The Importance of Customer Retention in SaaS M&A
What is Customer Retention?
Customer retention refers to a company's ability to maintain its existing customers over a sustained period. It is a critical measure of customer satisfaction, product-market fit, and overall business health. High retention rates indicate strong customer loyalty and consistent revenue, which are key drivers of SaaS company valuations.
Why Retention Metrics Matter for Companies and Buyers
Retention metrics provide insights into the stability and growth potential of a SaaS company. For founders, improving customer retention leads to more predictable revenue, enhanced customer lifetime value, and increased profitability. For potential buyers or investors, these metrics reveal the long-term viability of a company and help assess its scalability and sustainability. A SaaS business with high retention rates is often viewed as a lower-risk, higher-value acquisition target.
Key Retention Metrics, How to Calculate Them, and Good Benchmarks
Note: The benchmarks provided assume a B2B SaaS context. Generally, enterprise-focused SaaS companies have higher benchmarks compared to SMB-focused companies, while consumer SaaS typically has significantly lower benchmarks.
Gross Dollar Retention (GDR)
Definition: GDR measures the percentage of revenue retained from existing customers, excluding expansion revenue (upsells, cross-sells, and upgrades).
Formula: GDR = (Revenue at Start of Period - Revenue Lost Due to Churn) / Revenue at Start of Period * 100%
Benchmark: A GDR of 85-95% is considered strong for SaaS companies.
Note: This metric is arguably the most important and most scrutinized by buyers among all retention metrics.
Net Dollar Retention (NDR)
Definition: NDR measures the percentage of revenue retained from existing customers, including expansion revenue.
Formula: NDR = (Revenue at Start of Period + Expansion Revenue - Revenue Lost Due to Churn) / Revenue at Start of Period * 100%
Benchmark: Best-in-class SaaS companies have NDR above 110-120%, indicating strong growth within the existing customer base.
Logo Retention
Definition: The percentage of customers (logos) retained over a given period, regardless of revenue fluctuations.
Formula: Logo Retention = (Customers at Start of Period - Customers Lost) / Customers at Start of Period * 100%
Benchmark: SaaS companies with 80-90% logo retention are generally in a healthy range, but higher retention is preferred for enterprise SaaS.
Churn Rate
Definition: The percentage of customers or revenue lost over a given period. Effectively, churn is the inverse of retention.
Formulas:
Customer Churn = (Customers Lost During Period) / (Customers at Start of Period) * 100%
Revenue Churn = (Revenue Lost Due to Churn) / (Revenue at Start of Period) * 100%
Benchmark: Healthy SaaS businesses aim for a monthly churn rate below 1-2% and an annual churn rate below 10-15%.
Lifetime Value of Customers (LTV)
Definition: LTV estimates the total gross profit a customer generates over their lifetime with the company.
Formula: LTV = (Average Revenue Per User (ARPU) × Gross Margin) / Customer Churn Rate
Benchmark: A high LTV signals strong customer value; SaaS companies often target 3-5x their Customer Acquisition Cost (CAC).
Customer Acquisition Cost (CAC)
Definition: CAC represents the cost incurred to acquire a new customer.
Formula: CAC = (Total Sales & Marketing Expenses) / (Number of New Customers Acquired)
Benchmark: SaaS companies should aim for efficient CAC recovery within 12 months.
LTV/CAC Ratio
Definition: The ratio between customer lifetime value and customer acquisition cost, indicating profitability.
Formula: LTV / CAC = Lifetime Value (LTV) / Customer Acquisition Cost (CAC)
Benchmark: A 3:1 or higher LTV/CAC ratio is ideal, meaning for every $1 spent acquiring a customer, the company earns $3 or more in lifetime value.
How Customer Retention Affects Valuation
Retention metrics are critical in M&A because they reflect revenue stability and growth potential. High retention rates lead to:
Higher Valuations: Investors and acquirers value SaaS companies with strong retention, as recurring revenue is more predictable and profitable.
Lower Acquisition Risk: A company with high retention is less likely to face revenue volatility post-acquisition.
Better Growth Multiples: Companies with high NDR (110%+) and low churn often command higher revenue multiples (10x+ ARR) compared to those with poor retention.
Customer Retention as a Strategic Advantage
For SaaS founders, prioritizing customer retention is not only a strategy for growth—it’s also a key driver of valuation. By optimizing retention metrics, reducing churn, and maximizing customer lifetime value, founders can position their company for a successful exit at a premium multiple.