profitability
8-9
Balance sheet
9-10
Conclusion
10
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PitchBook 3Q 2018 Analyst Note: SaaS Framework
Introduction
The rapid advancements in bandwidth and cloud infrastructure
over the past two decades enabled a new wave of cloud-native
software firms to provide powerful software solutions directly
via the internet. This cloud-based business model has since been
dubbed as software-as-a-service (SaaS) and has seen massive
adoption by upstart companies looking to disrupt the legacy, on-
premise software providers and incumbents adding a cloud-based
offering.
A main drawback of legacy offerings is that the housing,
ownership and operation of the hardware have historically
been the responsibility of the client. SaaS addresses this
shortcoming and drastically reduces the total cost of ownership
by eliminating expenses for in-house servers, data storage and
dedicated personnel for maintaining infrastructure. With SaaS
adoption being primarily motivated by these cost savings, we
think that SaaS businesses still have a degree of pricing power
when it comes to software licensing fees, which should facilitate
continued growth.
While the potential cost savings have been evident for some
time, security concerns regarding the storage of sensitive or
confidential information on third party systems were a main
hindrance to SaaS adoption; however, improvements in cloud
security have dramatically reduced these issues. Still, handling
client data securely will continue to be a priority for SaaS
businesses and advancements in cybersecurity should be quickly
adopted or innovated on by players in the space.
Not your parents’ software company
In addition to differences in how services are delivered, legacy
offerings and SaaS providers have drastically different sales
models. Legacy products often charge a large upfront software
license fee, whereas SaaS businesses typically sell service
subscriptions through which revenue is earned ratably over the
life of the contract. In a similar vein to the increased flexibility in
pricing, SaaS allows for immediate product updates and upgrades,
an improvement on the periodic version releases of on-premise
software.
SaaS businesses are asset-light and generate recurring revenue
that drives cashflow, but revenue recognition policies caused by
the subscription model can skew evaluation of SaaS companies
because of the mismatch between revenue and costs. Since most
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PitchBook 3Q 2018 Analyst Note: SaaS Framework
major costs (including sales and marketing) are recognized upfront,
analyses of SaaS companies that rely on GAAP earnings measures
can be difficult and unreliable. Improvements have been made
to address this, as new rules that went into effect on January 1st,
2018 now allow companies to recognize commissions over time
to match revenue more closely. While investors familiar with
software firms have begun to understand the dynamics of the
SaaS model, we often see these companies examined through the
same lens as traditional business models, revealing a fundamental
misunderstanding in how they should be analyzed and valued.
The maturation of cloud providers in recent years and relative
ease to set up a SaaS business have attracted many startups
to pursue this distribution model. This influx has only been
perpetuated by a number of large VC exits in the space over the
past few months, paving the way for more investment activity
to follow in the near future. As a result, many of today’s SaaS
companies are coming through the VC funnel and scaling rapidly
due to the benefits that the model provides, including the stability
of recurring revenue, an expedited path to cash flow positivity
and favorable operating leverage.
Because of the limitations of traditional analysis techniques and
our familiarity with SaaS businesses, we created a framework
to provide a comprehensive lens through which to view these
companies. This piece is meant to serve as a starting point for
company analysis and as a guide to some of the most important
data points of SaaS businesses. This will also serve as a template
for our own company research and coverage of the broader SaaS
market. We hope this is beneficial to you and your practice.
Framework scope
1. Solution
2. Sales and marketing
3. Revenue analysis
4. Path to profitability
5. Balance sheet
Solution
The goal in this section is to determine the market size, product
market fit and the problem the company is solving. These are
the first key factors in determining a company’s potential size
and growth. Here the company must find its balance between
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PitchBook 3Q 2018 Analyst Note: SaaS Framework
target market size and level of competition. These two factors
tend to have a positive correlation (i.e. the larger the market, the
greater the competition), so finding the correct mix is critical to
the company’s success. It is also important here to assess the
differentiation of the business that makes it unique to innovate
on an existing process. The distinction between filling an unmet
need or creating a new solution to disrupting or competing in an
existing field will have a marked effect on the total addressable
market (TAM) and the long-term outlook.

Qualitative assessment
Does the company’s solution fit into an existing SaaS category?
• Customer relationship management (CRM)
• Enterprise resource planning (ERP)
• Accounting or billing
• Marketing
• HR
• Collaboration or project management
• Other
Determine the company’s TAM either from management
statements or via outside research if the company doesn’t report.
What are the end markets a given service can serve? What would
be the individual TAM within each end market? Is there any
potential for the company to pivot to increase TAM? Consider the
associated costs and benefits of a potential change of course.
Who are the company’s competitors?
What makes the solution differentiated? Does it address an
unmet need or fill an underserved niche? Does the company
communicate why it chose this product?
• Sector
• Business expertise
• Leadership team background
• Other
Sales and marketing
Sales and marketing represent the largest and most significant
expense category for SaaS businesses, which makes it essential to
determine how the company positions itself in its market and to
assess the viability of the sales approach. Much of this will depend
on the business’s ideal customer profile and the complexity of
the product. For example, while heavily integrated products for
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PitchBook 3Q 2018 Analyst Note: SaaS Framework
enterprise clients might require field and inside sales forces, other
products may be just as successful employing channel sales or
self-service strategies.
While sales approach and efficiency are key to the growth of the
business, the marketing function must be effective enough to
supply a sufficient quantity and quality of sales leads.
Determining the company’s demand generation strategy or
pipeline of leads is an important predictor of whether the
company will meet sales goals. Investing money into these
expenses is critical to growth; however, monitoring related
efficiency metrics is important to understanding if the company is
allocating capital prudently or implementing a growth-at-all-costs
mindset. These spending decisions will determine the trajectory
and long-term success of the business.
Qualitative assessment
What is the company’s go-to-market strategy?
• Platform or horizontal
• Targeted or vertical
While a company can be targeted from an end user (focusing
on healthcare firms) or use case perspective (pure accounting
solution), for this analysis we will focus on targeted strategies
from the use case or solution perspective. However, it is essential
to exercise some prudence here, because there is a good deal of
nuance in this determination.
Based on the company’s solution or TAM desires, does one or
the other go-to-market strategy make more sense? Anecdotally,
a targeted approach is easier to sell because the product can be
specialized and the value proposition is simpler to communicate. It
is also easier to build an initial product, as the platform approach
requires building out multiple services at the outset.
Does this make them a more likely acquisition target or an
acquirer? For example, vertical strategies may be easier to tuck
into a platform business looking to expand its product offerings,
while platforms may look to consolidate with other like businesses.
What is the company’s sales approach?
•
Inside sales
• Field sales
• Channel
• Hybrid
• Self-service
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PitchBook 3Q 2018 Analyst Note: SaaS Framework
How long is the sales cycle? Determine if that information is
available or use the best estimate based on client type and
product complexity.
Who is the company’s ideal customer? Either find or develop the
company’s ideal customer profile (ICP). While the following bullets
provide a starting point, additional detail is always valuable.
• Enterprise (e.g. money-center banks, diversified insurance
companies)
• SMB
• Consumers—which subset?
• Derive an exact figure or estimation for average contract value
(ACV). If no explicit value is given, make inferences based
on customer type or monthly recurring revenue (MRR/# of
customers).
Is there a benefit to its chosen sales approach given its product
or go-to-market? For example, channel sales eliminate the need
for a full salesforce, as the product is sold through partners
or resellers, a self-service channel for individuals, very small
businesses, etc.
What is the company’s marketing or demand generation
strategy? Does it have a clear pipeline of leads or an existing
customer base it can upsell? What are its primary channels used
to generate leads? What is the cost to generate demand or leads?
Relevant metrics
Customer acquisition cost (CAC) should be broken out by the
costs allocated to procuring new business versus retaining current
clients, if possible. Consider the length of the sales cycle to
determine the lag of expenses. It’s also worth determining how
much of marketing’s effort is spent on new business. Use CAC to
calculate other key SaaS metrics.
CAC =
sales & marketing expense
# of new customers acquired
CAC payback
period (months)
=
CAC
MRR x gross margin
x 12
Customer lifetime
value (CLTV)
=
ARR - average cost to service
churn % + WACC - subscription increase
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PitchBook 3Q 2018 Analyst Note: SaaS Framework
Customer lifetime value (CLTV) is a measure to value the cash
flows produced by one customer. Breaking down the formula,
CLTV consists of the margin the customer generates after
discounting for churn and the time value of money. This can be
an important metric on its own, but the CLTV/CAC ratio gives
context and meaning to the customer value calculation. This
ratio gives a picture of the company’s return on every dollar used
to acquire customers. A three to one CLTV/CAC ratio has been
posited as a positive benchmark, and a ratio of greater than one
is key to confirm the company isn’t spending more on customer
acquisition than the margin the customer provides over their
lifetime.
This measures the percentage of revenue that is spent by the
company on the sales & marketing function. How has the ratio
evolved historically? Are there levers to be pulled here to lessen
the burden?
Revenue analysis
As investors have looked to software for top-line growth over the
past 20 years, revenue metrics have had an outsized effect on
valuations. While many valuation models are based on earnings,
SaaS companies tend be valued based on revenue, especially
at the earlier stages of their lifecycle. Revenue streams can also
be used to access debt via revenue-based financing. To assess
the quality of the company’s revenue, we examine gross margin,
payback period and churn. Churn is especially important, because
this measures the amount of revenue or number of customers
that the company loses annually, which indicates the stickiness
of the product. The churn figure is also useful when evaluating
the business’s current state if it were to stop investing in growth
initiatives (i.e. sales and marketing).
Sales & marketing burden =
sales & marketing expense
revenue
=
CLTV
CAC
Customer lifetime value to CAC ratio
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PitchBook 3Q 2018 Analyst Note: SaaS Framework
Relevant metrics
Break out by subscription revenue (ARR or MRR), if possible. Also
consider sales growth, which gives insight into future revenues.
Conduct a year-over-year (YoY) and competitor comparison.
This measures the company’s cost to provide the service. Is the
trend toward improvement or deterioration? Does this have
anything to do with product or services mix and/or mix shift?
Conduct a YoY and competitor comparison.
This measures the annualized increase in revenue the company
makes by spending one additional dollar on sales and marketing.
A ratio above 0.75 is preferable, and investment in sales and
marketing is worthwhile. If under 0.5, the business needs to
change something before investing further in sales and marketing.
It tends to track lower as a company ages and scales and as the
market becomes more saturated.
This measures how quickly your CAC is recouped. For example, if
CAC is $10,000 and the ACV is $8,000, the payback period is 15
months (five quarters). This is almost synonymous to the inverse
of the sales efficiency formula. A payback period of six to 12
months is best-of-breed, and less than 18 months would be highly
preferable.
Revenue churn can also be calculated. Churn is the sign of
stickiness and customer retention for a SaaS business. It can
be analyzed as a percentage of either revenue or clients. Net
negative churn is seen as a holy grail in SaaS businesses, which
Payback period
(in years)
=
CAC
ACV
Churn =
Δcustomers
Δtime*beginning customers
Sales efficiency =
ΔQ = quarterly rev*4
sales & marketing exp
t-1
Revenue growth =
revenue
t
revenue
t-1
- 1
Gross margin =
gross profit
revenue
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PitchBook 3Q 2018 Analyst Note: SaaS Framework
occurs when the net renewal rate or upsell is greater than the
churn. This translates to revenue growth from the existing
customer base.
Path to profitability
GAAP profitability isn’t always the company’s principal concern,
especially at a relatively early stage when the company is still
working to grow revenue and customers. For instance, companies
may opt to increase headcount aggressively, which will lower
current net income or operating income but expands potential for
future growth. This growth is important in the world of SaaS, since
that is what attracts many of the investors to the space. However,
we think it is becoming more common and even necessary for
companies to show progress toward profitability or at least have a
plan to do so. Most recently, companies have tried to exhibit that
progress by turning cash flow positive, a move that proves the
company can fund itself internally and won’t need to rely on large
secondary offerings in the public markets.
Relevant metrics
Net income/(loss), cash flow from operations (CFO) or free
cash flow (FCF) margins. Is the margin trending positively
or negatively? What expense categories are driving outsized
effect? Where can potential levers be pulled? Conduct a YoY and
competitor comparison.
Use the “Rule of 40.” Growth and profitability of 40% or higher is
a positive sign. This is a simple rule of thumb to judge the health
of a SaaS business once it hits ~$1 million in MRR. For example, if
you are growing MRR (you can also use ARR or revenue) at 20%
YoY, you should aim to operate at 20% profitability. Choose NI,
EBITDA, CFO, or FCF margin depending on the stage of business
and fixed asset decisions.
Balance sheet
When evaluating the company’s balance sheet and financial
condition, it is key here to examine the capital structure. This gives
insight into how much equity the company has sold to investors
or if the company has raised any debt and what that will mean for
further financing needs. Also consider the current cash balance
and how long of a runway this cash will provide at the current
burn rate before needing to seek more capital. In the current
VC environment where huge sums can be raised by successful
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PitchBook 3Q 2018 Analyst Note: SaaS Framework
companies, this cash on hand or the ability to raise outsized
rounds is becoming a competitive advantage.
SaaS businesses regularly operate with negative net working
capital (NWC) due to the large sums in the unearned or deferred
revenue account, especially if the company is growing sales.
Efficiently managing working capital is key to the cash flow
of SaaS businesses. For this, we consider the company’s cash
conversion cycle (CCC), days sales outstanding (DSO) and days
payable outstanding (DPO). Essentially, how fast do you get paid
versus how fast must you pay expenses? A negative CCC provides
the company with a cash benefit.
Qualitative assessment
What is the company’s financing history?
• VC funding
• Debt
• PE ownership
Are there any issues of which to be aware because of this?
• Debt burden
•
Investor rights
• Potential future dilution events
• Other
Based on cash flow information in the previous section, is it likely
that the company will need to raise additional funds in the next
12-18 months?
Relevant metrics
SaaS CCC =
average A/R
billings / 365
( )
average A/P
cost of sales / 365
( )
-
Conclusion
Now that we have gathered all relevant information for the
company, it is essential to bring it all together and examine the
full picture. It is helpful here to compare against general SaaS
benchmarks and preferably a small group of public or private
competitors. In general, this is the area to synthesize the answers
from the five categories of the framework to get an idea about
the overall state of the business and its prospects going forward.
It is key to use the information gathered to make projections
about the business as future results are what ultimately drive
shareholder value.