Decoding Product-Market Fit, ARR/FTE Benchmarks, Talent Trends & More
Digesting Insights From the Data
👋 Hi, I’m Andre and welcome to my weekly newsletter, Data-driven VC. Every Tuesday, I publish “Insights” to digest the most relevant startup research & reports, and every Thursday, I publish “Essays” that cover hands-on insights about data-driven innovation & AI in VC. Follow along to understand how startup investing becomes more data-driven, why it matters, and what it means for you.
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Welcome to another “INSIGHTS” episode where we cover the most interesting startup research & reports from the previous two weeks.
We read all reports, studies, and papers about startups and the wider ecosystem, and condense the most important insights for you.
The only source you need to keep up with data-driven startup insights.
Decoding the Science of Product-Market Fit
In our last episode, we identified bad product-market fit as one of the top reasons why startups fail. Luckily, First Round Capital published a comprehensive report helping founders transform PMF from art to science. The report focuses on sales-led B2B startups but many of the very actionable findings transfer to other verticals as well.
Four Concrete Levels: First Round identifies four levels of PMF—Nascent, Developing, Strong, and Extreme—each requiring different strategies and outcomes. This methodological segmentation helps founders identify their current position and strategize for progression.
Three Critical Dimensions: Their framework expands PMF assessment beyond mere customer satisfaction to include demand and efficiency. This ensures the product not only meets needs but is also scalable and market-ready.
Leveraging Tactical Levers: The framework introduces four levers—Persona, Problem, Promise, Product—that founders can adjust to streamline their path to PMF, drawing from real-world applications by companies like Looker and Ironclad.
✈️ KEY TAKEAWAY
First Round's PMF Method provides a more navigable path to finding product-market fit, potentially reducing the role of luck and emphasizing strategic effort. With peer benchmarking and practical exercises, it offers founders a detailed roadmap to reach and sustain PMF.
Silicon Valley Exodus: Talent Trends in Tech and Venture
2023 marked a paradox in the tech industry: Significant layoffs totalling more than 260’000, juxtaposed with a burgeoning AI boom catalyzed by the rise of platforms like ChatGPT since late 2022. SignalFire's comprehensive review unveils not just shifts in where tech talent resides, but also deep insights into generational workforce dynamics and the dispersion of AI expertise.
Geographic Shifts in Tech Talent: Austin and New York City have emerged as major hubs for tech relocations, with Austin experiencing a 23% growth in VC-backed startups and NYC gaining the largest share of relocating tech workers. Silicon Valley, while still a major player, is seeing a net outflow of talent to cities like NYC and Austin, challenging its long-standing dominance.
Generational Dynamics in the Workforce: Gen Z is ascending into management roles at a slower pace compared to previous generations, with many preferring job flexibility over traditional career ladders. This generation also changes jobs twice as frequently as Gen X, reflecting a more dynamic and less employer-loyal labor market.
Evolving Qualifications and Roles in AI: The demand for AI talent continues to grow, yet fewer AI roles are being filled by candidates with graduate degrees, indicating a shift towards skills and practical experience over formal education. Data engineering roles have overtaken data analyst positions, highlighting the evolving needs within tech companies as they adjust to more AI and data-centric operations.
✈️ KEY TAKEAWAY
The landscape of tech employment is undergoing profound changes with significant implications for where companies are based and how they hire. Founders need to adapt to these shifts by leveraging remote work, reconsidering traditional degree requirements, and responding to the faster job-switching tendencies of younger generations.
SaaS Efficiency: ARR per Full-Time Employee
In SaaS, the simplicity of the annual recurring revenue (ARR) per full-time employee (FTE) metric belies its importance. This straightforward measure offers a clear snapshot of organizational efficiency and effectiveness without the convolution of complex calculations. OpenView’s Kyle Polar provides their latest insights on what constitutes "good" and "great" performance across various revenue bands:
Benchmarking ARR per FTE:
For companies generating $1-$5 million in ARR, a good efficiency ratio is $90k per FTE, scaling up to $150k+ for great performance.
Firms with $5-$20 million ARR should aim for at least $150k per FTE, with $250k indicating top-tier efficiency.
As companies grow larger ($20-$50 million ARR), the threshold for good performance increases to $200k per FTE, with $275k+ reflecting industry-leading efficiency.
Enterprises surpassing $50 million in ARR are considered efficient at $250k per FTE and exceptional at $300k+.
Industry Standards: The median ARR per FTE for public SaaS companies stands at $283k, with the top quartile achieving $369k. Notable high performers include Dropbox at $799k ARR per FTE, Twilio at $771k, and Adobe at $617k, showcasing the potential of optimal operational scaling.
Strategies for Improvement: Streamlining operations and enhancing productivity are pivotal. Focusing on automation and employee training can substantially uplift this metric. Strategic hiring and resource allocation also play crucial roles in optimizing revenue generation per employee.
✈️ KEY TAKEAWAY
The simplicity of ARR/#FTE calculation and its comparative nature makes it a critical performance indicator in the SaaS industry. As we look towards the second half of 2024, enhancing employee output through technological integration and strategic workforce management will be key drivers in maintaining or surpassing these industry benchmarks.
Equity Refresh Grants: Essential for Sustained Employee Engagement
Retaining top talent is as critical as attracting it. Recent data by Carta reveals a significant trend: Nearly half of all employees at startups receive equity refresh grants by the end of their second year, and this figure jumps to almost 70% by the end of their initial four-year equity grant period. Here's a closer look at how these grants are structured and their strategic importance:
Time-Based Refresh Grants: These are awarded after 2-3 years to incentivize continued employment beyond the initial grant. Unlike the initial grant, these refresh grants typically don't have a cliff, allowing for immediate vesting, which can double the equity compensation as it overlaps with the tail end of the initial grant. Carta introduces a variant called the "boxcar" grant, where the vesting starts 12 months post the initial grant period, smoothing the potential drop in equity compensation after year four.
Promotion Grants :Issued when an employee is promoted, these grants adjust an employee's equity to align with the midpoint equity level of the new role, ensuring that promotions are accompanied by corresponding increases in equity compensation.
Performance Grants: Allocated to high performers upon achieving significant milestones, these grants are generally sized at 20-30% of the initial grant, reinforcing a performance-oriented culture.
✈️ KEY TAKEAWAY
As competition for talent stiffens, especially in tech and AI, effective use of refresh equity grants can be a game-changer in employee retention and satisfaction. Refresh grants not only incentivize long-term commitment but also align employee interests with the growth and success of the company. This strategic tool is becoming indispensable in the modern employment landscape of startups.
Clarifying CoGS vs. OpEx in SaaS: Optimizing Gross Profit Margins
The delineation between Cost of Goods Sold (CoGS) and Operational Expenses (OpEx) is a pivotal area of SaaS financials, impacting critical metrics like Gross Profit (GP) and Gross Profit Margin (GPM). Dirk Sahlmer's article reveals common misconceptions and best practices for categorizing these costs correctly to ensure accurate and beneficial financial reporting. Here’s a breakdown of the key components and their implications:
Understanding CoGS and OpEx: CoGS includes direct costs associated with delivering a SaaS product such as hosting, DevOps, customer support (excluding sales activities), third-party software costs, and transactional fees. OpEx involves ongoing expenses related to the operational management of a SaaS business like sales, marketing, R&D, and general administrative services.
Impacts on Gross Profit Margin: Misclassification of OpEx as CoGS can artificially inflate GPM, misleading stakeholders about the operational efficiency of the business. For example, a typical GPM for a mature SaaS company should realistically fall between 75% and 80%, with variances explained by factors like cloud resource intensity or third-party integrations.
Where to Classify Customer Success: The placement of Customer Success costs depends largely on the nature of the tasks performed. If focused on onboarding and retention without sales targets, it should be categorized under CoGS. If there is a sales component with commissions on renewals or expansions, then it belongs in OpEx as part of Sales & Marketing (S&M).
✈️ KEY TAKEAWAY
Proper classification not only aligns with best financial practices but also positions a SaaS company more favourably during valuation assessments, particularly in M&A scenarios. Transparency is essential as it directly influences key performance indicators critical for evaluating long-term profitability and operational success.
SaaS Industry Update: Stabilization Amidst Challenges
Accounting for almost 50% of VC funding (Dealroom) in recent years, SaaS is often looked at as a bit of a leading indicator when it comes to funding trends. Wrapping up Q1 2024, the SaaS sector shows signs of stabilization after a tumultuous end to 2023. Despite flat growth across the industry, there are subtle indicators that the worst may be receding into the rearview mirror. Chart Mogul’s Sofia Faustino recently published the Q1 24 report:
Steady State of Growth: The median year-over-year growth for SaaS companies remained consistent at 24%, a decline of 11 percentage points from the same period last year (35%). This suggests that while growth has slowed, it has not plummeted, marking a possible shift towards more sustainable, albeit slower, growth rates.
Potential Recovery Signs: Although the recovery is not uniform across all segments, there has been a slight uptick in growth in certain SaaS niches as compared to the latter half of 2023. This uneven recovery highlights the variability within the industry, with some areas beginning to rebound faster than others.
Challenges in Retention: Median Net Revenue Retention (NRR) has stabilized at 63%, continuing to signal difficulties in customer retention across the board. This figure, a four-year low, emphasizes ongoing challenges within public cloud software companies in maintaining their customer bases.
✈️ KEY TAKEAWAY
The SaaS industry, while no longer in freefall, still faces significant hurdles in reigniting robust growth. The key to navigating Q2 will be enhancing operational efficiencies and perhaps more critically, improving customer retention strategies.
Stay driven,
Andre
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