Talk to most growth capital firms, especially those on the west coast of the US, and you’ll hear how much they love enterprise software and associated tech services, because they share a highly attractive characteristic: long-term recurring revenue.
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Needless to say, grabbing these investors’ attention is no easy task for developers. Just to get through the door, more often than not they will need to demonstrate sustained year-on-year growth above and beyond 20%, and annual recurring revenues upwards of £7.5m.
Investors love these recurring revenues because they support much greater scalability than one-off sales. Other non-recurring revenues linked to consultancy, implementation, or even hardware are of much less interest in this regard.
On the other hand, profit is considered far less important at this stage to investors – simply because it’s assumed that everything will be reinvested for future growth. Losses and cash burn need not be a problem, as greater revenue growth rates will rectify them in the mid to long term.
But crossing these basic financial hurdles is just the beginning – then the serious scrutiny begins. So, what are these investors really looking for?
Don’t get stuck
If revenues and revenue growth are the starting point, a key metric is the stickiness. This is measured in customer retention rates and their inverse – your rate of churn – and how much the product sticks in the market. Are users trying it out and then moving on? Or do they sign up to stay? The ideal client retention rates would be above 90%.
Moreover, the more demonstrable the increase in activity after the initial sign-up – taking on more seats, for example, or spreading coverage into different territories or divisions or business units – so much the better.
Focus on the mission
Another significant question for investors will always be how mission-critical both the problem and the software solution genuinely are. In other words, the more essential it can be shown to be, the easier the sell to new customers, and the greater likelihood of retention for existing customers.
This is hard. Either it’s solving a problem that no one has noticed before (so how mission-critical can it be?), or completely reinventing the way something is currently done in large enterprises (with all the challenges of bureaucratic inertia, internal politics, multiple conflicting stakeholders, sceptical procurement departments, and so on).
If the developer isn’t meeting one of these criteria, the chances are they’re offering an incremental enhancement to something that already exists. If so, margins are more likely to be competed away by larger incumbents defending their turf, or by other plucky startups that have identified the same opportunity. It’s not an impossible route, but expect a rough ride from investors with models like this.
Scale of the market
The next question is the scale of the potential market, and what proportion of it counts as your addressable market. A critical need in a small niche can be lucrative, but won’t offer the growth potential investors are necessarily looking for. The larger the addressable market – the larger the group of potential customers with the same problem or need – the better.
That being said, the solution should focus on a segment sufficiently well-defined to be comprehensible. It shouldn’t be too general – a radical new solution which claims to be for “every” business is unlikely to be taken up by very many. A specific vertical – especially high-margin ones such as life sciences, health, financial services – is a good start.
If the customer base is disparate and diversified, the focus should be on finding a theme that unites a coherent and targetable market. Perhaps the product targets SMEs, or companies with 200-500 employees, or those with accounts receivable or debtor books in excess of US$1bn. But it had better be a robust and defensible sector – an ex post justification for a random customer base will convince no one.
Leading by example
Lastly, it is important to remember that investors are interested in the developer and the team, not just their product. Do they have the skills and the individuals in place to build the business to support their revenue profile and, crucially, do they know how they plan to spend the large funds raised?
So, would-be developers take note: you’ll not only need a clear, well-articulated growth plan, but a solid idea of who you’re targeting and how, and finally the humility to acknowledge where you need additional help and support – which is a key part of the investor role after all.