The Mythical Creature of SaaS: Stock-Based Compensation

Ah, stock-based compensation (SBC)—a creature of folklore in the financial world. Some claim to have seen it in action, others deny its existence entirely. Yet, like a boogeyman, its presence looms large, especially in SaaS companies, where SBC can make up a staggering 20% to 40% (yikes!) of revenue depending on company size, growth stage, and strategy.

And in 2024, we looked back upon the last few years of carnage.

Let’s rewind to the pre-COVID era, 2010 to 2020. The SaaS playbook was clear: grow at all costs. Multiples expanded, value was created, and SBC quietly fueled the talent arms race. With everything going right, no one rocked the boat.

Then came COVID: a period of hypergrowth and historically low interest rates. As valuations skyrocketed, SBC became a non-issue—it was a necessary byproduct of growth. And if the valuation is climbing, who cares?

But as the market cooled post-COVID, the reckoning began. Investors scrutinized dilution’s impact on their returns, and SBC’s cost moved from a line item to a headline.

In many cases, SBC ballooned to over 20% of revenue, with yearly dilution climbing north of 10% as a result. This wasn’t just a SaaS nuance—it was a drag on shareholder value, exacerbated as stock prices fell. Twilio, for instance, became a lightning rod for criticism, with activist investors raising concerns about its SBC strategy.

To put this into perspective, SBC at 20% of revenue is akin to adding a whole new department to the P&L, rivaling benchmarks like 30% for S&M or 20% for R&D. It's a massive burden—and one that SaaS companies, public or private, can no longer ignore.

Today, discussions about SBC dominate boardrooms, particularly for late-stage companies navigating private markets. For CFOs, having a clear philosophy around SBC is no longer optional. It’s essential to address why the company is allocating equity, how it impacts investors, and what the long-term trade-offs are.

There’s an argument for SBC’s benefits—it aligns employees with the company’s success, reduces cash burn (ostensibly replacing or subsidizing heavier cash salaries), and incentivizes long-term performance. But there’s also the other side of the coin: dilution. Investors have grown more vocal about balancing these priorities.

As CFOs, we bear the responsibility of weighing these trade-offs carefully. Every decision to grant equity, limit cash burn, or optimize for dilution must be intentional and defensible. And they’re all linked.

Investors aren’t inherently against SBC, but they expect management to have a clear strategy that aligns with the company’s goals and shareholder interests.

In SaaS, the saying "a lot of revenue cures a lot of sins" holds true—but not indefinitely. SBC, when mismanaged, becomes a sin too big to ignore. For companies scaling rapidly, the key is to treat SBC not as an afterthought but as a core part of financial strategy.

In the end, SBC is neither a villain nor a savior. It’s a tool. How you wield it—whether for talent acquisition, cash preservation, or alignment—determines whether it remains a mythical creature or a strategic asset.

To go deeper on SBC, here’s a convo I had with Clio’s CFO, Curt Sigfstead. This guy gets it.