Software companies live in a world in which the allocation of capital to either doing something new or doing something bigger never ceases. How does one pick and choose the order of priorities or even how something gets posted on the list of priorities? Interestingly, one of the highest returning capital investments in software land is often left off the list (clue: not all revenue is the same).
Investing in Sales as a Benchmark for Success
Our analysis consistently shows that a robust sales engine is key to success. In the realm of Energy SaaS and B2B software, an investment in sales processes and resources can yield up to an 8x return at exit over four years, translating to an impressive IRR of about 66%. This "scaling product market fit" becomes a vital benchmark against which other projects are measured.
Evaluating New Product Development (SKU) Investments
Diversifying your portfolio with a new product, or "energy software," can be a game changer, but it comes with increased risk. When investing in a new SKU, the payoff should be, in our judgment, threefold that of scaling an existing SKU. Said another way, the IRR for establishing product market fit could be around 200% (i.e. 3 x 66%). This high reward possibility sensibly reflects the inherent risks, but also the potential for significant market impact and revenue generation from successful new products. If an advocate for the new SKU can't support a case for 200% IRR . . . the new SKU does not make it onto the list of priorities.
One Priority That Can Pay Very Heavily — Elevating to Upmarket Sales
The quality and nature of your customer base profoundly influence exit valuations. That variance in quality can have a material impact on the price someone is willing to pay at exit (note to self: quality may be measured in a way that is not so obvious). Let's say there are two companies competing in the same sector, each with $20 million in revenue, Companies A and B. Company A is comprised primarily of mid-market customers and Company B is comprised primarily of upmarket customers (all other things are equal). Which company sells for more at exit and why?
Upmarket is that bucket of the largest, most sophisticated prospects/customers in your target market. Large acquirers are more interested buying you for your upmarket accounts than they are in the alternative of mid-market accounts for simple reasons: they can likely sell more of their own stuff to upmarket accounts (than they could elsewhere), at a lower cost, with less likely churn. Even if they are interested in your mid-market accounts, they are not interested in buying you at the same price, again for simple reasons: they can't sell as much, it occurs at a higher cost, and churn is more likely. So the answer to "which company sells for more at exit?" is Company B.
If we say the difference in price between Companies A and B is one turn of revenue at exit (ask any professional investor if they believe that) then we are talking about $20 million in incremental exit value. That is a big number. What should you be willing to invest to make that happen? If you perceived going upmarket as the risk equivalent to proving product market fit (i.e. 200% IRR), you might be ecstatic to invest $1.2 million in a strategy that can produce this outcome (i.e. the present value of $20 million to be received in four years discounted backwards at 200% required rate of return).
Investing in strategies to target upmarket customers, akin to a calculated risk similar to proving product market fit, can result in significant returns. At MOIC Partners, we specialize in guiding companies through this process, ensuring that your move upmarket is both strategic and profitable.
