We’ve written a report on 10 Secrets to Scaling Up. There are more than 10 but then who’s counting? A scaleup is defined as a company with an average annual growth of at least 20% over three consecutive years. The notion of growth is critical to achieving scale, and regardless of sector, entrepreneurs work hard to grow their businesses. But how do we measure success in scaling, and what is the secret to growth?
To answer these questions, we looked at thousands of software companies to uncover their secrets to driving growth. This report sets out important growth metrics, particularly for those selling Software as a Service (SaaS).
We begin with the standard formula for valuation:
valuation = revenue x revenue multiple
Growth has a dual effect on this formula: firstly, higher growth rate results in higher revenue (one dimension of the formula). And secondly, the increased growth rate increases the revenue multiple (the other dimension in the formula).
Given this relationship between growth and valuation, any company wishing to compete as a world-class business must be growing wildly to generate superlative returns for a venture capitalist (VC). Because of the dependence of returns on growth. VCs consider a 10–20% growth per month in the seed stage and 60% per year in the expansion stage as a minimum to consider a business worthy of investment. In practice, many VCs will actually only consider companies with annual growth rates of 100% as prospective investments.
Market Size & Innovation Adoption
We looked at SaaS Unicorns and public companies to learn about the impact that market size has on growth. We found that the first requirement for growth is to be situated in a large market. It is virtually impossible to grow sufficiently or quickly in a small market. History shows that high-growth companies tend to be consumer-based, serving markets that are broadly based and horizontal—rather than vertical—in nature.
After market size, the next most important factor is the rate at which the market takes up and adopts new innovations. If a new company is selling a product or service that their target market has never purchased before, the rate of diffusion will be slow. Even in a large market, poor uptake will slow down the potential growth of the company.
Capital and People
To determine how much capital and how many people are required to drive high growth, we looked at the results of thousands of public and private software companies.
Our results suggest that an average public software company needs $1.23 of capital for every dollar of revenue earned. Capital requirements are lower for growth rates below 20%, but when growth is higher than this, substantially more capital is required. For a company that is scaling successfully, the ratio of capital to revenue should be between 1:1 and 1.5:1.
The data also shows that the amount of capital required for human resources is at least $300k-$500k per employee for rapid-growth companies. The average revenue per employee is $330k.
Thus, a company attempting to scale up should expect to raise approximately$12.5 million of capital for every $10 million of revenue (1.25:1). This would fund 30 employees (at $400k of capital per employee) and produce $10 million of revenue (at $330k revenue per employee).
We must keep in mind that how and when you raise funds also matters. Firms that raised the highest amounts in their first year of seeking capital subsequently raised far more than firms who raised less capital in their first year. The relationship is particularly strong in the first five years of fundraising, showing that there is a definite advantage to raising more money the first time you raise it.
A fine balance must be struck in terms of timing. The data shows that waiting slightly longer to raise funds generally results in a larger first round and is better correlated to higher amounts raised in the long run. However, there does not appear to be any benefit in waiting more than 5 years to raise your first round.
To understand what drives growth, we partnered with Openview, a US-based VC that conducts an annual survey of SaaS companies.
We divided the companies in Openview’s database into three stages of growth: validation stage (below $1 million in revenue), efficiency stage (approaching $5 million), and scaling stage (above $5 million). Based on the analysis, we can draw some conclusions about operational variables and their relationship to growth:
- Growth declines, on average, as firms move from inception to scale. While average growth rates in the validation stage are 150%, they decline to 67% by the time firms are in the scaling stage.
- In the validation stage, businesses favour employment in marketing and sales (M&S) over research and development (R&D), at a rate of 2:1. This declines to 1.15:1 by the scaling stage.
- The higher the M&S employee composition, the higher the business growth. This correlation between employee composition and growth holds at all stages.
- Significant funds are spent on M&S at all stages. But, while the ratio of R&D to M&S stands at 1.75:1 in the validation stage, that ratio flips to 1:1.45 by the time a firm reaches the scaling stage.
- Higher spending on M&S is correlated with higher growth rates.
- The higher the burn rate, the higher the growth rate at all stages.