KEY POINTS:
- Understanding key finance terms is essential for negotiating SaaS agreements effectively.
- Having a strong grasp of financial terms empowers in-house counsel to be an extremely commercial operator, prioritizing the right things and balancing risk appropriately.
- To learn even more, ask your finance team and deal desk to help you become more financially literate.
The language of business is numbers, not words. This is one of the first things I learned after making the move from the firm side to the in-house side. In fact, I work in the SaaS business-to-business (B2B) space now, which has its own made-up finance vocabulary! “Rule of 40” and “SaaS Magic Number” are phrases I hear daily as we grow the business and track these key metrics.[1]
Whatever your sector, having a strong grasp of key finance concepts is guaranteed to help you negotiate SaaS agreements more effectively and position yourself as a valuable business partner. For example, there’s no point in heavily negotiating a contract with a low TCV (see below for definition). It’s a waste of time and precious resources, and very soon business users will just see you as a blocker. Understanding these terms and how they impact the value of a contract to your business is crucial.
Here are the top nine finance terms you need to know to help you negotiate SaaS agreements more effectively.
1. Revenue Recognition
Revenue Recognition is an accounting principle that determines when revenue is recognized in financial statements. In SaaS, it’s usually recognized over the subscription period in which the service is delivered. I use this term the most at end of quarter because it directly relates to termination for convenience clauses, which are often a net point along with indemnity caps.
Buyers usually want termination for convenience in the contract for flexibility. But sellers cannot recognize that revenue if the customer can terminate at any time, for any reason. Most buyers understand this and drop it, but very large ones will insist on it, especially if you’re using their template. As a workaround, speak to your finance team to see if it can stay in, provided the termination clause is subject to customer acknowledging payment is upfront in full and they have no claw-back right.
2. ACV (Annual Contract Value)
ACV is the total value of a new customer’s contract over a 12-month period, including any recurring fees (e.g., Onboarding (defined below)) or additional services (e.g., Professional Services (defined below)). Use this figure as a benchmark for triaging contracts and how hard you negotiate. The business will absolutely not want you to spend weeks negotiating a $40,000 contract vs. a $400,000 one. In fact, very low value deals require an entirely different strategy. Such as setting a threshold amount beneath which Legal doesn’t negotiate. If you can, try to push your terms “as is” or use hyperlink terms that you can reference in your order form).
3. TCV (Total Contract Value)
This factors in the overall value of the subscription if it’s more than one year, so it reflects the full potential revenue for the initial term plus renewal periods. Similar to ACV, use it to triage how heavily you negotiate (if at all). Bear in mind the flip side of this: if TCV is very high, the business might be more comfortable conceding bigger points (such as greater indemnity caps).
4. ARR (Annual Recurring Revenue / MRR (Monthly Recurring Revenue)
ARR is a key metric used by businesses that sell subscriptions. It measures all revenue generated by customer contracts over a recurring billing cycle, typically the next 12 months. SaaS companies typically break this down into quarterly company targets. If they sell monthly subscriptions, they set the company target monthly (MRR). Whether it’s ARR or MRR, for Legal this number is made up of SaaS agreements. I recommend you join regular forecast calls to understand how these numbers break down in terms of deals and prospects, and get ahead of what you need to prioritize.
5. ASP (Average Selling Price)
The ASP is the average initial price of a product or subscription service sold to a new customer. It is simply calculated by dividing revenue in a given period (e.g., a quarter) by the number of new subscriptions sold. It’s the average price of the contracts you are negotiating. SaaS companies will want this to increase as they grow and you should notice this increase quarter on quarter.
6. EOQ (End of Quarter) / EOM (End of Month)
EOQ is the chaotic conclusion of one of four specific three-month periods on the financial calendar. Many SaaS businesses mirror the usual calendar year from January 1st through December 31st. But some choose to shift to a fiscal year to end on January 31st to reduce stress over the holiday season, when most folks burn out or go on vacation.
But EOQ isn’t just about closing deals. Quarterly revenue targets are a chief metric for SaaS B2B companies and usually scrutinized by boards and potential investors. Always remember that your hard work at EOQ is contributing to the big picture!
EOM is the main metric used by SaaS companies that sell subscriptions monthly rather than yearly.
7. Renewal Rate
SaaS isn’t just about winning new logos and ARR. A key part of growing a business is getting your existing customers to renew their subscriptions and use your product for longer. Renewal rate is calculated by dividing the number of customers that renew at the end of a specified time period (e.g., quarter) by the total number that were up for renewal, multiplied by 100 (to get a percentage).
Legal will often be asked to review terms in renewal order forms. In order to manage these simple but high-volume contracts, I use a playbook with bespoke terms pre-drafted so the business can self-select these in our CLM tool.
8. PS (Professional Services)
Similar to renewals, PS is key to expansion and retaining existing customers because you can go deep on deployments and sell extra features and products. As a lawyer, this is where you have to teach the business about the difference between a SaaS agreement (sale of your tool only) and a master services agreement (sale of services performed by human beings, plus SaaS).
9. Onboarding
As with PS, onboarding is another separate line item on order forms that feeds into pricing. Onboarding is what happens to a customer after they’ve bought your tool. They are introduced to your product in a way that encourages them to adopt and keep it. A great onboarding experience is an extremely powerful marketing tool for finding new customers.
By having a strong grasp of finance aspects of SaaS agreements, you are helping the business win new customers and generate revenue quicker, which is one of the main ways you show your value as a lawyer (especially in rapid scale where I work).
[1] “Rule of 40” is that a SaaS company’s growth rate, when added to its free cash flow rate, should equal or exceed 40%. Over 40% means the business is generating profit at a sustainable rate. Below 40% means it may be facing cash flow or liquidity issues.
“SaaS Magic Number” tracks the sales and marketing cost of bringing in revenue. Put simply, for every dollar spent on sales and marketing, how much is the business making in revenue?
