There may be errors in spelling, grammar, and accuracy in this machine-generated transcript.

Katie: Welcome to the Best Metrics podcast. Each episode, we meet with industry experts to discuss how they evaluate financial statements, what metrics they commonly use, and how their clients have improved. We'll also gather suggestions of how you can incorporate the same insights and processes into your own practice. Thanks for listening and enjoy this episode.

Glenn Dunlap: Welcome [00:00:30] back to the Best Metrics podcast in the industry. We're exploring today is the technology and SaaS industry, certainly one with many relevant applications for our day to day lives here. To give us a full picture of of the important metrics for this subject, we're excited to welcome not one, but two guests, Patrick Smith and Wade Malik of CLA. Hi, guys. Hello. Hello. Welcome, welcome. Uh, based out of Seattle, Patrick is the managing principal for the technology industry at [00:01:00] CLA. He has a strong background in tech accounting, spanning 25 years in the industry and many with of those with tech and SaaS companies themselves advising on business matters like multi state income tax, sales and use tax, international tax and financial reporting, in addition to the and all those, uh, taxes that we just mentioned there. Uh, so also joining us is CLA, CFO technology tech industry leader Wade Malek from Madison, Wisconsin. Wade has extensive experience in strategic planning for financial departments of tech companies. He takes [00:01:30] a holistic approach to advising for tech and SaaS companies, making sure to gather information regarding areas of the business beyond just the finances in order to, uh, make make recommendations to those companies. So welcome to both of you and I look forward to our conversation. So well,

Patrick Smith: Thank.You for having us.

Glenn Dunlap: Yeah, absolutely. Before we jump in, let's talk about CLA a little bit. And in each of your practices, um, you know, CLA is one of the top ten firms, um, in the country, I think.

Patrick Smith: Yeah, we're. Yeah, we're number eight, um, of [00:02:00] the I call them the global eight. But, uh, you know, one of the things that we really focus on is working with closely held businesses and their owners, um, we're, you know, strong middle market firm, and we've got about 9000 CLA family members across the country, 130 offices. So, um, kind of the kind of the best of a big firm, but with that kind of local firm feel. So we're really excited to be here and, uh, love the opportunity to, to share our thoughts on, on these metrics with you and your [00:02:30] audience. Yeah.

Glenn Dunlap: That's fantastic.

Patrick Smith: Wade, do you want to introduce yourself real quick?

Wade Maleck: Yeah, sure. Like Glenn said, uh, you know, I'm here in the Madison office, lead the outsourcing team for our technology industry. Um, I've enjoyed working with startups both inside and outside of CLA. Uh, being CFO and CEO.

Glenn Dunlap: You're an absolute masochist if you're doing that. So. It is it.

Wade Maleck: It can be maddening at times, stressful [00:03:00] at times. But in the end, you look back and all you learned and all you did and it's fun.

Glenn Dunlap: It's no two are the same, are they? I mean, there's always something different about each one of them. There's similarities, but there are a lot of lot of challenges in that. So. Well, it's, uh, it's great. This is obviously, um, near and dear to my heart being, uh, an owner of a tech and SaaS company, if you will, myself. Um, you know, so, uh, I'm excited to have these conversations and, and, uh, and get your thoughts on this. So, uh, the way we typically [00:03:30] open up, I'm going to open up with you guys, too. And let's just start with, um, um, when you're meeting with a new company, a new client or new prospect, uh, or even when you sit down with one of your existing companies, you get a set of financials from them. I'm assuming you're getting a PNL on a balance sheet, and you're looking at those numbers like what? What are the first things that your eyes are drawn to, especially in a SaaS company? Like what? What are the things that you're looking for right away that start to tell you the picture of what you're what you're seeing on those financials?

Wade Maleck: For? For me, it depends on the stage of the company. Okay. So depending [00:04:00] on early stage early or the stage, I'm probably looking at different things in a later stage. So my early stage clients companies, you know I'm looking at you know what cash do they have on hand. What are they burning. Um, just to get an idea of what their runway is, looking at their equity section to get an idea of how much capital maybe they raise. Is it preferred stock. Is it common stock. And you know, then looking some of them may give me a year over year [00:04:30] comparison. Some of my earlier stages are month over month. And so I'm just looking at the progress that they're making in terms of revenue or if it's deferred revenue. So just kind of skimming, if you will, the balance sheet and income statement and going, okay, what's story obviously is this trying to trying to tell me just from the numbers okay.

Patrick Smith: Yeah I'll, I'll look at the the equity section pretty closely too. Right. So you know who's [00:05:00] on the cap table. Um, what type of equity has been raised? Uh, whether it's, uh, actual price rounds or, uh, safes, uh, which, which is the, uh, you know, a very popular Y Combinator, um, way of raising, raising funds. So, you know, kind of looking at kind of who's on the cap table, what's what's that look like? And how does that and how that relates to kind of the other things that Wade was talking about in terms of churn cash on hand. Um, and. [00:05:30] How they're categorizing their PNL. You know, you know, what are they looking at? How much is R&D versus G&A? Um, and the other things you can kind of learn from, especially in the early stage, you know, how sophisticated their, their financial accounting is or isn't, as the case may be. So that's another kind of area that I look at as well.

Glenn Dunlap: Yeah. That's great. Are there things that you're looking for in particular Patrick you mentioned like R&D or G&A. Are are there things [00:06:00] that you would expect, um, say as a percentage of revenue or. Um, uh, I think I suppose it also depends on if they're a startup and they have no revenue. That might be a tough one to manage. Right. But, uh, or to measure. But are there things that you're looking at as a, you know, percentage of expenses, even if there's no revenue? Like what? How much they should be spending on R&D versus Ghana SG&A?

Wade Maleck: One of the big ones is the cog section that I look at, because in your reoccurring [00:06:30] SaaS model, you know you're targeting a 75 to 85% margin. And so looking at that, I'm going, okay, are they in that range? If they aren't, maybe they're early stage and they're working toward that at some point. So that's where the like looking year over year or month over month kind of helps you to tell that story where they're progressing towards that. Yeah. Trend. Exactly.

Glenn Dunlap: Okay. And what [00:07:00] do you typically put into the Cogs. So you mentioned R&D, but are you also putting things like the infrastructure support and things like that. So you know if they want their web hosting or storage and all of those things go up in the cogs, or do you see that down below the line?

Wade Maleck: So that's uh, that's always an interesting one, because there's actually not a lot that goes in the Cogs. Everybody thinks that R&D, everybody thinks that all your hosting goes into there and a SaaS company, it's actually customer success. And that's pretty [00:07:30] much all that goes into the Cogs line item. Okay, you're hosting the one that always got me was hosting. Hosting doesn't go in there unless you're charging specifically. And everybody has a little different thought process on it. But general rule of thumb is unless you're charging like a storage fee for how much they can or, you know, something that's closer closely related to what a hosting fee would be, [00:08:00] that's generally a below the cogs line item, just like R&D is a below the cogs line item.

Glenn Dunlap: Okay, so if you see customer experience as a Cogs line item, then how would you break down sort of the sections underneath that you've got, uh, you know, you know, uh, just regular opex SG&A, do you break those things down? Are you selling, selling, sales and marketing? Um, you know, technology expenses. What do you expect to see on the on the, you know, breakdown of a PNL below the line? [00:08:30]

Wade Maleck: I usually so there is I think it's four that I usually break them down into. I have customer success, so I maybe they take a step back. Most startups use QuickBooks. And so in QuickBooks, I actually use classes as my departments to kind of help give that multi-dimensional aspect to the financial statements, because if you start adding sections for each department, you're duplicating all of your [00:09:00] GL accounts, and it becomes a little unwieldy when you do that. So I actually use classes. So, um, customer success like we talked about. That's one of my classes always, uh, G&A, R&D, you know, research and development, um, marketing and sales. I split out marketing and sales into their own buckets. Sometimes they have the same leader and their initiatives are obviously linked, but I like to budget for them separately. [00:09:30] Call them out separately, because some metrics we look at are sales metrics. Some metrics we look at are marketing metrics. So I like to have those expenses pulled apart for some of that more, uh, looking at these future metrics of the organization.

Glenn Dunlap: So where do you put do you put them like their web hosting and things like that in the G&A category?

Wade Maleck: Yeah, if it's web hosting for the platform itself. Yeah. Oh, web hosting for the platform itself. I put in R&D. If it's just general [00:10:00] web hosting, I, uh, I put it in the DNA. Okay. Sorry.

Glenn Dunlap: Yeah, that's all right. I was so for there for an application, you would put that into R&D. So where everything they're doing there. So yeah.

Wade Maleck: Like your Google and like your your AWS. Yep yep exactly. Yep. Okay.

Glenn Dunlap: Yeah okay. That makes sense. You don't make sense.

Patrick Smith: And actually that's that's really helpful. And just putting my tax hat on real quick. Um, being able to identify those costs relative to, [00:10:30] you know, an R&D tax credit or uh, now under section 174, having to capitalize those costs for tax purposes, uh, you know, kind of really thinking about, okay, what is R&D and what is what is and also what is, um, you know, maintenance, you know, you know, you have engineers that are doing development, but you also have folks that are kind of just kind of upgrading or maintaining the, uh, bug fixes, things like that. It's I think it's important to split those things out into separate buckets [00:11:00] so that we can quickly identify, uh, because those bug fixes and the maintenance piece is currently deductible versus R&D, which has to be capitalized.

Glenn Dunlap: Okay, okay. That makes sense. Yeah. That's good. Those are, uh, a good way to to think about that. It's, uh, and I can also understand how you're talking when you're talking about classes that that would make sense instead of, um, having a chart of accounts that becomes a mile long, if you can fix it.

Wade Maleck: You have. Yeah. [00:11:30] For each line item, you have a payroll, you have R&D payroll, you have sales payroll, you have marketing payroll. You just had added for accounts for really one line item.

Glenn Dunlap: And you have you may have some people that split, you know, across each of those things too. So that could be, uh, you know, in our, in our firm, we we certainly have people that wear a few different hats. So it's, uh, not always an easy split. Yeah. That's good. Um, so we talked about the equity section. You're looking at that on the balance sheet there. Probably in most, um, SaaS [00:12:00] firms are not too much in terms of are to be looking at right now. I'm not sure why I got I got two thumbs up there on my. But yeah. Doing good Glenn. Yeah that's right. Yeah that's right. Yeah. The, uh, the, uh, self-encouragement there from the iOS or um, but the, um, no, are really if you're thinking about from a balance sheet perspective, there's not really, uh, much other than, you know, there should be, you know, cash and, and, uh, and equity. Right. Or maybe there's some debt on the books, but, [00:12:30] um, we're not really tracking inventory. We're not really tracking are in most cases.

Patrick Smith: Yeah. You know, there's, you know, there's some also kind of off balance sheet type items, you know, if you've got, uh, deferred compensation, uh, agreements, um, and, uh, you know, deferred revenues, you know, in a SaaS company isn't huge. Most of that is going to be, you know, recurring, um, monthly subscriptions or annual subscriptions, uh, you know, which is, which is good. Uh, so that, you know, that [00:13:00] goes into sort of that MRR, you know, uh, monthly recurring revenue or are annual recurring revenue, you know, those are, you know, key metrics for, you know, where a SaaS company is and where it's headed. And if that's trending up. So, yeah, that's definitely an item. So getting that monthly financial statement is, is is key, uh, to understand those trends.

Wade Maleck: Yeah. Just to add on a little bit to to Patrick, it depends on, I would say the target [00:13:30] of the SaaS company. If you have the self-serve SaaS company, all their swipe and credit cards, people are coming to the website, swipe and credit cards. Yeah. Not going to be a lot of are not going to be a lot. Maybe there's some deferred revenue on there. Um, but if you have more of an enterprise company, software SaaS company, um, probably going to have some are might have some other things. And to other thing that [00:14:00] Patrick said was bookings. That's one of my favorites when it comes to because it's not a true accounting. I lineatum. It's not anything you see on the income statement, but I have clients where there is lead time because there's enterprise customers, there's, um, onboarding, there's implementation. And so the time from when the client signs the agreement until you start seeing revenue. Yeah. On the line item, [00:14:30] it could be six months. And so I want to show I don't want to wait six months to know, hey, how is my MRI? I want to look at it as soon as I know and say, hey, my bookings in June. Let's say I know there's $2 million in bookings in June. I'm going to recognize start recognizing that in six months. And so it just gives me that little bit more of a leading indicator on how the company is doing in the health. And it's one of those that I report [00:15:00] to the board. It's like, hey, look at how great we're doing. We signed $2 million in deals this.

Glenn Dunlap: Month, right? But that's not on the PNL, right?

Wade Maleck: Nope, it is not. It is a off balance, off PNL, off financial statement item that I report separately to the board and even to the executive team, too.

Glenn Dunlap: Okay. Yeah. So that's good. How how do you, as the accountant, learn what the bookings are? If it's, you know, you're not it's not in the traditional [00:15:30] financial statement information. So you're getting that from sales team. You're getting that from. How does how does that get reported to you. And how do you report that on.

Wade Maleck: Yeah. So every month usually there's a CRM system of, of some sort HubSpot, Zoho, Salesforce, you know, the big ones that are out there. And so every month it's looking at yeah. What are the deals that close that month. What do we estimate the revenue on these deals to be. And that's what I use. So we get as close [00:16:00] as we can to just as an indicator. The thing that I always say is these are indicators KPIs key performance indicators. So they're not the one metric is not saying, oh I'm doing terrible. You have to use them in concert. So it's an indicator of how the company is going. So I don't get too caught up in the pennies or even the dollars on that, depending on the size of the company.

Glenn Dunlap: Right? Right. Okay. [00:16:30] So you're just you're pulling that from the CRM and that's going to be a footnote to the financials or an addendum or something. Yeah. Got it. Okay. Other things, other non-financial things that you track like that. Um, so you know, one of the things I, you know, think about like number of customers or subscriptions or, you know, deal size, you know, those kinds of things. So what makes up the MRR r so just to get a sense of, of those things.

Wade Maleck: Yeah. Some of the metrics that include nontraditional accounting items. [00:17:00] You know I look at average revenue per employee. Make sure that's trending in the in the right direction. Depending on your type of SaaS company would determine what is a good revenue per employee. So I look at it as more of a trend, some benchmarks out there or revenue, you know, what's the revenue per customer. Right. Because we're going to use that in some of our metrics when, you know, when we start putting together a dashboard [00:17:30] with the revenue per employee or, I'm sorry, revenue per customer, I'm going to use that with the churn metric to figure out what my lifetime value is with that customer. So average revenue per customer divided by the churn tells me what the lifetime revenue of that customer is going to be. So I know how much I can expect to earn from a customer, because how [00:18:00] much I earn from that customer is going to tell me how much I can spend to acquire that customer. Yeah.

Glenn Dunlap: Right. Okay.

Wade Maleck: And generally you want to see a 4 to 1 on that. So I want four times my cost to be paid back over the life of that customer.

Glenn Dunlap: Yeah. Yeah four times my cost. So yeah.

Wade Maleck: So so your numerator yeah. Your numerator is under.

Patrick Smith: Your you need 400 LTV [00:18:30] to cover. The the.

Glenn Dunlap: All right, I'm sorry. Say that again, Patrick.

Patrick Smith: So if if for if your customer acquisition cost is 100. Okay. Um, your lifetime, your LTV on the on the customer needs to be 400. Um, to to really, you know, recover that.

Glenn Dunlap: Uh, yeah.

Wade Maleck: It's just showing your you're doing well when it comes.

Glenn Dunlap: Yeah. Yeah, yeah. And 44 to 1. Seems like [00:19:00] that, um, should be, uh, you know, easily attainable. I don't know, maybe it's not. Maybe there's, uh, a lot of firms that are spending or churning too quickly. Right. If that's, uh, that could be another element of that. So, um, so talk to me about how you measure the churn. So where does the churn where does that churn number come from? You. You're looking at how many customers you're getting that information again from a CRM.

Wade Maleck: Yeah. That's usually coming from from the customer success team because right after the customer sales [00:19:30] team brings on the customer, then they hand it off to the customer success team. And the customer success team is responsible for continuing the relationship with that customer, trying to make sure that they don't churn. Some do also have the responsibility of growth inside of that customer. So expansion revenue as well. But on the on the churn calculation, yeah, I'm working with the customer success [00:20:00] team to go, okay, what were the customers coming in dollar amount coming into the period, whatever it is, if it's a quarter, if it's the year, if it's the month, and then what is the dollar amount of those customers coming out of whatever the period is we're looking at. And then figure out what the ratio, you know, what the percentage is. And then yeah, that's my my churn rate. Obviously shorter time periods are more more volatile and longer time [00:20:30] periods. But yeah. So I'm using that and going, okay, what did we turn? And other ones that I saw, I talked about expansion revenue. That's another one that I look at is I go to my customer success team, say, all right, our existing customer base, what did we increase our revenue with that existing base.

Wade Maleck: And it's and it can be through [00:21:00] additional seats that we're adding on. It can be through additional revenue streams. So we're adding another product. They're adding another module feature, whatever it is. So what is our expansion with our existing customers. Likewise I'm talking to them about hey what's our contraction. Right. So is it going down. So I'm separating those three with our existing customer base. So I'm looking [00:21:30] at churn. How many of our customers are churning. How many are we losing. I'm looking at expansion. So all of our existing customers how what's the percentage we're increasing with those that are increasing and then contraction. What is it that we are decreasing with those that are decreasing? Okay. And the reason I get those numbers is I add them all together the percentages. And I go, am I growing or am I [00:22:00] contracting in my existing customer base? So am I having to add more customers in order to continue to grow this company? Right? Right. Or can I increase my revenue just on my existing client base? Investors, acquirers love that. If you can increase revenue off your existing customer base, right. Because then you don't have the you don't necessarily need the kak, right. The expensive part of the company.

Glenn Dunlap: Yeah. It's more cost [00:22:30] effective to grow an existing client than to go attract a or capture another one. So. Right. So if you exactly if you're seeing that that is a expanding or you may have may have priced yourself to a place where you don't have the opportunity to expand it. Right, that could be another, another element. So that's yeah that's great.

Wade Maleck: Um, and if we add the so just to add on to that, it actually has a name though adding those three together. It's called net negative churn. Net negative. So you're adding all of those together [00:23:00] and you're going in. And it's a little counterintuitive because you want the number to be negative. But net negative churn you're taking all three of those numbers adding them together and going is that number negative. So you have your churn all looking at it as positive numbers. That's why it's a it's a negative. It ends up being a negative number. So you look at the positive of the churn, the positive of the contraction. And [00:23:30] then you subtract out expansion percentage. And you want your expansion to be bigger than the first two numbers combined. And that's why it would be a negative number. I know I always lost myself on that one because it's like, why is it? Why do I want it to be negative? But it's just, uh, we've come up with all of these SaaS specific metrics and they're continuing to add new ones, um, very rapidly.

Patrick Smith: Yeah. I would also think that that in [00:24:00] looking at those specific metrics, especially with the expansion, you know, you can identify the modules that are doing well and the ones that are not. And, you know, are there opportunities to, you know, kind of shift the business? I mean, not just looking at, hey, we're we're growing just from our client base, but then you can actually make strategic decisions around the product itself.

Wade Maleck: Mhm. Yeah. That's something that you can do in the PNL is break out. You know maybe when it becomes [00:24:30] $5 million of, of reoccurring revenue, some, some target like that, it's like, all right, I want to break this out separately in that, uh, revenue section of the income statement because I want to start to track this separately and then, yeah, you can do some of those metrics, or you can go back to the whatever your subscription management software is and run reports and do some, uh, calculations there as well.

Glenn Dunlap: Yeah. Because the contraction, if you're looking at if those numbers are either losing [00:25:00] people or you've got the contraction and it could be caused, that could be a certain element of the, of the app itself is that I think that's where you're going, Patrick, with that. So if you've identified there's, there's we keep losing business in this one particular area. We either need to bolster it or do something to modify this in some pricing.

Patrick Smith: Issue like like you had brought brought up that, hey, maybe we're charging too much for this. Maybe we need to adjust that. Um, so yeah.

Glenn Dunlap: Customers aren't realizing the value in it. So we either, you know, it could be a key issue. We need to go out there and help them [00:25:30] to, to realize the value that we that we expect that they should get or suspect that they should get. So yeah, those are that's good. And you mentioned 5 million. Wait, is that a number where you start to see where, um, you've got enough revenue, enough size that it becomes there things that you'd want to to subdivide some of those things and start to evaluate things differently.

Wade Maleck: Yeah. I mean it is company dependent, but 5 million I've seen out there as a as a benchmark for [00:26:00] when you start breaking the revenue out into its separate line item. I always one thing I should say is I always separate reoccurring revenue from one time or onboarding or implementation revenue. So I always have those separate. And we didn't talk about that when looking at a financial statement, because I also break the costs out separately. So your implementation and onboarding I break out separate from my [00:26:30] traditional, um, customer, usually more so, uh, one time, either we're doing some sort of special um module or special development for the customer creating an integration. Um, I'll break that out separately because that's going to be probably, um, something I'm giving away or doing that cost. And it's going to skew my margin numbers.

Glenn Dunlap: Right.

Wade Maleck: Yeah.

Patrick Smith: Those professional services [00:27:00] piece, you know, depending on how big that that is relative to, you know, the software itself, you're definitely going to if it's significant, you're going to want to kind of track those that revenue and costs that, like you said, does have a different margin, then you're going to get on that recurring, you know, software revenue.

Glenn Dunlap: Yeah, that makes sense. That makes sense. Yeah. Especially, you know, those one time things uh, we are. Uh, often find difficult to, you know, to build the same [00:27:30] margin in that we do in the rest of it. So I think that's, uh, that makes perfect sense to separate that out.

Katie: Business owners are surrounded by data, but are desperately looking for the insights they need. Using benchmarks and industry metrics can be a great way to start a conversation with your clients and provide the clarity they need. The only challenge is having access to solid metrics for your clients when you need it. That's where our sponsor peer review data can help. Peer review data enables you to turn tax, [00:28:00] audit or client accounting files into meaningful reports and insights by comparing your clients to thousands of other companies within the same industry, peer view data will help you to show your clients how they're doing, how they're doing against their peers, and how they could be doing better. Quickly connect to apps like Qbo or Xero, or import trial balances from many other applications, and you'll have comparative reports ready in minutes. Go to Peer Review Data.com to get started and see how you can get back [00:28:30] in front of your clients and grow your consulting revenue.

Glenn Dunlap: What are the ratios of metrics are you looking at when you're looking. So, you know, we've gone through some with the average revenue and uh, this uh, net negative churn. So what else? Uh, what are other metrics do you look at or things are you calculating on a monthly basis.

Wade Maleck: So another one of my favorites, this will be Wade's favorites KPIs here. Um.

Glenn Dunlap: Is it's going to [00:29:00] be all of our favorites from now on Wade. So you know hopefully.

Wade Maleck: I get everybody here on board here. Um, another one is rule of 40. And I don't know, that's kind of one that's been hit or miss whether people have seen or heard that one. Um, this.

Glenn Dunlap: Seems like there's some modifications on that too. Like there's some derivations of it now. Right. So I'm hearing some of those things. But let's, let's talk about what rule of 40. Maybe we can, you know, look at some of the others too.

Wade Maleck: So going into this, what we're trying to figure out is are we using capital efficiently [00:29:30] to grow the business. And 40 is this magic number that we've determined as a technology, as a SaaS community, to be whether or not we are growing efficiently. And so what we're looking at is we're looking at growth of revenue over a time period versus EBITDA percentage. So if I'm growing year over year, 60%. [00:30:00] And I'm doing -20% in EBITDA. I net the percentages together and it's 40%. So that's indicating to me that I'm using capital efficiently, even though the company is losing money, which some people are like, you're losing money, how can you be doing things well? How can you be spending money? Well, you're losing money. But that 40% is [00:30:30] that indicator that I am growing at a fast enough pace compared to what I am burning. Basically, as an organization, it's not exactly burn because EBITDA isn't always that, but basically. Right. And so if I end up at 35%, I should take a step back, possibly, and go, hey, am I spending too much in areas? Do I need to cut back? Am I not having the traction? But I thought I would with some of the spend [00:31:00] here, some of these, uh, you know, this cash outflow.

Glenn Dunlap: Right? But also it becomes an indicator, like if you're only growing at 30%, you should be making 10% on the EBITDA side. So, I mean, there's a there's an element there too that says that, you know, there's you can sort of way that out. Like if profitability or, you know, the positive number in EBITDA is is your focus, then you may you may, you know, give up some things on the sale side. Right. So there's there's it's always sort of that, you know, give give versus get [00:31:30] or just the push pull on those, those relationships.

Wade Maleck: Yeah I mean that's a great point because even if I'm making money as an organization, am I making enough for how fast or slowly in that case, the company is growing? Because, yeah, if I'm putting 20% to the bottom line in EBITDA. So, hey, I, I don't have to go out and get investors if I don't want to. That's where we're all striving to be, as you know, startup SaaS companies. But if I'm only growing 10% [00:32:00] year over year, maybe I need to spend a little more in order to really, you know, get some traction, some additional traction here on that top line.

Glenn Dunlap: Do you see that? That's something that investors are are keenly clued into. I mean, is that something that they're willing to fund those those losses against higher growth for sure.

Wade Maleck: I mean that's the that's the give and take here. It's like, what are you going to do with my money? Right. What's the return? [00:32:30] Going to be if I give you $1 million? What are you going to do with this? Right? How how have you been doing? Talk to me about what? Traction is a great word. And investors like to just throw that around. But what's your traction been as a company? And what do you think you're going to do to the valuation? Because yeah, one of the things that they're trying to figure out and this is a little off topic, but am [00:33:00] I going to get ten x or something on my. Is the company going to increase ten x in value is basically what they're trying to figure out give or take.

Glenn Dunlap: So there yeah. So one of those ways is higher sales growth. You know the growth rate that that's going to help them achieve that ten X versus you know the measuring the bottom line right. So it's like how much are you having to spend to get there. But but the but the element of it is is looking at that growth rate. Right.

Wade Maleck: So looking at that growth rate again looking at the net negative churn number that we talked [00:33:30] about. Yeah those are two big numbers to them that they're looking at. All right. Is this company doing what they need to be doing as an organization. For putting capital to use.

Glenn Dunlap: Yeah. Makes sense. Rule of 40. So again is that something that you would typically. So you're like are these things that you're putting on the financial statements every time you you issue them you got negative churn and the rule of 40.

Wade Maleck: So I'm usually it's it's it's not a footnote or anything [00:34:00] to the financial statement I'm usually creating. Um, for a lot of my clients, I create a whole financial report monthly, and I have a dashboard and it can vary from, you know, we'll call it cards that have these numbers and maybe so. So a card would be revenue and it shows the revenue for the month. It says your revenue this month was $100,000. Same time period last month it was $50,000. [00:34:30] Your growth was X percent. So I've got these little cards that I usually put in a financial report, and then I usually have some graphs in there as well, like your cash balance. As I like to put a little like line graph where they can see where the cash is trending is usually down, unfortunately. Um, because cash, cash burning organizations. Right. Um, and then I usually like to include, like their forecast into [00:35:00] that and say, how much are we planning on burning as an organization in future periods? Because I want to know my cash out date. Right? I got to work backwards from that, right? Either figure out when I need to raise money, or I need to cut expenses for the revenue I have as an organization. So I'm creating a whole financial report that I'm delivering to my CEOs, and we are constantly refining it and improvising on it, just like the startup is constantly [00:35:30] improving on their product, I'm working with them to figure out, hey, what's the most relevant information? How do you want to see it, what's the visualizations of how you want to see it? And then we take some subset of that information and we'll put it in a board report. So it's generally some consolidated financial statement, some subset of the metrics that we look at as an organization on a monthly basis [00:36:00] okay. And generally we're looking over a quarter, one quarter because boards that I've worked with in the past are like, yeah, it gets kind of volatile from month to month. Let's look at what a quarter over quarter looks like.

Glenn Dunlap: Yeah. Makes sense. Yeah. You can have big renewals or big, you know, big month or big sales or something that could really drive something that looks wacky. But, um, it starts to flatten out a little bit over a quarter of a quarter basis. Then, you [00:36:30] know, too small of a window. Yeah. Those are good. What, what, um, other metrics that you're that you, you like, you commonly use.

Wade Maleck: Another one is and this is related to cost of goods sold as I like to look at average cost of service. And so what we're looking at is your Cogs divided by the total number of customers. And what that's telling me is how much am I spending.

Glenn Dunlap: To service those.

Wade Maleck: Each. Exactly. Yeah. The name gave that one [00:37:00] away.

Glenn Dunlap: Yeah yeah yeah yeah.

Wade Maleck: And factoring that in because when I'm looking at some of the metrics over time. So when I'm looking at what is my lifetime value of that customer. Over. You know the cost to acquire that customer. I'm actually netting out the cost of servicing that customer. I didn't say that when we were talking about it, because I didn't want to confuse things. But when I'm looking at [00:37:30] that, I am netting out how much does it cost me to service this customer? Because that's the true money that I get to keep as an organization to pay back that acquisition costs. And likewise, when I'm looking at another one, uh, that I like to look at is how long does it take me to get my acquisition cost back? Um, right. So to break.

Glenn Dunlap: Even on.

Wade Maleck: Exactly 18 months is a generally accepted time [00:38:00] period when you're saying, um, how long does it take me? So. Right. So if I'm spent $1,800, let's say, for easy math, $1,800 to acquire that customer, and I get $100 every month from them, 18 months to pay that back. Now I have to take out if it costs me $5 a month to service that customer. So I'm only getting $95. So I'm a little above [00:38:30] 18 months because I'm actually only getting $95 every month in net.

Glenn Dunlap: Yeah, that makes sense. That makes sense. The you mentioned upfront that you kind of separate out some of the, you know, onboarding one time, all of those things. So is that part of the customer acquisition cost. Are you looking at it from that perspective or are you looking at it this as an all in, uh, approach for each of these firms?

Wade Maleck: That's a really that's a really good question. Um. Because [00:39:00] those are generally like we talked about the break even or very minimal margin items. Okay. So they're basically paying for the cost that I'm putting into getting them onboarded or doing some custom service for them. So I, I don't usually include that, but if there's some leftover, I guess you could say, yeah, let's put that toward the acquisition costs. If I have 5% or something, I got 5% [00:39:30] margin on some of the professional services. You could um, I'm usually looking at reoccurring revenue because that's what we're going to keep over. Right? You know, the life of the customer in theory.

Glenn Dunlap: Right? Right. Okay. That makes sense. That makes sense. Well, those are good. Uh. Those are good numbers. Have you seen. Oh, well I shouldn't I don't mean to cut that off. So the other thoughts on other metrics, Patrick, do you have anything that you'd like to review or use each month?

Patrick Smith: You know, I mean, you know, quarter [00:40:00] over quarter growth, um, you know, kind of making sure that the, the, you know, the especially with that calculation of, you know, revenue coming in, that churn of revenue, um, I think length of time of maintaining unique customers so that, you know, you've got got kind of that long term customer, um, viability and stickiness, you know, kind of figuring out whether or not these customers are. And that's, you know, obviously part of the churn. So, uh, those are those [00:40:30] are the areas I would focus on. Um, and, uh. I don't know if there's anything, you know, Wade, from a from an equity perspective or a debt perspective. You know, I know a lot of companies raise money through convertible notes. Um, and, you know, if there's anything in the equity section, you know, convertible notes versus the actual price rounds, but I know that's a, you know, you want to be able to, you know, get a service that interest, that interest is going to come [00:41:00] payable whether it's either in cash or, you know, equity at some point.

Wade Maleck: Yeah, I would say. You know, the safe has been around for a decade or so. Um, but in the last couple of years, it's really taken off. And so what that's done is it's gotten rid of interest accrual and that future interest that needs to be paid. And you don't really [00:41:30] ever need to necessarily pay it back because it's for future equity. That's what safes are. And. So what I'm doing, though, those are classified on the balance sheet as debt. And so yes, I'm looking at what is it in that. Is there convertibles, is there safes. You know, what is it that. And I'm trying to clean that up. I'm working with my clients startups to, to clean that up before a, you know, a named [00:42:00] round, let's say, or before they go out and hit because. I had one client that he's had three safes, and it's like we're looking at a series A in the fall, and it's like, okay, we got to clean up the safes. Let's do a seed round. Let's clean up the safes so we can hit the round. The less explaining we have to do, the better to these new investors. Um, let's clean them up and let's move on.

Glenn Dunlap: And by cleaning them up, what you're meeting their way to find if I'm following this, is that by cleaning it up, you you basically [00:42:30] strike a price for a seed round. And so then that that kind of then sets everything for the safes that had had occurred already before that. Right. So that's, uh, that's the first sort of official round. Here's a seed round. We price it, we know what that is. And then when you go for series A, you've everything's been defined. Is that is that am I thinking of that right.

Wade Maleck: Yep. Exactly. Yep. You're converting it into an equity round with term's and evaluation and they own stock probably preferred. And yeah it's just to. So [00:43:00] when somebody is looking at the balance sheet or looking at even the cap table because everybody requests a cap table when you're going out to raise capital, it's very clean and straightforward. So the more straightforward you can make things, whether it's the balance sheet, the income statement, the cap table, the easier the the the pitch deck. When you give the the investor pitch, the more straightforward and easily digestible it is to a potential investor, the [00:43:30] less hurdles you have to clear to get them to invest in the company. So I'm trying to make things clean. I'm trying to make things easily understandable. That's my whole my whole purpose. And that's what I'm looking at, too. When I'm looking at financial statements is what doesn't make sense here. Right? What right? What is raising my eyebrows when I'm looking at this? Because that. It's questions to ask.

Glenn Dunlap: Yeah, that makes sense. What are the things that you see? Uh SaaS. [00:44:00] Firms. What are the most common mistakes that you see them make from a financial standpoint? Or, you know, I think about raising capital. There's obviously, uh, cap tables and things get messy and, you know, lots of cleanup to be done in those areas. But just, you know, on a regular basis, like what? What are the things that you see that become, uh, things you just have to work with them to clean up or overcome.

Wade Maleck: So the controllable items that they can, they have full control over are what goes in [00:44:30] cogs, like we talked about earlier on in our conversation, is making sure things are classified appropriately on on the income statement. I'm also a believer. It's probably because I, I'm a CFO and I think financially is I like to classify things and departments as early on as I can, because while it doesn't necessarily tell you against [00:45:00] benchmarks how you're doing because early stage companies are going to be way off of what the over the industry benchmarks are. But I can measure progress. Like I can measure the progress of KAC over time. And hopefully I see that number coming down. And hopefully that's something I can tell the board and, and tell investors, um, a couple other things that I always see. And the reason I started with the controllable ones, because [00:45:30] you can control. But running out of money, it's not always the don't run up against running out of cash.

Glenn Dunlap: Right. That makes perfect sense.

Patrick Smith: Yeah. And Glenn, just to to kind of follow up on your, you know, kind of things that I'm seeing that companies are missing. You know, those pitfalls. Uh, definitely around equity comp, um, when issuing either restricted stock or some type of equity comp, I'm seeing a lot of, uh, investors [00:46:00] and founders kind of missing the 83 B election, which is a key item for basically getting preferential treatment when those restrictions elapse on that, on that stock issuance. So that's an area that I think a lot of companies or a lot of founders don't really understand the importance of making that election. And. Unfortunately, there really is no good way to fix that. Okay, so there were what's happening [00:46:30] is the, you know, later down the line, they realized that didn't happen. And now we're trying to backpedal and figure out how do we get that, get a similar treatment. But the companies, you know, a year older the value has gone up. And now we're kind of stuck in a kind of a weird spot.

Glenn Dunlap: So so walk me through a scenario of that. Patrick. So because uh, 80 equity comp and so we're talking about um, in, in lieu of or in addition to compensation to cash compensation, [00:47:00] uh, you know, somebody in the firm has received equity as a, as part of their compensation package.

Patrick Smith: Correct. So they get.

Glenn Dunlap: Valued at at the last round or some, some number or something like that.

Patrick Smith: And usually it's especially in the early stage companies, it's valued pretty low. Right. Because the company isn't worth much at that point. And so when you get issued restricted stock, for example, the value of that restricted stock at that point is zero because you have either time based [00:47:30] or performance based restrictions. Um, the tax code allows you to kind of pretend like you've received the stock in full, uh, from a tax perspective. And that election is done under section 83 B that says, okay, let's say I receive stock. Um, it's worth $100. And that's, you know, 10% of the company, whatever, whatever that is. Um. If you don't make the 83 B election and then a year later, you know, 25% [00:48:00] of that vests, and now the company is worth, you know, $1 million. Well, that spread the value on the date of that restriction lapse becomes compensation to, uh, the receiver of the stock. Okay. Now now you've got $1 million of comp, no cash to pay any tax. It's a bad answer. Okay. Um. When you make the 83 B election. When you receive it, you're picking up the $100. So you've [00:48:30] basically accelerated the restriction vesting on day one. And so as those lapse and as the value of the company goes up and those restrictions lapse, there are no tax events. At that point, the risk is if you leave the company, you lose the the stocks that haven't invested yet. But the upside is when you do exit, it's all capital gain because you started that clock. Okay. So and it's it's and you have to make the election within 30 [00:49:00] days of the grant. You got to mail it into the IRS. I've seen issues where, you know, the mail failed and it didn't get to the IRS. So now we're in a spot where, okay, it's a year later. The value has gone up. How do we kind of navigate this okay. And it's and it can be pretty significant to the to the founders.

Glenn Dunlap: Yeah, that's a definitely a pitfall to avoid right there. Yeah. I mean you're hoping that you want the stock to to form perform really [00:49:30] well. But the flip side is if you have no cash to pay the tax element, no tax. It's bad. Yeah it's bad. Yeah. I don't know who whispered that's bad but that's bad.

Patrick Smith: That was me. Yeah.

Patrick Smith: Yeah. It's not good.

Glenn Dunlap: Yeah that's good.

Patrick Smith: And then and then the other thing is around the cap table are sort of those what I, what I refer to as Post-It note grants. Um, you know, you've got a key, uh, engineer or key, you know, person in the business and he's [00:50:00] like, yeah, you know, we'll we'll get you 10% of the business and all this stuff, but you never get around to papering it and issuing the stock. And now there's a new investor coming in that seed round when you're trying to clean up the safes or whatever it is. And now you got a person going, um, where's my, where's my piece? And, and it's just one of those things. And, you know, kind of to Wade's point is what you're trying to do is create a, a friction free environment for either an investor [00:50:30] or a, um, a buyer to, you know, make a decision on. And these are the types of things that create friction in deals, uh, that can then, you know, maybe even change the enterprise value of what you're, what you're going to get out of the deal, right?

Glenn Dunlap: For sure. Um, so this is, uh, you know, could be a potential pitfall, too. We talked about bookings a little bit, but we I don't know that we specifically addressed, uh, revenue recognition. So one of the things I want to go back and take a think about from a revenue side, [00:51:00] is this thinking about, um, you know, you mentioned there were companies that have a lot of self-serve clients that come in, they swipe a credit card, and it's going to be the recurring stuff. But when you have the enterprise deals, you may be getting paid on an annual basis or a quarterly basis. And that's, uh, that changes some things up there. So, um, how do you handle, um, you know, how do you see firms handling, um, revenue recognition, especially when, let's say it's a large enterprise deal and you get that, you know, one check, uh, annually, but. [00:51:30] You know? So what's, uh, what do you do from there?

Wade Maleck: So we brought on clients that simply just as the checks come in, they put them to revenue. Yeah. Yeah, exactly. And so that that's that can be fine in the beginning, but it doesn't tell the story to, uh, the team on what is really, really happening. Um, so, I mean, in the beginning of a company, you can use a spreadsheet [00:52:00] and say, this is the payments and this is the time period, and then what do I recognize each month? So you got client on on the row and you got, um, payments and then you got months, you know, across the top and simply use a spreadsheet to say, all right, how much of this. Deferred revenue if you will. Mhm. Am I recognizing each month and hopefully at some point it becomes zero, at least on the spreadsheet in the deferred revenue that can say okay, yes, this makes [00:52:30] sense. I'm recognizing all the revenue that I should be. Um, there's programs out there that you can use as you become more sophisticated. Uh, subscription management programs that, um, can do multiple things not only help you with deferred revenue or revenue recognition, also with the actual management of the person's subscription and when it ends and terminates, because those are two separate issues. Right. That companies [00:53:00] have to deal with is how do I turn off somebody's subscription when it is done? And how do I recognize the revenue from that subscription over the appropriate. Time period.

Glenn Dunlap: Do you look at an element of it too? So whether the if it's cancelable and if it's any of it's refundable, if there's, you know, if there's an annual contract they're going to get a payment up front. But, but. But if they cancel, they don't. They don't get any of the money back. Do you look at that differently than you would [00:53:30] if, um, if it was something where they had to there was, in essence, a liability potentially on the books. Right? I mean.

Wade Maleck: Yeah.

Wade Maleck: Yeah, usually I'm putting on the books the part that is ours to keep. So that's all going in deferred revenue. So if it's six months, say they have a six month agreement and out, I'll put six months on and then I'll recognize it. And once we hit whatever milestone it is that says you're on the hook for the next six months, I'll put the next six [00:54:00] months on the books and recognize it and depending on when they pay. So that'll be my deferred revenue portion of it, but also maybe have a receivable, because if that doesn't match up right, they owe six months of this contract and I they've committed to it. And then they they have to physically give me a check or ACH or whatever it is, I'll have a receivable then that says six [00:54:30] months of a receivable, and maybe they're paying me in monthly installments and then I'll reduce the receivable. Over time. So it depends on the specifics of the contract. But usually I start with deferred revenue of whatever they're committed to as an organization.

Glenn Dunlap: Mm.

Glenn Dunlap: Okay.

Wade Maleck: There's all sorts of little details, um, that we read.

Glenn Dunlap: Brex spreadsheets can get pretty unwieldy pretty [00:55:00] quick as you, as you add customers and. Yeah, yeah. And different contracts and managing all that stuff. Yeah.

Patrick Smith: Mhm.

Patrick Smith: Well it's definitely important to make sure you're, you're putting them in the right period. I mean that's really just what's, what's what's key. That just because someone gives you a boatload of cash for upfront that's great. But you can't necessarily put it on the, on the PNL until you've earned it.

Glenn Dunlap: Well that's right. So, uh, you know, and I think too so let's talk about let's [00:55:30] go to a tax for a second, Patrick, and throw a tax question at you. I mean, I think, uh, for the longest time, software was exempt from a lot of the, you know, salts kinds of things. Right. So, you know what? What's, um, what are you seeing now in terms of, uh, you know, what's happening in this, in this space?

Patrick Smith: Yeah. I mean, from a from a, uh, sales and use tax perspective, especially software and software as a service. You know, a lot of companies went, hey, we're we're a service. You know, most [00:56:00] states don't tax services. And, um, so, you know, the states are becoming savvy. They're they're figuring out that there is money to be had in this space. Um, I think the Wayfair case is a good example of kind of the. You know, states looking at the concept of economic nexus where just because you know, your your SaaS company, you got eight guys sitting in in, you know, Silicon Valley and, but you've got sales [00:56:30] all over the country, you know, all those states kind of want a piece of that action. Um, so a lot of states are, uh, implementing, uh, you know, digital, uh, sales tax collect and remit. Um, you know, starting to tax services. But each state is different. So that's the beauty of our country. We've got 50 different tax codes that we get to try to figure out. Um, so, you know, they're becoming more aggressive. Um, and, [00:57:00] you know, kind of going back to your other question around sort of pitfalls or things to, you know, uh, uh, traps for the unwary, uh, especially around not so much in raising capital, but when doing an M&A deal, um, sales and use taxes, usually the number one exposure item for a business, uh, because one, no one's really thinking about it. Um, it's like I said, it's 50 states. When you're a SaaS [00:57:30] company, you become you can become multistate and international overnight, right? Um, and now you end up with, you know, big company problems without, you know, kind of big company resources to, to solve them.

Patrick Smith: So, you know, one of the things that we do, you know, prior to if there is a deal in the offing, you know, 1 or 2 years down the road, we'll do kind of a reverse sales tax audit. And, and that's where we can go in and say, okay, well where where you have Nexus, what [00:58:00] is your exposure? Should we go back there. There are things called voluntary disclosure agreements where you can go, uh, to the state and say, look, you know, we should have been collecting and remitting. We didn't make a culpa, you know, here's the tax. And they'll usually forgive the penalties and interest because what happens is even, you know, and the thing with sales tax, it's not even your liability yet. If you don't do it um, at point of sale, then it becomes your liability, right? It's something [00:58:30] you should have collected and remitted from the customer. Uh, so that's that's an area that I think a lot of companies aren't really thinking about, but really should start. Um, and, you know, you know, a pound of prevention is worth it. Or an ounce of prevention is worth a pound of cure. Um, because it's going to cost you on the back end, even though there might be some pain in the front end. You got to file these sales tax returns. You got to, you know, do the work. Uh, but at the end of the day, that's going to be, again, one of those friction points in a deal, [00:59:00] right? That says, you know, that could change the value of the of the transaction. Right.

Glenn Dunlap: Yeah. Interesting. Well, those are uh, those are definitely things to to think. I mean, if you're in a SaaS space, right, you're you're likely raising capital, thinking about an exit. I mean, those are and those are the things that, um, everything you're doing here in terms of the reporting functions are, are to communicate with your current investor group, but also potentially to, to an acquirer. And those are the pitfalls of uh, uh, [00:59:30] sales and use tax or equity comps or those kinds. There's all those things that become tripwires that, um, you know, can really get in the way.

Patrick Smith: Yeah. Well, the other.

Patrick Smith: Thing that that if you if you do it right, if you've if you're thinking about these things, I it creates even more confidence in either buyer or investor. Right. It's like okay, these guys kind of got their act together. They're thinking about the right things. They're, you know, trying to being good stewards of of the capital that we're we're providing. Um, and I think that goes a [01:00:00] long way as well.

Glenn Dunlap: Yeah, yeah. That's great.

Wade Maleck: Preach that with my founders that I work with. The the investors are looking for you to be proactive and thoughtful when it comes to these things. You know, there's an issue or a potential issue. You're aware of it. You're, um, you're not unconsciously incompetent. You're consciously incompetent.

Wade Maleck: So, you.

Wade Maleck: Know, you have a blind spot. You just haven't dealt with it yet, right?

Patrick Smith: Yeah. [01:00:30]

Glenn Dunlap: Yeah. Right. Well, that's, uh, I think you just described most of us. Most of us that are in this space anyway, so that's good. Well, gentlemen, this has been great. I there's a there's a ton of meat, um, in this conversation that I think that, um, you know, any new, uh, adviser or accountant in this space would certainly, uh, be able to take a look at this and understand this, uh, a lot better. Um, will ultimately, uh, publish, [01:01:00] uh, some blog posts and some other things that will have the, the, um, ratios, the formulas that we all talk through today and some of the explanations for those and some details around that. So if you're looking for that, you should be able to see that on our website. But if somebody wants to reach out to to you guys, how do they how do they reach you? Patrick. How would somebody get a hold of you or reach you if they'd like to?

Patrick Smith: Uh, I'm I'm definitely on the LinkedIn if you want to connect with me there. Um, uh, I come up pretty quickly in the search. Um, but, uh, it's, [01:01:30] uh, Patrick Smith at cla connect. Com, uh, for, uh, direct email.

Glenn Dunlap: Yeah. Great. Thanks. Wade. Yeah.

Wade Maleck: Yeah. Same thing. Uh, you can find me on LinkedIn, send me a note, a connection. Happy to talk KPIs and metrics and all these things. I love it, as you can tell. Um, and then, yeah, same thing, same email convention that Patrick says Wade dot Malik at CLA connect. [01:02:00] Com so happy to happy to help. That's all I want to be is just helpful.

Glenn Dunlap: Well that's great guys. Well I appreciate you joining us today. This has been great. Uh, it's been insightful and I'm sure that, um, uh, our listeners have, have enjoyed it and will be enriched by it as well. So we certainly appreciate that. And, uh, until next time, we'll, uh, we'll look forward to catching up with you later.

Patrick Smith: Thanks, Glenn.

Wade Maleck: Thanks, Glenn. Thank you. Bye bye. Have a good one.

Glenn Dunlap: All right. Thanks.