Net revenue retention and 3 things every venture capitalist looks for

When considering an investment in a software-as-a-service (SaaS) business, potential investors want to ensure the business has a stable or growing customer base. This consideration makes perfect sense. 

Because SaaS businesses are subscription-based, a business can have a solid product, great management team and steady history of growth, but if the business’s net revenue retention (NRR) is average or below average, obtaining funding could be challenging. 

Why? Investors consider NRR a key performance indicator (KPI) for a SaaS startup. 

Any startup seeking investment should understand the importance of analyzing and optimizing NRR internally before a funding round. The startup should do so especially if its KPI metric is average or below average.

To understand this information comprehensively, we’ll cover what NRR is, its importance, and how a related KPI (e.g., gross revenue retention, or GRR) enables investors to assess whether a business is retaining its existing customers. 

What is NRR?

NRR is the percentage of recurring revenue retained from existing customers over a month or a year. NRR also includes revenue from customer upgrades, cross-sales, downgrades, and cancellations.

According to industry data, the valuation of a SaaS business with high revenue retention can be double that of a company with average rates. 

In this space, potential investors will focus their analyses on the business’s customer base and growth potential.

NRR and GRR do not directly indicate to management or an investor that the business is losing customers. These KPIs tell investors how well the business is generating and retaining revenue from customers over a certain period – again, usually a month or a year.

Overall, NRR helps businesses determine their “churn” rate. 

A churn rate is the percentage of current customers who cancel their subscriptions. A deep understanding of a business’s NRR and churn rate will guide management towards ways of optimising their NRR to attract investors.

[Related: How to calculate burn rate (the right way!)]

Why is NRR important?

NRR helps a SaaS venture understand how its churn rate influences its overall revenue and whether it might be losing low-value or high-value customers. Think of NRR as a proxy for customer satisfaction and success. It’s a primary consideration for an investor.

A business that retains NRR indicates that its sales and customer teams are generating repeat sales or expanding sales to existing customers. 

Enthusiastic customers are more likely to praise the business’s virtues and products to other potential customers. Or, in other words, they’ll say good things about the company, which will likely lead to more sales and, consequently, more growth. 

Understanding NRR is critical because the average cost to acquire new customers in the SaaS industry is only $205. In essence, the SaaS sales environment is highly competitive compared to other sectors.

An NRR over 100% indicates a business is retaining existing customers and growing sales quite well. Moreover, an NRR at 100% means the company can continue to grow even if it doesn’t gain another customer.

How to calculate NRR

To calculate NRR, you need four specific data points:

• Last month’s recurring revenue

• Churn rate (percentage of current customers cancelling their subscriptions)

• Revenue ‘expansion’, meaning revenue from upgrades, cross-sales, and increased prices

• Revenue from any downgrades or cancellations

Once you know this information, the formula to calculate NRR looks like this: 

NRR = [(total revenue + expansion revenue) – churn] / total revenue

Example of an NRR calculation

Assume the SaaS business has 100 customers paying $2,000 per year to subscribe to its software. During the relevant period, 10 customers canceled, 80 renewed their subscriptions, and 10 upgraded to a $4000 per-year subscription package.

With this information, the business’s NRR is as follows:

[($200,000 + $40,000) – $20,000] / $200,000] = 110%

In this example, the business and potential investors can see that, although the business has lost some customers over the period, the average revenue generated by each remaining customer has increased.

From an investor’s perspective, this business’s NRR suggests a stable customer base and future revenue growth.

GRR and NRR: What’s the difference?

GRR also measures revenue lost from the customer base, but the calculation doesn’t include expansion income from cross-sales, upgrades, and price increases. 

In this way, GRR provides a clearer picture of existing customer retention because increasing expansion income can’t obscure customer cancellations. That’s why many investors prefer to analyze GRR rather than NRR.

GRR will always be equal to or lower than NRR, and GRR will never be greater than 100%.

GRR = (total revenue – churn) / total revenue

In the example above, GRR would equal 90%. GRR shows investors that while the business may be doing a great job at upselling some existing customers, if it’s losing customers on an absolute basis, growth could eventually stall or decrease. That’s if a large, critical customer cancels their subscription.

In other words, NRR may be above 100%, but if GRR is low, potential investors will be very cautious and will likely request further analysis or decline the investment opportunity altogether.

The three things venture capitalists look for in NRR and GRR

An NRR at or above 100% suggests a business is excelling at upselling and servicing remaining customers (despite any customer losses).

Unsurprisingly, potential investors in a SaaS business want to see an NRR at or above 100%.

High GRR indicates a sustainable revenue stream and future growth. Generally, in the SaaS investing ecosystem, many venture capitalists look for a GRR between 75% and 90%. 

Some venture capitalists prefer NRR to provide an insight into product acceptance and customer satisfaction because it focuses on revenue generation from all sources, including upgrading happy customers.

To a potential investor, a high NRR and a lower GRR might mean the business is focusing its sales and marketing efforts on high-value customers and shedding low-value ones.

Lastly, potential investors in a SaaS business want to see a low churn rate. The NRR and GRR help with that analysis. A low churn rate means the company is excelling at retaining customers in an absolute sense, but doesn’t account for revenue expansion.

In short, a business with a high NRR and a high GRR is likely to attract the interest of venture capitalists. A company with a high NRR and low GRR might raise questions about growth sustainability.

A business with a low NRR has work to do if it seeks investment.

How to optimize your NRR

A high churn rate or low NRR could indicate deficiencies in customer or technical support and technical issues. Or it could mean that sales teams are trying to upgrade new customers too aggressively (or too quickly), and these customers are leaving at the first opportunity. 

In any case, what can a SaaS business do to increase NRR?

Customer segmentation is a valuable analytic exercise. 

Separating high-value and low-value customers will inform strategies to increase revenue expansion among high-value customers. 

For high-value customers, a high-touch model with substantial personal coaching and training may be the ideal solution. The business might interact with low-value customers using a more tech-focused approach.

Another way to increase NRR is to monitor customer behavioral data and other adoption trends closely. 

Quantitative and qualitative data on service utilisation, product usage, engagement, customer support, and satisfaction should provide a ‘customer health’ score. For example, analyzing such data may provide insight into the optimal time to cross-sell or upgrade, particularly when a high customer health metric is present.

Relentlessly focusing on customer success can also benefit NRR. 

Customer success directly correlates to the value a customer realises in doing business with your business. If the company doesn’t have a dedicated customer success team, you should consider creating one.

If your business has a client success team but is losing customers at an unacceptable rate, the business could attempt to link all or part of the success team’s compensation to customer renewals and expansion revenue.

The goal of any effort to increase NRR is to increase customer success.

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