Building a business around monthly recurring revenue (MRR) makes growth more predictable, and provides investors with a useful metric for understanding trends in profitability and cash flow. This makes the MRR business model popular with technology startups that offer software as a service (SaaS).
The relatively consistent revenue streams provided by the MRR subscription model enable startup founders to generate accurate financial forecasts and plan ahead with greater confidence, which makes scaling up easier. Angel investors watch the rates of MRR growth closely because this is what ultimately delivers them an attractive return on investment (ROI).
MRR numbers capture the so-called momentum of a business, which is another way of saying how quickly and efficiently the business is growing. Month on month revenue growth percentages indicate whether a business is acquiring new customers or not. These percentages also reflect how much money is being spent by each cohort of customer, and whether these trends are going up or down.
MRR is calculated by taking the average revenue per user (ARPU) on a monthly basis and then multiplying it by the total number of users in a given month. This provides the headline monthly number. However, MRR provides its most useful insights about the performance of your business over time when used in conjunction with monthly sign-up rates and other metrics.
Taken together, this data will tell you the contribution being made to revenue by new customers (new MRR) and by existing customers who are spending more (expansion MRR). You can also discover how much revenue is being lost to cancellations (churned MRR) or downgrades (contraction MRR). Without these cohort numbers, your headline MRR isn’t telling the whole story.
With accurate metrics, both founders and investors benefit from a nuanced understanding of how the business is performing, which empowers them to make better decisions that optimise profitability. Granular MRR data is best viewed over a longer timeframe in order to reveal reliable revenue trends. Otherwise decision makers risk being distracted by short-term volatility or one-off anomalies. For this reason many investors also refer to annual recurring revenue (ARR) when making business valuations.
MRR is not recognised by International Financial Reporting Standards (IFRS), nor is it a generally accepted accounting principle that needs to be reported to tax authorities or government agencies. But the importance of MRR to investors means that great care needs to be taken not to make the numbers look better than they really are. Quarterly or annual contracts at full value should not be included in the calculations for a single month. Nor should one-time-only payments, or customers on a trial. All discounting needs to be accurately reported as well.
Clearly, MRR is a powerful and insightful metric for tracking growth and guiding strategic decision making. It also incentivises startup founders by encouraging them to focus on customer retention, thereby reducing churn, and improving service to align with the customer’s needs.
For sales teams, MRR can be used as a goal. An MRR quota, as it is known, is what a sales team is expected to achieve in terms of revenue growth based on the deals they are able to close over a set period of time. The quota serves as an incentive to enhance sales team performance. It also tells management whether sales and marketing strategies are delivering the expected results.
A subscription based MRR business model is of particular benefit to a startup founder when they are looking to fit their product or service into an appealing market. A product or service that comes with a low monthly payment and no commitment to an annual contract is tempting to first-time customers and encourages them to try it out. Even if the customer eventually churns, the startup gains valuable insights from their feedback and online activity.
A focus on MRR values can play an important part in an investor’s exit strategy. A growing MRR will attract the interest of potential investors or could even trigger a business acquisition. While some fortunate businesses get acquired pre-revenue when MRR is zero, a positive or growing MRR tells a compelling story of growth that clearly raises the chances of a successful acquisition which allows investors to exit with a high ROI.
Brauzz is an example of a Pitchdrive Alumni business that is built around a subscription model. It provides customers with multi-purpose household cleaner refills in a way that saves on plastic waste. A flexible subscription model enables the customer to save money and get refills delivered to their door on a regular basis so they don’t need to remember to stock up. The business benefits from this arrangement by receiving a regular and more predictable revenue stream.
Similar benefits apply to another Pitchdrive alumnus, Boombrush, which sells sonic toothbrushes on an MRR subscription basis. The MRR business model provides the company and its investors with consistent revenues. In return, customers receive a market-leading product and great service, with control over their subscription.
A subscription business model based around MRR is of particular interest to SaaS technology startups where investors often need to invest significant amounts of capital at the outset. MRR metrics allow investors to monitor revenue growth closely and address warning signs such as growing churn rates or falling customer spend in a timely manner. Flexible subscription models generate valuable feedback via customer trials. This helps founders refine their offer in the knowledge of a relatively stable and predictable revenue stream that also facilitates scaling up.
If you’re an early-stage start-up seeking investment or guidance on your next steps, get in touch with us today to find out more about how Pitchdrive can help.