“40% rule” : SaaS business line life and death

cloud network hunting note: in this paper, the author is Brad Feld (Brad Feld), boulder, Colorado, managing director of a group. Field, investment in the United States a number of software and Internet companies. After a recent board, he again to share with you a new law: “40% rule” – that is, growth rate and the sum of profit margin should be 40%.

recently, I attended a meeting of the board, at the meeting, I learned from a later investors some have never even heard of the new knowledge. He said his company often USES 40% rule to determine whether a software company operation is good, of course including software as a service company. The norm of software as a service company is generally, assumes that the total profit of $50 million, in my imagination, only when the maximum rate of climb (MRR) of 1 million when the company’s business development is the most perfect.

the investor said 40% of the law, refers to the growth and profit margins should be equal to 40%. So, if your growth rate of 20%, so it should increase your profits by 20%. If the growth rate of 40%, profits, no increase without decreases. But if the growth rate reached 50%, the profit is likely to reduce 10%. So if you can go beyond 40% rule, that your company shall not be able to.

in the software as a service enterprise, the growth rate is very easy to calculate. Just compare the MRR year-on-year growth rate of each month, you can get your gross earnings, but remember that you also make sure that when computing MRR in your general accounting standards bill didn’t show up some wrong data, especially including instant service. So from time to time to check it again your gross annual growth is significant, no matter you are using AWS, or other cloud services, or directly run a data center, you need to make sure that the cost of sales and profit growth.

but profit is another situation, usually profits is hard to define. Here our profits really interest, tax, depreciation and amortisation, or operating income, is the net income, or net cash flows, or just cash flow, or other? Here, I’m going to on the basis of the interest tax, depreciation and amortisation, then with the other percentage data for testing. If your company happens to run on the AWS or other cloud services, then define profit not too difficult but also relatively stable. But, if you run on your own infrastructure, your interest, tax, depreciation and amortisation, operating income and net cash flows and net income and cash flow you have very big difference, because of equipment procurement, debt financing or rental and other expenses. So, you are in need to be careful when using profit figures, which data should be used, and it depends on your company run properties.

although we know that if growth too fast will lead to loss, but as long as no more than 40% of this point, we can still look forward to a more satisfactory rate. Today, some people focus on MRR growth, some people are concerned about ARR (accounting rate of return) growth rate, and some people will be more care about the year-on-year growth rate of each month. Others will focus on the same strange gaap earnings on such data, in order to prove that the growth rate. No matter what your concern is, you need a reference line. To my personal experience, MRR year-on-year growth rate is the most easy to calculate and ambiguity of the smallest, but I will not only look at this data, other data measurement can help me get a more accurate answer.

I often hear some small software as a service company said, “if we slow down growth, we can immediately profitable.” Indeed, that is true, but if you put the growth slowed to 20%, so although your profits rose by only 20%, but it also shows your company operation is good, will soon be from small to medium-sized and even large successful enterprises. So, if you want to get vc financing, then try 40% rule.

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