Want to be a VC investor? Start learning the lingo.
Genevieve Signoret
(Hay una versión en español de este artículo aquí.)
As many of you know, besides managing portfolios in public markets, at asset management firm TransEconomics I co-manage two Delaware-based funds in private markets. One, Tealta Growth, is a fund of international venture capital funds. The other, Tealta Income, is a fund of US commercial real estate funds.
Our investors in the Tealta Family of Funds receive a weekly newsletter called Tealta Talk. Usually, it updates Tealta investors on our portfolio funds. But sometimes instead it introduces jargon to help beginner private-capital investors more shrewdly monitor their investments. Our most recent edition is a case in point. It introduces the single metric that venture capital investors in Software as a Service focus on most obsessively—ARR.
After publishing Tealta Talk this week, it occurred to me that La Carpeta Negra readers, too, could find it useful. So, below, I quote it in full.
Please let me know what you thought in the comment section below or by email. Or comment on or ask about anything else related to investing in international public or private markets.
Tealta Talk Term of the Day: ARR
In the VC world, players throw around terms and abbreviations all the time, as if everyone in the room knew what they meant. (Oops, we just did it ourselves! We said “VC” instead of “venture capital”. You see?) But here’s the fun part for you, Tealta Growth investor: you’re a VC player now, too. So you, too, get to throw around cool jargon like the best of them—or at least tune in to the conversation when others do.
Today’s Tealta Talk Term of the Day is ARR, the metric VC investors in SaaS (Software as a Service) most like to throw around. And obsess over.
You may be wondering why the SaaS subsector of the tech economy pulls in so much VC capital. And why we hold one portfolio fund that even specializes in it.
Mutual attraction is the answer. Founders are drawn to VC investors because, to succeed, they face huge upfront development costs. VC investors fall for SaaS founders because, once a SaaS company’s subscriber base hits a critical mass, its profitability can explode.
So, what is SaaS? It is rental software. Do you hold a Microsoft Office 365 license? Have any for-pay apps on your smart phone? If you answered yes to either question, you are a SaaS subscriber. To enjoy these apps, you pay annual or monthly rent.
Now, picture yourself on the other side of the transaction, as a SaaS producer. You collect that monthly or annual rent. It constitutes your ARR, or Annual Recurring Revenue. What entrepreneur does not love recurring revenue? You’re sitting pretty, right?
To an extent, yes, but your fixed cost is huge; your breakeven ARR, therefore, high. And must be paid up front. You need to develop the software, the marketing platform for peddling the software and collecting rent, and infrastructure for servicing subscribers and bringing out nonstop updates and upgrades. It is this upfront cost that draws SaaS founders to VC investors.
Now, with upfront fixed costs so high, why would a VC investor even want to fund you? Because there is a flip side: your variable cost—your cost component that goes up with each new subscriber—can be tiny. This means that, once you hit a critical mass of subscribers, not only will you be profitable, but also your profit margin can start to shoot up.
You may wonder why we’re so keen for you to become comfortable with the term ARR. It is because everyone in the world of VC funding for SaaS is obsessed with ARR.
Early-stage SaaS companies can go years before hitting profitability. VC investors understand and expect this. It makes no sense for them to focus on profits. Instead they focus on ARR and its rate of growth. Every dollar of VC funding for SaaS founders, and every minute of their time spent mentoring these founders, are aimed at accelerating ARR.
Congratulations: you are now one of the cool kids. Anyone in the room throws around the term SaaS or ARR, and you can chime in intelligently.