Why Early-Stage Startups Should Focus on Revenue Quality, Not Just Growth

Most early-stage startups emphasize growing revenue, and rightfully so. After all, if you can’t grow revenue, you won’t be in business for very long. That’s why it’s a big deal when your startup hits $1 million, $5 million and $10 million thresholds (and so on).

However, when your startup starts to hit its funding milestones, it’s just as important to focus on the quality of your revenue as the revenue quantity. This ensures the stability, sustainability and profitability of your startup’s revenue streams. Understanding revenue quality is also about knowing how it’s earned and aligning revenue with your startup’s strategy, and how it supports future cash flows.

When to Shift from Revenue Accumulation to Revenue Quality

So, when’s the right time to transition from tracking revenue growth and focusing more on understanding the quality of your revenue? Usually, there are five signs you should be on the lookout for, including:

1. When you’ve hit $2-$3 million in annual recurring revenue.
2. When there’s significant momentum in sales or early traction.
3. If your customer acquisition costs (CAC) are rising.
4. If your revenue streams are inconsistent.
5. If your customer lifetime value (LTV) is low.

By focusing more on the quality of your revenue, you can better understand how your startup makes its money, whether your current business model is sustainable and what changes you need to make to streamline operations. As your early stage company evolves, investors aren’t as interested in its potential as they are in its long-term sustainability, underscoring the importance of being able to back up revenue numbers with the right data.

Understanding the SaaS Revenue Roll-Forward

A SaaS revenue roll-forward is a method for tracking and projecting your startup’s recurring revenue, specifically focusing on new customer acquisitions, upselling, downselling and churn impact. Simply put, it helps your startup determine how its ARR and MRR change over time due to various factors. Roll-forwards offer more than just a snapshot of your startup’s revenue, but a detailed assessment of how it’s changing — and what factors are spurring it — over time. This analysis also helps with net cash forecasting, which is essential for managing burn rates and increasing long term value.

New and Expansion ARR

New ARR represents newly acquired customers, while expansion ARR represents additional revenue gained through upselling, cross-selling and upgrades with existing customers. Both are important, but expansion ARR is one of the strongest indicators of product-market fit and value delivery, as it more clearly represents customer loyalty and the ability of your startup to grow existing strategic relationships. New ARR is important for earning new customers, but it can also mask retention problems.

Contraction and Churn ARR

Contraction and churn are metrics that can reveal problems with your startup and its business model. Contraction occurs when customers downgrade their service, while churn occurs when they stop doing business with your startup entirely. Both serve as warning signs about problems with your product-market fit and can also demonstrate difficulties with onboarding and the overall success of your customers when using your product.

The Core Metrics for Revenue Quality

Your startup should be tracking four foundational metrics to assess qualitative factors of revenue:

Net Revenue Retention (NRR)

NRR is the single most important indicator of revenue quality. It measures the percentage of revenue your startup retains from its existing customers over a specific period, including gains from expansion and offsetting contraction and churn. It’s typically calculated as regularly as annually and follows this formula:

• NRR = (Starting revenue + expansion – contractions – churn) / Starting revenue

NRR is an excellent measure of customer loyalty, can help predict future revenue and is an overall indicator of your startup’s health.

Gross Revenue Retention (GRR)

Gross revenue retention measures the percentage of recurring revenue your startup retains from its customer base over a specific period. It reflects how well your startup can keep its current customers and revenue stream in check. Especially important for SaaS startups, GRR directly measures the stability of a startup’s recurring revenue stream. It’s calculated by following this formula:

• GRR = (Starting ARR – churned ARR – Contraction ARR) / Starting ARR

A GRR of 90 percent and above is considered strong, 80-90 percent is considered good and anything below 80 percent is problematic.

Customer Churn Rate

Customer churn rate measures the percentage of customers who stop using your startup’s service or product over a specific period. It helps assess customer satisfaction, loyalty and can help spur changes to how you operate your startup. The formula is as follows:

• Churn rate = (Churned customers / total customers at start) x 100

For an SaaS startup, you generally want to keep the churn rate under 5 percent each month.

Expansion Rate

The expansion rate measures the percentage increase in revenue from existing customers. It’s typically used to calculate a startup’s success with upselling, cross-selling or other spending strategies and is a key indicator of your startup’s overall sustainable growth.

• Expansion rate = Expansion ARR / Starting ARR

Interpreting Metrics Against Benchmarks

When interpreting quality metrics, it’s important to consider more than the raw number, but also customer size, industry and acquisition channel. Cohort analysis is a method of segmenting data into groups based on shared characteristics and then tracking these groups over time. Beyond the raw number, cohort analysis helps your startup better understand the behavior of your customers and how this behavior evolves. It can also help identify trends that may not be obvious in aggregate data, especially when dealing with risky assets.

Prescriptive Approaches to Improving Revenue Quality

If your revenue quality needs improvement, there are various strategies you can implement to improve it. Here’s a closer look at them:

Fix Onboarding to Improve GRR

Onboarding is often directly tied to GRR, as streamlined onboarding can help reduce churn and improve customer retention. Some strategies to help improve onboarding include:

• Arranging guided setup flows
• Regular check-ins
• Time-to-value tracking

Think of onboarding as an opportunity to make a true first impression with a customer. Starting the process early, providing clear and frequent communication, and personalizing the experience can help improve product adoption and build better initial customer relationships.

Tiered Pricing and Usage-Based Upsells

How your startup structures its prices can help create natural expansion. Consider implementing different pricing models, such as usage tier models, feature unlocks and team-based pricing to facilitate expansion. Think of it like this: As your customers use your product more, they’re more likely to upgrade to higher tiers offering more features or increased usage limits.

Tiered pricing helps create more predictable revenue streams, improve customer lifetime value and even help reduce churn.

Churn Analysis and Win-Back Loops

Understanding churn is important for reducing it. Your startup may also benefit from a strategy for regaining lost customers.

Consider creating a churn analysis framework in which you conduct exit interviews with departing customers, identify the reasons for their departure and accumulate the feedback you gather to gain actionable insight into ways you can improve. Based on the information you obtain, you can institute a win-back campaign that attempts to recapture lost customers by proving that you can meet their needs.

Customer Success-Led Expansion

Consider customer success as a revenue driver rather than just a support function. By doing so, you can transition from reactive support to more proactive customer support. Some of the specific customer success tactics that drive expansion include:

• Health scores
• Usage triggers
• Renewal planning

Focus on Ideal Customer Profile (ICP)

Poor customer fit leads to churn — regardless of the quality of your product or service. That said, it’s important to avoid poor customer fit by focusing your marketing on attaining the ideal daily active users. You can identify your ideal customer based on the retention and expansion data you obtain. From there, it’s important to align marketing, sales and onboarding to ensure you’re attracting the right type of customer.

Transform Your Growth Story with Quality Metrics

Focusing on your quality metrics isn’t just good for the health and success of your startup, they can also help tell its story in an impactful and engaging way. Good quality metrics directly translate to higher valuation and better fundraising outcomes. Creating a compelling narrative around your data and KPIs can make your startup more attractive to investors and communicate your success. For companies looking to eventually enter the stock market, solid revenue quality metrics can significantly influence valuation multiples and investor confidence.

Beyond Growth—Building a Sustainable SaaS Business

If you want your SaaS startup to grow sustainably, it’s important to focus on more than just your revenue growth, but the quality of your metrics. Pay close attention to key metrics like NRR, GRR, expansion and churn — and make changes as necessary to ensure that your startup has a stable foundation. The better your quality metrics are, the more resilient and successful your startup will likely be long-term.

Elevate Your SaaS Metrics with Graphite

For more information on the importance of the quality of your metrics and to engage with a professional about quality assessment and improvement, contact Graphite Financial today. As experienced financial experts who specialize in working with startups, Graphite will assess your metrics and help put an effective improvement plan in place. Contact Graphite today to schedule a consultation.

FAQs

At what ARR level should SaaS startups begin focusing on revenue quality metrics?

While this depends largely on your startup, most startups begin to focus on the quality of their revenue when they reach between $1 and $3 million.

What’s the difference between Net Revenue Retention (NRR) and Gross Revenue Retention (GRR)?

Both of these alternative metrics are used to measure retention, but they have significant differences. NRR considers retained revenue and additional revenue from upselling, cross-selling and expansions. GRR, conversely, focuses on retained revenue and measures how well your startup is keeping its current customer base.

Which revenue quality metric has the strongest correlation with SaaS company valuations?

NRR is the most critical indicator of revenue quality. It measures the percentage of revenue a startup retains from its existing customers over a specific period, including gains from expansion and offsetting contraction and churn.

How does a company’s pricing model impact its expansion potential?

As your customers use your product more, they’re more likely to upgrade to higher tiers offering more features or increased usage limits. Tiered, usage-based or feature-unlock pricing helps create more predictable revenue streams, improves customer lifetime value, reduces churn, and boosts your startup’s valuation.

What are the most common causes of early-stage SaaS churn?

Some common causes of churn include poor onboarding, lack of customer success initiatives, poor customer support and a poor overall value proposition.

How should revenue quality benchmarks differ between enterprise and SMB-focused SaaS companies?

Benchmarks should reflect business models, customer acquisition strategies and revenue profiles.

Can a company with high growth but poor retention metrics still raise a successful Series B?

While it’s possible, it’s more challenging and less likely. Series B investors don’t just want to see potential, but evidence of a sustainable business model.

What organizational changes typically accompany the shift from growth focus to quality focus?

Changes in culture, process and priorities are all typically involved in a shift from a growth to quality focus.