In Crossing the Chasm, Geoffrey Moore asks startups to pick an initial beachhead market in which they believe they can be the market leader i.e they have 50% or more of the total market. To put it an inverse way if you want to have $15m of revenue that means that the total spend in the market you pick must be at most $30m annual spend for that product.
But what about revenue growth. A recent article by Scale Partners discusses the Mendoza Line for startups. For non-baseball fans, the Mendoza Line is a baseball term for the batting average below which a hitter is not worth hiring for Major League Baseball. That article posits two principles:
The first is that most venture investors prefer to invest in companies that have at least the chance to become standalone public companies (which is not to say most achieve this objective). Looking at the realistic low bar of what it takes to be a public company, this implies being at run rate revenue (ARR) of $100 million at the time of IPO, while still growing at 25 percent or greater in the following year.
The second is that most of the time, growth rates only decline, but do so in a way that is on average fairly predictable. For a best-in-class SaaS company, the growth rate for any given year is between 80 percent and 85 percent of the growth rate of that same company in the prior year. We refer to this as growth persistence (and this assumption holds true from about a $10 million run rate on).
If we look at the simple tables below we can see some interesting math. I have picked 7 years here as the target horizon, being a typical exit time for founders and investors.
Let’s say you have a company who is currently doing $200k ARR. This may be your typical seed company or even pre-seed. It is still trying to identify product market fit, it doesn’t have many reference customers (maybe 1 or 2) and it is still trying to decide if it should hire more people. It might have only a couple of people outside the co-founding team. Let’s also say your goal is to be doing $30m ARR in 7 years. The below table shows that you therefore need to grow your revenue around 2x per year every year for the next 7 years to get there. Note that these are compound rates, which means that in Y6 you would have had to been doing around $15m ARR, to have made your goal of $30m ARR in Y7. Also note that in Y1 for example you would have only been growing from 200k to 400k i.e 200k ARR, whereas in Y6 you would have been growing by $15m ARR – clearly a much harder task. In fact most people expect growth to decline for this reason as you increase your absolute revenue (e.g see this post, where they discuss how it is likely to be no more than 80% of last years’ growth).
| Revenue Target $m | ||||||||
| Y1 | Y2 | Y3 | Y4 | Y5 | Y6 | Y7 | ||
| CAGR | 1.0 | 5.0 | 10.0 | 15.0 | 20.0 | 25.0 | 30.0 | |
| Today’s Revenue $m | 0.1 | 900% | 607% | 364% | 250% | 189% | 151% | 126% |
| 0.2 | 400% | 400% | 268% | 194% | 151% | 124% | 105% | |
| 0.3 | 233% | 308% | 222% | 166% | 132% | 109% | 93% | |
| 0.4 | 150% | 254% | 192% | 147% | 119% | 99% | 85% | |
| 0.5 | 100% | 216% | 171% | 134% | 109% | 92% | 79% | |
| 0.6 | 67% | 189% | 155% | 124% | 102% | 86% | 75% | |
| 0.7 | 43% | 167% | 143% | 115% | 96% | 81% | 71% | |
Ok so that seems really hard, and most people say, oh that’s because the base is so low so the growth numbers look abnormally large. But let’s do the exercise but assume you did really well and you had $2m ARR today instead of 200k. $2m ARR is by any standards a company that has taken the step up from “idea” to “business”. It has made, or made great steps towards product market fit, it has at least 1-3 key clients or a decent number of users, it has a medium sized team outside of just the founders. It is doing 10x the revenue of the first company we looked at.
So let’s assume the same goal – $30m ARR in Y7. I did this with a team the other day and found that most people (myself included) cannot visualise these compounding numbers in their head post say Y3 or 4 (in fact what company forecasts more than 3 years!) and if you asked one of your team you might get some of the following answers:
- Some people will largely assume that 10x more ARR to begin with means the growth rate is 10x less, so it will be something like 10% instead of 100% per year
- Others will look back at high school math and remember that compounding interest is different to simple interest, so 10% doesn’t look right but it probably should be say 3-4x less and may guess say 25%
- Very few people (in our real world example nil) will guess anything above 40%
So what’s the actual answer. 47%. Yes, even starting with a base 10x bigger than the first company, the second company still has to grow its revenue by half every year! Did you guess that? Ask anybody in your sales team if they are happy with their sales target being increased by 50% or 100% each year.
| Revenue Target $m | ||||||||
| Y1 | Y2 | Y3 | Y4 | Y5 | Y6 | Y7 | ||
| CAGR | 5.0 | 9.2 | 13.3 | 17.5 | 21.7 | 25.8 | 30.0 | |
| Today’s Revenue $m | 1.0 | 400% | 203% | 137% | 105% | 85% | 72% | 63% |
| 1.5 | 233% | 147% | 107% | 85% | 71% | 61% | 53% | |
| 2.0 | 150% | 114% | 88% | 72% | 61% | 53% | 47% | |
| 2.5 | 100% | 91% | 75% | 63% | 54% | 48% | 43% | |
| 3.0 | 67% | 75% | 64% | 55% | 49% | 43% | 39% | |
| 3.5 | 43% | 62% | 56% | 50% | 44% | 40% | 36% | |
| 4.0 | 25% | 51% | 49% | 45% | 40% | 36% | 33% | |
Of course, both companies will be hiring more, advertising more, attacking new channels and hopefully establishing a leadership position in one or more markets- the point of this exercise is to ensure that everyone on your team has aligned expectations about how much more revenue they need each year and are focusing and resourcing appropriately. In the first example, what would have happened if you grew your ARR by 75% per year instead of 100%. 75% is pretty good right? You would have actually ended up with $10m ARR instead of $30m ARR. In fact, if you had grown at 100% every year except the last 2 years in which you grew 80% you would only have $20m ARR instead of $30m ARR. That would have cost you multiples of $10m if you were acquired at Y7.
So here’s a quick exercise you and your team can do. Take your next 12 months’ sales forecast budgeted growth rate and assume that you grow that rate for the next 6 years post that. If you have a 24 month forecast, take the average of the next two years’ growth rate and project it out for 6 years. If the number you calculate isn’t the number you want, then you’ll have to work out what items can make massive change in the business. Remember, by massive change, if you only had $150k ARR instead of $200k ARR today and you doubled every year for 7 years you’d only have $13m ARR instead of $30m ARR. Remember also, that keeping the same growth rate as your business scales is also increasingly hard because the numbers get progressively larger on an absolute scale.
So assuming that it is hard to grow by more than 80% (see the original article on growth persistency by Rory O’Driscoll of Scale Partners) of the previous years’ growth in the next year, even if you are at $2m today, to make $30m or more ARR in 7 years you’ll need to think about targeting doubling your business next year rather than just 50% growth. Did you think you’d have to grow that much and are you thinking big enough with your go to market strategy?
| Revenue Target $m | ||||||||
| Today’s Revenue $m | Required | Y1 | Y2 | Y3 | Y4 | Y5 | Y6 | Y7 |
| Growth | 195% | 156% | 125% | 100% | 80% | 64% | 51% | |
| 0.2 | 0.6 | 1.5 | 3.4 | 6.8 | 12.1 | 19.9 | 30.0 | |
| Growth | 86% | 69% | 55% | 44% | 35% | 28% | 23% | |
| 2.0 | 3.7 | 6.3 | 9.8 | 14.1 | 19.1 | 24.5 | 30.0 | |