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Editor’s note: This article is from WeChat public account “ GGV Jiyuan Capital ” (ID : GGVCapital), author of the GGV Corporate Services Group.

Must read for business service entrepreneurs: Core indicators that affect company valuation and development

In this article, from the perspective of investors, we will theoretically talk about how to value corporate service companies and tell entrepreneurs which indicators will affect the performance of a company’s listing.

First, we will introduce the current US secondary market valuation system and core indicators of interest.

Secondly, we will analyze the reasons why these indicators are important in the light of the characteristics of the Chinese market and dig out some more essential factors that affect the development of the company.

As a global venture capital organization, GGV has been looking for enterprise services companies with revenues that are predictable, high quality, and fast growing. How do we judge their value?

Part 1. SaaS valuation system for US stocks

The value of a company is equal to the discounting of its future free cash flow. This is the most standard definition in financial textbooks. However, in actual valuation, especially in the changing technology industry, predicting a company’s future cash flow requires too many assumptions. So, people often use “divide valuation by profit” as an indicator to compare companies horizontally, which is also often said as P / E.

For corporate service (especially SaaS) companies, since the cash received will be amortized to the next 12 months and recorded as revenue, and the market and research and development costs are recorded in the month, it is rarely a financial profit And during the period of rapid growth, sales and research and development expenses are constantly strengthening, so cash flow will also be loss.

In this case, the entire secondary market is”Company value divided by company income” to evaluate the company. The most commonly used indicator is “company value divided by company’s revenue forecast for the next year” (EV / NTM Revenue Multiple). This multiple is the recent median market value of about 8x.

The following is a picture displayed by GGV Jiyuan Capital Management Partner Jeff Richards at the GGV Evolving Enterprise event. It is Morgan Stanley’s analysis of the market value of listed enterprise software companies. The horizontal axis is the company’s revenue increase. The ordinate is the multiple of the company’s value / 2020 revenue. It can be seen that the company’s revenue growth rate and the valuation have a very obvious positive correlation.
Must read for business service entrepreneurs: core indicators that affect the company's valuation and development

We will also have dozens of US stocks The data of listed enterprise service companies are compared as follows:
A must read for entrepreneurs of business services: core indicators that affect the valuation and development of a company

First, revenue increases The indicator of speed is positively correlated with multiples of market value.

Second, the more important indicator of Net Retention is also closely related to the company’s market value. For example, a company with more than 130% of its revenue can get a valuation premium of up to 20x. Companies with revenues below 110% often have valuations below 10x.

The valuation of traditional Internet companies is often directly affected by profitability, such as Ali, Tencent and other companies. But in the corporate services industry, the correlation between the company’s profitability and company valuation is not obvious, and some companies with very low net profit margins have also received higher valuation premiums. Similarly, the free cash flow rate has little effect on the company’s market value. Because in this high-growth market, even if it is a listed company with a market value of billions of dollars, investors still hope that the company will vigorously invest the cash of revenue into new customers and product development. However, it should also be noted that although the financial profits of these companies are mostly negative, the cash flow level has actually started to be profitable.

Of course, There are also many important factors that affect the company’s market value, such as team, technical route, shareholder structure,Competitors, etc. These factors are difficult to quantify, but they are often reflected in the above indicators over time.

Some friends who used to be hedge funds told me half-jokingly that investing in these SaaS companies does n’t even need to understand the company ’s business. Take these indicators to compare them horizontally, and then buy them. Company, guaranteed to earn plenty of money.

Part 2. High predictability, high quality, and fast-growing income

Why are the above observations worth considering for Chinese startups and primary market investors? How does GGV invest in corporate services companies in China and judge their value?

In a word, we are looking for companies whose revenues are consistent with predictability, high quality and rapid growth.

Must read for business service entrepreneurs: Core indicators that affect company valuation and development

01 First define revenue: The importance of revenue to enterprise service companies is equivalent to DAU to social media and GMV to e-commerce.

The income of a single customer can clearly show: whether the customer’s problem is important, whether the product can really solve this problem, and whether the effect can be clearly quantified.

When we look at the company, we will focus on one question: Why do customers pay the same amount to product A and product B to the same customer base?

There are many calibers of income, but entrepreneurs should clearly know that cash income> finance income> contract income.

Must read for business service entrepreneurs: Core indicators that affect company valuation and development

SaaS companies in the United States are so sought after, mostly because they have received cash for a year in advance.

The income of listed companies in the chart just mentioned refers to financial income (that is, the income recorded in the company’s financial statements through accounting standards) In our usual judgment of the company, it is also very Pay attention to financial income rather than contract revenue, and attach great importance to the time of receipt of cash income. The contract revenue we see is sometimes appraised to future financial income in accordance with accounting standards, but the contract revenue is not received in cash. In this case, our consideration of this revenue will be discounted. .

Concept explanation: Suppose a SaaS company signed a two-year contract in January 2019, a total of 2.4 million, 100,000 monthly, and payment at the beginning of each year. The data will reflect that in January 2019, the company’s contract revenue was 2.4 million, cash income was 1.2 million (of which 1.1 million was prepaid), and financial income was 100,000.

In the traditional software service market in China, there will be a certain gap between the contract and the business that is actually realized. Often it may happen that a sales contract is signed and the subsequent execution cannot keep up with the customer. Without acceptance, this cannot be recorded as financial income. Or, after the software delivery is completed, you can get cash back in half a year or even a year in arrears, and you may not even get it.

So companies in the industry are still selected to serve early-stage entrepreneurs. Try to find customer industries or product functions that can receive cash first, and avoid falling into “empty and superficial performance, working hard but not receiving money.” “Trap.

If the entrepreneur is already in an industry with a long accounting period, he should also work hard to manage the speed of contract delivery and payment. We have seen a lot of companies that think that there are a lot of big contracts on their hands that can “sit back and relax”. After one or two years, the financial income is far lower than that year ’s expectations, or they are unable to carry out the services suffering from these big contracts new business.

Another concept of revenue is sustainable revenue. If a company has subscription-based revenue, it can calculate the company’s ARR (Annual Recurring Revenue) and MRR (Monthly Recurring Revenue).

Concept explanation: Suppose the company has signed a new 1.5 million contract, of which 300,000 is a one-time project implementation cost, and 1.2 million is a softIf an annual fee is used, the company’s ARR will increase by 1.2 million and MRR will increase by 100,000. If all the company’s contracts are calculated and aggregated, the ARR and MRR at each time point (ARR / 12) can be obtained.

Newly signed contracts each month may have fluctuations and seasonality. If the newly signed contract income is recorded as financial income, statistics show that the report will make it difficult for investors to see the law, but by flat Amortized MRR is recorded as financial income, which can help investors to clearly see this growth trend, and it can also help founders to set goals and manage companies.

02 Predictability is our most important factor

As mentioned earlier, The secondary market attaches great importance to the income retention Net Dollar Retention indicator, which is the most important indicator of future income predictability.

The calculation method is that all income generated by existing customers in the new year (including the renewal and purchase of existing modules, additional purchases of new modules) is taken as the numerator. All income is used as the denominator and the two are divided.

For companies with sustainable income, such as Net Dollar Retention from 2018 to 2019, the calculation method in the financial report is the sum of the ARR of all paying customers in December 2018 as the denominator. The sum of ARRs for the same batch of customers (ie, new customers acquired in 19 years) is the numerator.

Formula:

Must read for business service entrepreneurs: Core indicators that affect company valuation and development

Customer group is defined as: all Paid Customers as of 12 months prior to the current day.

Molecule = ARR of the guest group at this moment

Denominator = ARR of the customer base 12 months ago
Must read for business service entrepreneurs: core indicators affecting the valuation and development of the company

(Attachment: Slack listing prospectus )

There is another algorithm that is commonly used for primary market companies. Similar to the C-end APP’s calculation of user retention, that is, users are divided into different groups according to customer acquisition time, and then monthly or Based on quarterly calculations, indicators such as half-year retention, one-year retention, and two-year retention are obtained. The example shown in the figure below is assuming that a good Chinese SaaS startup company might have a retention map. In Q5, about 80-100% of the income is retained.
Must read for business service entrepreneurs: core indicators that affect the valuation and development of the company

Why do revenues stay Net How important is Dollar Retention? Use plain words to understand the meaning behind it for entrepreneurs:

At the beginning of the year, Net Dollar Retention multiplied by last year’s income, which is the bottom-line income from existing customers. That is, even if the company cuts off the sales team and no longer acquires new customers, this part of the revenue can be maintained this year.

Net Dollar Retention is the most attractive feature of the entire enterprise software industry. In the To C market, there are very few products that really have defensive barriers (such as WeChat with obvious network effects, Taobao with obvious bilateral platform effects, or obvious headlines accumulated by data algorithms). Even if it is a bilateral platform that just needs high frequency, such as a taxi platform, consumers will switch to competing products with little care. So even if the company has tens of billions of revenue this year, next year must go all out to retain customers.

In the To B software market, once users use a product, they have accumulated data and workflows on the platform, making switching difficult. So as long as an enterprise software product cuts into the customer, if it really generates value, it will have excellent retention. And with the growth of the client company itself, the company sells more modules to the same client, and the payment of a single client will continue to increase, so you can see this Net Dollar greater than 100% in a large number of enterprise service companies Retention indicator.

What can a good retention do?What happened? The picture published in the Slack listing prospectus can be seen:
Must read for business service entrepreneurs: core indicators that affect the company's valuation and development must have for business service entrepreneurs Read: The core indicators that affect the valuation and development of the company <strong> It can be clearly seen that as a good enterprise software product with Net Dollar Retention, its growth is largely driven by old customers, and the pressure on new customers every year is minimal. </strong></p> <p> <strong> Every enterprise service company should list its own indicators to evaluate its own company. </ strong> In China, it ’s too far to reach the target of 170% or 140%. Entrepreneurs can first set the goal to be greater than 100%, that is, the revenue of each batch of customers will not be lost in the future. . </ p></p> <p> <strong> We can go back to this calculation formula and take a closer look, especially the molecular part: </ strong> </ p></p> <p> <strong> As mentioned earlier, </ strong> </ p></p> <p> <strong> Numerator = ARR for all customers who were paying 12 months ago </ strong> </ p></p> <p> <strong> Denominator = ARR of all customers who paid 12 months ago at that time (that is, 12 months ago) </ strong> </ p></p> <p> <strong> Taking a closer look, we can divide the paying customers 12 months ago into retained customers and lost customers. </strong></p> <p> <strong> Numerator = ARR for renewal of customer’s existing module + ARR for renewal of customer’s existing module + ARR for renewal of customer’s new module </ strong> </ p></p> <p> <strong> Among them, the renewal of the customer ’s original module ARR = denominator-the ARR of the lost customer-the reduction of the customer’s original module </ strong> </ p></p> <p> <strong> For investors, the core of a company’s valuation is the predictability of revenue. </strong></p> <p> From the results, each of the above variables will affect income in the new year. However, the proportion of lost customers and retained users, and the renewal revenue of retained customers’ original modules, are relatively stable without major fluctuations (Related to whether the product really solves the customer’s existing scenario). </ p></p> <p> But the additional purchases of the original modules are full of uncertainty, especially when it comes to cross-departmental purchases. The addition of new modules is even more uncertain. </ p></p> <p> <strong> So, the basis of maintaining a good income retention Net Dollar Retention is to maintain a high proportion of retained customers, plus a high renewal fee of the original module. </ strong> </ p></p> <p> <strong> For entrepreneurs, maintaining a high percentage of retained customers is a top priority for strategy and products. </ strong> </ p></p> <p> <strong> The customer churn is no more than three reasons: the client company closed down, the customer switched to another product, and the customer abandoned the use of this type of product. </ strong> </ p></p> <p> If the customer failure rate is high, then entrepreneurs should strategically consider whether they choose the wrong customer industry and customer size; if customers switch to competing products, entrepreneurs should continue to step up iterative products; if customers simply give up using this type of Product, then entrepreneurs should think about their own track, is there an unrealized demand, or is there no product-market fit? </ p></p> <p> Don’t be fooled by new sales. Many times, an excellent sales team can let users buy products for the first time, even if the product is rotten and useless; Okay. </ p></p> <p> <strong> In the Chinese market, we have seen some excellent startups of Net Dollar Retention (more than 110%). They have chosen a good industry. The product really solves the customer ’s problem. Customers continue to buy, Additional purchases. </ strong> </ p></p> <p> For these companies, the company’s revenue growth is highly predictable. Even in the face of market fluctuations, it can maintain good revenue growth. Such companies have achieved higher revenue in less time. Of course, they also have a higher valuation premium in the capital market. </ p></p> <p> <strong> However, we also need to recognize China ’s national conditions: most large enterprises ’software budgets are still traditional project systems, so most startups that serve large enterprises only have very poor revenue retention. The annual project can be recorded as income, and after that, only 15% of maintenance costs will be paid each year. </ strong> </ p></p> <p> Some particularly good products have contracts every year, and there will be one period, two periods and three periods, so from the results, the company ’s Net Dollar Retention will be good, but we must also deeply realize that this is only the original module Increase the purchase, and the modules that have been sold will no longer generate sustainable income. In this model, if the customer suddenly does not increase the purchase, and continues to use the company’s products, it may not bring a Dividend income. </ p></p> <p> <strong> As an investor, how do you look at such a company? Investor ratings are reflected in valuations. The more revenue-prone the company, the higher the valuation. </ strong> </ p></p> <p> <strong> In the secondary market, this indicator is already strongly related to valuation multiples. In the primary market in China, we have actually seen a lot of unreasonable situations. </ Strong> For example: a company whose entire income is only a one-time project, and all future growth depends on newly acquired customers, has also achieved too high Valuation. However, we believe that as these companies grow their revenues and move towards the secondary market, the valuation will be beaten back to the prototype. At this time, investors who invest in such companies with 20x or 30x income will find it difficult to obtain returns . </ p></p> <p> <strong> Quantify how much the specific impact of Net Dollar Retention on the valuation will be. Our Silicon Valley counterpart BVP statistics. </ strong> </ p></p> <p> <strong> <strong> <img alt = < / strong>

We also made a DCF (Discounted Cash Flow) model for GGV. Assume that the company’s revenue is 100 million US dollars, and the annual revenue of new customers is 50 million US dollars. All other assumptions are based on the median industry value The following two figures are obtained.
Must read for entrepreneurs of corporate services: core indicators that affect the valuation and development of a company

corporate services Entrepreneurs must read: Core indicators affecting the company's valuation and development

As an entrepreneur, what should you do?

Most of the entrepreneurs in China’s enterprise service sector are very good. They have many years of industry experience, and have comprehensive skills in technology, sales, and management. But what makes some companies stand out from their peers? In fact, in most cases, it is a strategy, not an implementation. A highly performative entrepreneur can raise Net Dollar Retention from 70% to 80%, but