what-hockey-stick-growth-for-saas-companies-really-means
Article

What ‘Hockey Stick’ Growth for SaaS Companies Really Means

by John Kogan
June 14, 2021

The “hockey stick” metaphor is frustrating to many CEOs. As part of the vernacular, it’s used by everyone, but truly understood by very few. The frustration is even worse for SaaS companies because they have become virtually synonymous with the phrase based on both their sexy new business model and the very economics of the model itself.

To help shed some light on what your investors really mean when they use the term, let’s break it down.

Revenue Growth Over Time

Hockey stick growth refers to the shape of a company’s revenue growth over time. It starts with the blade of the stick, which is flat on the ice. That represents no revenue, just a flat line, while a new company develops its products and services. This phase may last years and is funded primarily by equity (as opposed to debt) investors. It takes a lot of faith from all parties, and a lot of hard work by the company, to get past the blade phase.

Then comes the inflection point — the curve on the hockey stick that sends it upward. It’s a steep, rapid curve that indicates tremendous growth in a short period of time. This represents product launch and dramatic market acceptance. (This model isn’t called the “wedge” for a reason. Wedge-shaped revenue growth does not get a VC excited.)

Picture a line that represents going from $5M in revenue at point A to $10M at point B. You can’t without one important element: time. Growing from $5M to $10M over ten years is roughly 7% annual growth. That’s boring to an equity investor and looks more like a return on debt, not equity. Now picture that growth over one year. That’s 100% growth!

A great illustration of this is data collected in 2015 by Tomasz Tunguz of Redpoint Capital that showed that publicly traded SaaS companies founded between 2008 through 2014 needed 50% less time to reach $50M in revenue than their counterparts founded between 1998 and 2005, and 82% of the companies that achieved $50M in revenue in under eight years were founded in the previous 10 years.

Hitting $50M of revenue in under eight years since founding is fast growth, especially considering the SaaS business model, which drives revenue over time as opposed to all revenue up front like many traditional business models (think perpetual-licensed enterprise software). What do you get when you found a company, spend a few years developing the product, and then launch and get to $50M revenue? The upward curve of a hockey stick.

Then it keeps on going. The shaft of the hockey stick represents continued rapid growth. The alternative is a hump which goes back down. But true hockey stick growth requires growth over years, not just months or quarters. This phase demonstrates that the early growth was not random and has real legs.

Sustained Growth

Techcrunch has a nice article on SaaS growth that pegs top SaaS companies at 80%-85% sustained growth from first revenue to an IPO. That is what your equity investors are looking for. Sustained growth is the key to massive value creation and is the indicator to the market that the company has what it takes to create tremendous value.

One thing that’s presumed at these companies is eventual profitability. It’s interesting to note that profitability is not a requirement for massive valuations, but it has to be achievable some time in the future. Being able to imagine that future is enough for many investors to impute their massive valuations in the present.

All of this points to the most common means of valuation in today’s market: the revenue multiple (and its sibling, the EBITDA multiple). Stated simply, the revenue multiple refers to the value a third party will pay for your company (or the market value in an IPO/SPAC). For instance, if you’re at $50M revenue and get an offer to buy your company for $500M, that’s a 10X multiple.

Only companies with tremendous growth get high multiples. Thus, it’s not just the revenue level that sets value, it’s revenue and growth, considered together. Which brings us back to the hockey stick. That shape defines both rapid and sustained growth, driving you to a higher base (defined by your revenue) more rapidly and a higher multiple (defined by your growth rate).

Low Churn

As noted above, the very economic model that drives SaaS/subscription companies leads to the hockey stick. For example, the old model of perpetually licensed software meant that you had to resell the vast majority of your revenue every year. The services component was the only element that maintained client revenue year to year.

With subscriptions, you get to keep everything that doesn’t churn out. So, your wins pile on your wins. This is part of what makes low churn so critical to long-term success and massive, rapid growth. Standing on the back of prior wins is a great way to accelerate growth.

So, there it is — the hockey stick shape is an apt metaphor for massive value creation and is highly fitting for SaaS software success stories. The leaders of hockey stick companies need to build every aspect of their company for massive revenue scalability and eventual profitability.

This trajectory is neither random nor lucky. It points to doing many things right as a leader over a sustained period of time, without being sunk by the mistakes which will surely occur.

To learn more about saas, contact our SaaS experts.

Stay In Touch

Sign up to stay up-to-date with the latest accounting regulations, best practices, industry news and technology insights to run your business.

Author
John Kogan
Director
Resources
Related News and Insights
Optimize High Tech Manufacturing Supply Chain Improved Operations Visibility
Webinar
Learn how companies can use D365 to improve forecasting, operational visibility and increase revenue.

October 7, 2021 | 10:00 AM - 11:00 AM PT
Dynamics GP to BC Powerful Financial Reporting Webinar
Webinar
Learn from experts about the robust financial reporting capabilities in Dynamics BC.

October 6, 2021 | 11:00 AM - 12:00 PM PT
5 Privacy Misconceptions Hindering Health Tech Adoption
Article
Proper understanding of global privacy rules is essential for innovation in the healthcare industry.

September 14, 2021