The New Metrics in M&A

A new wave of financial buyers is aggressively bidding for companies, particularly targeting smaller SaaS firms that focus on vertical markets.

These buyers are attracted to the financial predictability of subscription revenue, which enables them to make bold offers. To assess a company's annual recurring revenue (ARR) and its revenue predictability, they employ various metrics. Two of the most significant metrics are Gross Revenue Retention (GRR) and Net Revenue Retention (NRR). If you are a technology CEO with a recurring revenue model, it is crucial to understand these metrics, especially if you consider entering the M&A market.

1. Annual Recurring Revenue (ARR) Percentage

   
   

   Buyers are increasingly interested in the percentage of total annual revenue that is recurring, rather than focusing solely on total revenue when evaluating SaaS companies. Annual Recurring Revenue (ARR) quantifies a company's predictable income stream. A high ARR percentage of total revenue indicates a healthy, sustainable business model that investors highly value. Typically, prospective buyers of smaller SaaS companies require that between 70% and 80% of the company’s annual total revenue is recurring. However, requirements may differ; some buyers may insist on a higher percentage, while others may accept a lower rate depending on their investment thesis, the company's industry, business model, or stage of growth.

   
   

   Different buyers might classify various revenue sources as part of ARR, including maintenance revenue, managed services, contract renewals, and upgrades within existing customer plans. They may also distinguish between revenue contracted for a specific period versus month-to-month revenue. It is essential to clarify what constitutes ARR in discussions with potential buyers.

2. Gross Revenue Retention (GRR)

   
   

   Gross Revenue Retention (GRR) measures the amount of recurring revenue a company retains from customers over a specific period. This metric accounts for revenue lost due to customer downsells and churn, but it does not consider revenue gained from upsells, cross-sells, or price increases.

   
   

   GRR can be calculated in several ways, but typically, it involves comparing recurring revenue from customers for the current month with the recurring revenue from those same customers 12 months prior.

   
   

   Buyers often have different GRR expectations: some may seek a GRR of 90% or higher, indicating that the company retains nearly all its core revenue streams. Others might consider a GRR in the 80% range acceptable. A GRR below 70% raises concerns for potential buyers, as it suggests the company is losing revenue from its customers over time, possibly due to dissatisfaction, inadequate product or service quality, or competition. If your company has a low GRR, it will require careful strategy when presenting to potential buyers.

   
   

3. Net Revenue Retention (NRR)

   
   

   Similar to GRR, Net Revenue Retention (NRR) measures how much recurring revenue a company retains from customers over a given period. Unlike GRR, NRR takes into account revenue gains from upsells, cross-sells, or upgrades, as well as losses from downsells and customer churn. This metric demonstrates a company’s ability to retain customers while also growing revenue from them.

   
   

   Buyers generally prefer to see an NRR of over 100%, indicating strong customer retention and sufficient revenue growth within the existing customer base to offset any losses from downsells or churn. A high NRR is a positive signal for buyers, as it suggests that revenue will continue to grow even without acquiring new customers. A company with a robust customer base and high NRR can be attractive to prospective buyers, even if its overall growth rate is lower.ç

Get Professional Advice

While ARR, GRR, and NRR are not the only metrics that buyers consider, understanding them is essential—especially for SaaS providers considering entering the M&A market. Your financial and accounting teams should be well-versed in these metrics, so it is important to discuss them with them. Additionally, you may benefit from professional advice regarding these metrics from a financial or accounting firm.

Regardless of how positive your metrics are, numerous opportunities exist for technology companies in today’s M&A market. Codify has extensive experience in advising technology companies on sales deals, boasting an almost 20-year track record and having assisted more technology firms than any other firm in history. Their highly professional and detailed M&A process is designed to help sellers achieve optimal outcomes, including maximized valuations, well-negotiated transaction structures, minimized liabilities, and optimized tax implications. If you are considering entering the M&A market, please reach out to Codify. Their team comprises experienced dealmakers, all former CEOs who have run, sold, and acquired companies.