3 minute read / Oct 20, 2016 /
What is the Optimal Contract Length for Your SaaS Startup?
What is the optimal contract length with for your SaaS startup? Monthly, annual, multiyear? It’s common to see SaaS startups initially price their products on a monthly basis, then add an enterprise “Call Me” plan which hides behind it an annual contract. As the business increases its price point, it may eventually book contracts spanning two, three or even five years.
This pricing pattern has a certain rationale to it. It enables an early-stage software company to rapidly gather feedback. At the outset, when the business prices on a monthly basis, the startup is looking for as much information about the strength of their product market fit as possible.
Monthly payment plans minimize the friction associated with new users signing up and using the product, while still testing their willingness to pay. More users means more data means better test results on marketing, conversion funnels, and engagement. A monthly payment plan reduces the initial outlay a new user has to consider when trialing a product. In addition, the user knows they can turn at any time.
If the monthly churn figures are low, the startup gains confidence in the product market fit. Even though the users have the opportunity to cancel anytime, they continue to use the product.
After the initial testing phase with monthly pricing plans is complete, a startup will likely hire an inside sales team and compensate them based on quota. This is a natural transition point to adopt annual contracts, because quota calculation requires it.
When precisely to hire an inside sales team varies widely by company. Atlassian never did it. Salesforce hired teams early on, but moved to annual contracts after achieving more than $10M in ARR, and other companies start with annual contracts almost immediately.
Annual contracts bring predictability to a SaaS startup. Revenues committed for 12 months, and the cash flow characteristics of annual prepay contracts are an enormous boon for the business, reducing the total amount of financing the might have to raise.
In addition, annual contracts enable customer success teams to develop longer-term relationships with customers, create account plans and help their customers achieve long-term goals, rather than react to immediate fires in order to “save” revenue.
Multiyear contracts are more typical as price points approach $250k or $500k per year and as the startup matures. The buyer perceives far less risk in committing long-term to a vendor because that vendor’s stature as a market leader is supported by its brand, capitalization, references from customers and many other factors.
Matching your SaaS startup’s contract duration to the product development phase is a powerful tool for maximizing experimental data during the early days. Shifting to annual and longer term contracts after experimentation phase insurers/startups can benefit from stronger cash collections and structure sales goals effectively.