Note: this was originally published at https://alexoppenheimer.substack.com/

The three key characteristics of a SaaS company are: subscription, high margin, and scalability. There are so many new business models and new applications of existing business models into new markets that capture one or two of these, but in order to get the high multiples that SaaS companies achieve, it's critical to have all three. In addition, the "rule of thumb" metrics that I previously mentioned don't work so well in the absence of any of these characteristics. While the fundamental subscription math remains true, you have to dig much deeper to understand the impact on the cash flows, working capital needs, scalability, customer lifetime value and long term profitability to be able to assess the health and viability of a business.

For example, if we look at Lemonade, which priced its IPO today (424B4 here). Lemonade is a technology-enabled insurance company and insurance broker. I think most people would agree that it is not a software company. But if we look through the lens of these three characteristics and some of the key metrics, we can learn a lot about its long term prospects as a business.

1. Subscription: Insurance is probably one of the original subscription businesses, with people paying annual or monthly premiums. Revenue comes in regularly to support the clients’ claims.
2. Scalability: Assuming there's access to re-insurance and the capital to back up the insurance plans, this business is highly scalable and in a huge market.
3. Margins: This is where it gets a bit more complicated. This is not a 90% margin, AWS-expense only business. It's a complicated financial cycle and risk assessment business with very different capital, accounting and cash flow dynamics. Lemonade runs a few different businesses with varying risk ownership which have an impact on gross profit, and overall they achieved a gross margin of 17% in 2019.

Now let's take a look at some of the key metrics:

1. LTV: In most software businesses, especially those either creating or selling into new markets, it's almost impossible to calculate a lifetime value because we don't have enough data on the lifetime of a customer. In the insurance business, there's tons of data going back decades for hundreds of millions of people. Insurance companies run on actuarial science, which one could argue is the original data science application. To put it lightly, they understand data and have lots of it. While in a new-fangled enterprise or consumer software business, lifetime value is a shot in the dark, in the insurance business it's not, where it's reasonable to expect your customers to stay with you for 25+ years.
2. CAC Payback: Knowing you can keep your customers for a very long time is great and now you can calculate the CAC you can afford to invest in order to acquire them. Lemonade runs efficiently now with $1 of marketing to $2 of in-force premium on their platform. Gross margin-adjusted this obviously shifts the timeline out, but that's OK because the likelihood of keeping the customers for a long time is high. This introduces a new question: capital. With short paybacks, cash management isn't so much of a challenge, but as those payback times increase, so does the need to fund the working capital needs of the business. The time value of money becomes a factor here, but is manageable and calculable.

So a quick look through the lens of the fundamental subscription concepts makes it clear that even though Lemonade is not a software business, it is a subscription business with some highly favorable business and customer economics.

And congrats to the Lemonade team on the IPO!

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