Navigating Business Model Transitions in the Public Eye
12/8/24 Benchmarks for Operators
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Varonis, a cybersecurity company, recently celebrated a decade on the NASDAQ. During that time they’ve undergone not one, but two major business model transitions in the public eye. CFO Guy Melamed (a fellow Boston College Eagle!) shares some hard-earned wisdom from these experiences.
The Transitions
2019: Moved from a perpetual model to an on-premise subscription model
“The first quarter of 2019 aged me by five years.”
2023: Began transitioning from on-premise subscription to SaaS
Key Lessons
1. Align Technology with Your Goals
Melamed said the longest pole in the tent when it came to buy-in and readiness was systems. That’s right - not sales, not product, and not finance. Ensure your systems (and the people behind them) can enact the change you're trying to make:
"If you don't have the right technology to support whatever change you're trying to make, it's just not going to work."
You may need to add more IT headcount (increasing the dreaded G&A line)
Think: How do we track a deal throughout its lifecycle?
If you can’t bill your customers on day one, you’re dead in the water.
2. Rethink Sales Incentives
Align your sales team's incentives with the new business model. Varonis introduced a grading system for discounts to encourage appropriate pricing in their new subscription model.
"There has to be consequences if you are not positioning the transaction in the right way and you should be rewarded if you're doing it properly."
Incentives drive outcomes. Make it clear that your sales team will “win” at the individual level if they follow the new program
Editor’s note: I did this once at a prior company, and built something called a “cloud indifference model.” It made a rep indifferent between selling a subscription on-premise vs in the cloud
3. Communicate Clearly and Repeatedly
Overcommunication is key, especially with three main stakeholders:
Customers
Investors
Employees
"It's about making sure that employees understand why we're doing the change."
"No matter how much you plan and no matter how much the technology is at the forefront of the change, and no matter how many commission sessions you do, if management is not committed to change, it's not going to happen"
"There's a lot of things investors don't like, but one of the major ones is don't surprise them."
4. Prepare for Short-Term Pain
Be ready for initial challenges, including potential stock price volatility:
"We knew that there would be short-term pain, but we also expected it and believed that there would be long-term gain"
Varonis did indeed experience short term dips in stock price, which can be hard on employee and investor morale.
But as Melamed pointed out, it’s all relative.
5. Focus on the Right Metrics
During a transition, traditional financial metrics may become less relevant. Varonis focused on three "North Star" metrics:
Annual Recurring Revenue (ARR)
Free Cash Flow
ARR Contribution Margin
"We want to make sure that we're not just showing our growth levels, but we're also showing that we can structure the transition in a healthy way from a cost perspective."
Business model transitions should maximize total valuation - not a singular metric.
The Results
While these transitions are challenging, they can pay off. As Melamed notes,
"It ended up being a very successful transition. I think it was very catered to our customers that could consume more of the product. So it was a win-win and worked very well at the end"
Varonis' first transition from perpetual to subscription was completed in just five quarters, faster than the industry average of 4-6 years. And the company is now progressing well in its second transition to the cloud, with 43% of it’s $610M in ARR now cloud based as of Q3 2024 (Source: fleet.so).
Remember, transitions like these are never a smooth left turn. You have to prepare extensively, and also be ready to adapt when things inevitably don’t go to plan. But with the right approach and level of agility, they can position your company for long-term success and value creation.
Apple | Spotify | YouTube
TL;DR: Multiples are UP week-over-week.
Top 10 Medians:
EV / NTM Revenue = 17.9x (+1.5x w/w)
CAC Payback = 27 months
Rule of 40 = 53%
Revenue per Employee = $405K
Figures for each index are measured at the Median
Median and Top 10 Median are measured across the entire data set, where n = 110
Population Sizes:
Security: 17
Database and Infra: 14
Backoffice: 16
Marcom: 16
Marketplace: 15
Fintech: 16
Vertical SaaS: 16
Revenue Multiples
Revenue multiples are a shortcut to compare valuations across the technology landscape, where companies may not yet be profitable. The most standard timeframe for revenue multiple comparison is on a “Next Twelve Months” (NTM Revenue) basis.
NTM is a generous cut, as it gives a company “credit” for a full “rolling” future year. It also puts all companies on equal footing, regardless of their fiscal year end and quarterly seasonality.
However, not all technology sectors or monetization strategies receive the same “credit” on their forward revenue, which operators should be aware of when they create comp sets for their own companies. That is why I break them out as separate “indexes”.
Reasons may include:
Recurring mix of revenue
Stickiness of revenue
Average contract size
Cost of revenue delivery
Criticality of solution
Total Addressable Market potential
From a macro perspective, multiples trend higher in low interest environments, and vice versa.
Multiples shown are calculated by taking the Enterprise Value / NTM revenue.
Enterprise Value is calculated as: Market Capitalization + Total Debt - Cash
Market Cap fluctuates with share price day to day, while Total Debt and Cash are taken from the most recent quarterly financial statements available. That’s why we share this report each week - to keep up with changes in the stock market, and to update for quarterly earnings reports when they drop.
Historically, a 10x NTM Revenue multiple has been viewed as a “premium” valuation reserved for the best of the best companies.
Efficiency Benchmarks
Companies that can do more with less tend to earn higher valuations.
Three of the most common and consistently publicly available metrics to measure efficiency include:
CAC Payback Period: How many months does it take to recoup the cost of acquiring a customer?
CAC Payback Period is measured as Sales and Marketing costs divided by Revenue Additions, and adjusted by Gross Margin.
Here’s how I do it:
Sales and Marketing costs are measured on a TTM basis, but lagged by one quarter (so you skip a quarter, then sum the trailing four quarters of costs). This timeframe smooths for seasonality and recognizes the lead time required to generate pipeline.
Revenue is measured as the year-on-year change in the most recent quarter’s sales (so for Q2 of 2024 you’d subtract out Q2 of 2023’s revenue to get the increase), and then multiplied by four to arrive at an annualized revenue increase (e.g., ARR Additions).
Gross margin is taken as a % from the most recent quarter (e.g., 82%) to represent the current cost to serve a customer
Revenue per Employee: On a per head basis, how much in sales does the company generate each year? The rule of thumb is public companies should be doing north of $450k per employee at scale. This is simple division. And I believe it cuts through all the noise - there’s nowhere to hide.
Revenue per Employee is calculated as: (TTM Revenue / Total Current Employees)
Rule of 40: How does a company balance topline growth with bottom line efficiency? It’s the sum of the company’s revenue growth rate and EBITDA Margin. Netting the two should get you above 40 to pass the test.
Rule of 40 is calculated as: TTM Revenue Growth % + TTM Adjusted EBITDA Margin %
A few other notes on efficiency metrics:
Net Dollar Retention is another great measure of efficiency, but many companies have stopped quoting it as an exact number, choosing instead to disclose if it’s above or below a threshold once a year. It’s also uncommon for some types of companies, like marketplaces, to report it at all.
Most public companies don’t report net new ARR, and not all revenue is “recurring”, so I’m doing my best to approximate using changes in reported GAAP revenue. I admit this is a “stricter” view, as it is measuring change in net revenue.
Operating Expenditures
Decreasing your OPEX relative to revenue demonstrates Operating Leverage, and leaves more dollars to drop to the bottom line, as companies strive to achieve +25% profitability at scale.
The most common buckets companies put their operating costs into are:
Cost of Goods Sold: Customer Support employees, infrastructure to host your business in the cloud, API tolls, and banking fees if you are a FinTech.
Sales & Marketing: Sales and Marketing employees, advertising spend, demand gen spend, events, conferences, tools.
Research & Development: Product and Engineering employees, development expenses, tools.
General & Administrative: Finance, HR, and IT employees… and everything else. Or as I like to call myself “Strategic Backoffice Overhead.”
All of these are taken on a Gaap basis and therefore INCLUDE stock based comp, a non cash expense.