Thinking upstream in product and finance
Since joining Columbia Lake Partners (a venture credit/equity fund focused on software and internet companies in Europe) almost 5 years ago, I have spent time working with 20+ European portfolio companies on topics such as finance, growth and strategy. Prior to Columbia Lake, I spent time as a financial analyst in banking where I worked with 15-20 Silicon Valley based technology businesses for 2 years. Over time I started to think more about how teams in those cohorts managed finance, BI and strategy and how this might need to change given the environment we find ourselves in today (i.e. global impact of COVID on many industries and end-markets that software businesses sell into etc).
Quick recap of 2020: In terms of managing a venture-backed software business through this period of uncertainty , it would appear that there were a few options to consider in March/April this year to extend cash runway and not depend on raising external rounds of financing:
trimming fat in commercial and engineering teams to reduce overheads and extend cash runway, specifically for new markets/non-performing employees and for new product releases/R&D investments.
raising as much capital from existing investors/lenders to provide cash through ideally the end of 2021 (with the aforementioned reductions in overheads).
These changes can be made based on a high-level cash analysis for the business over the next 18 months but it does not show you the full picture of how the business is actually operating. It would appear to me that there are many things that sit upstream of bookings, costs and cash that are important for managing the business through this period. To me it feels like a new set of tools and renewed focus on product is required today more than ever. This will help management teams to monitor business resilience over the coming months and navigate this period of uncertainty with the highest chance of emerging at the other end unscathed.
In terms of what actually sits upstream of revenue, cash and costs in the business performance funnel, for most software companies this would be pipeline data, conversion, bookings, renewal rates and ramp periods/% of sales reps hitting quota. If any of these metrics deteriorate, there will very likely be an impact on either revenue and/or expenses, and thus some cash impact for the business. Nota bene: understanding cash is always king for any venture-backed company going from financing round to financing round .
““There are two things in business that matter, and you can learn this in two minutes- you don’t have to go to business school for two years: high gross margins and cash flow... All companies that go out of business do so for the same reason – they run out of money.””
Now lots of companies will stop here and most board reporting will show these aforementioned KPIs (pipeline, bookings, renewals etc) as well as the corresponding financial statements and cash impact. It is also worth noting here that most software companies are also finding it harder to close new business from new customers since March, as evidenced by this piece of research from the folks at NEA:
NEA’s research piece ‘Enterprise Software in a Remote World: COVID-19's Continued Impact on Business’
So taking this at face value and assuming that new bookings growth will naturally be slower during this period (unless you are Zoom or Slack), then it seems paramount to focus on and track what you can control: retaining revenue from existing customers. This will likely form most of your cash receipts through this period given slowing new business/less cash coming from new customers. An entry-level analysis of the existing customer base would likely begin at customer revenue churn rates, renewal rates and maybe logo churn (ideally segmented). However I would argue that there are important things that actually sit upstream of these typical retention metrics that management teams track. Most obvious to me are product analytics and engagement metrics. I think of the funnel as follows:
Many management teams and boards focus their efforts on leading indicators (i.e. KPIs) right of the red dotted line instead of looking at product metrics that sit upstream of renewals/cash from customers
Product analytics and engagement metrics that will drive renewals and churn would include:
User engagement (% of users who login daily/weekly/monthly, average time spent per session, total number of users relative to size of customer organisation, integrations with other applications consumed by the user etc.)
North Star product metrics that show value is being delivered and that track important events (e.g. contacts created as a CRM company, tickets managed as a customer service software company, servers monitored as an APM [Application Performance Management] company etc).
In fact, understanding these two sets of metrics would reveal a lot about the resilience of revenue from existing customers than just renewal rates and churn (status quo for board reporting today). Both renewal rates and churn are ‘after the fact’ metrics given that customer has already decided to leave your service. Moreover given many enterprise software companies renew licenses on an annual/multi-year basis, you could have a scenario where revenue retention and churn look fine on a monthly basis in the period since March 2020 (‘Things are great, COVID has not impacted us’) but product usage/value has actually deteriorated. So when those customers come to renew later this year/early next year, they have actually reduced their consumption of the product (leading indicator) and there is a higher probability of them leaving your service or down-selling (i.e. churn/cash impact). I started to think a lot about this back in April when COVID was in its first flush; management teams would state that renewals and churn were fine and business was good without having dug into the product usage/value analytics that sit upstream of renewing customers and retaining revenue/cash.
From a technology stack perspective, there are product analytics tools such as Amplitude that finance teams and boards should be using (alongside product teams) today to assess the health of the business going forward. I think every monthly KPI report should include data from tools like Amplitude on understanding product adoption and milestones/events in the product experience that drive value and ultimately renewals of customers. Only tracking renewals, churn and the corresponding financial/cash impact will not show you the full picture of how resilient your existing customer base and corresponding cash runway actually are.
