One of the first challenges for a startup is acquiring customers. Once customers have been acquired, a new challenge emerges: retaining them. For investors, understanding how a startup manages customer retention is an important metric to consider. In this blog, learn more about customer retention metrics and assessing customer retention when conducting due diligence on startups.

Assessing Customer Retention

When assessing the subset of overall startup metrics related to retention, investors typically focus on a core set of metrics to evaluate retention health. The following are some of these metrics.

Net Revenue Retention (NRR)

Net Revenue Retention is an important metric for startups that may be utilizing a subscription revenue model and relies on recurring revenue as a key metric. NRR measures the percentage of recurring revenue that is retained from existing customers over a given period, typically one year. This metric also accounts for upsells, downgrades, and churn. To calculate:

Net Revenue Retention = (Starting Revenue + Upgrades – Downgrades – Churn) / Starting Revenue

An NRR over 100% indicates that revenue growth from the existing customer base outweighs revenue lost from downgrades and cancellations. Investors typically want to see a higher NRR, as it demonstrates the startup’s ability to grow organically, indicates customer satisfaction, product re-use, and reduces the startup’s reliance on acquiring new customers in order to grow.

Churn Rate

Churn Rate is a metric that puts a number to the rate at which customers stop doing business with a company during a specific period, typically over a month. It is generally expressed in terms of customer churn or revenue churn. To calculate:

Customer Churn Rate = (Customers Lost in Period / Total Customers at Start of Period)

Revenue Churn Rate = (Recurring Revenue Lost in Period / Recurring Revenue at Start of Period)

Low churn rates generally represent a strong product-market fit and customer loyalty while higher churn rates can represent potential issues with product value or competitive positioning.

Customer Retention Rate (CRR)

Customer Retention Rate measures the percentage of customers that a company retains over a given time frame. This metric is the inverse of customer churn. To calculate:

Customer Retention Rate = ((# of Customers at End of Period – # of New Customers Added During Period) / # of Customers at Start of Period) x 100

This metric can provide a straightforward view of customer loyalty over time. While this can be a useful metric, using CRR in isolation does not typically capture the revenue value or growth potential within the retained cohort.

Retention Metrics Across Revenue Models

With these retention metrics serving as a measure of customer loyalty and turnover, a key consideration for investors is that retention metrics may not be a quality metric for certain types of businesses. The relevance of retention metrics is intrinsically tied to the company’s business model, revenue model, product type, and customer interaction cycle.

When evaluating retention metrics, investors should consider the following types of purchasing decisions to avoid putting too heavy an emphasis on retention metrics if they aren’t relevant for a certain startup.

One-Time or Infrequent Purchases

Certain types of products involve a single transaction with no expectation of a recurring commercial relationship. For example, durable goods like a refrigerator, computer, or a software license that holds a perpetual right to use may be a one-time or two-time purchase. Therefore, monthly churn or NRR are irrelevant metrics. There may be cases, like a Ring camera, where the hardware purchase itself is a one-time or infrequent purchase, but the company also utilizes a monthly or annual subscription model for additional features like longer video storage and the ability to download videos to a device. For investors assessing these types of companies, they may want to shift focus to metrics like customer lifetime value (LTV) or referral rates.

Medium to Long-Cycle Repurchases

Some products may have medium to long replacement cycles, like automotive parts, medical devices, or enterprise software with multi-year contracts. For these businesses, retention is more relevant than one-time or infrequent purchases, but is measured over a longer period of time, like years instead of months. Key metrics when assessing these types of businesses may include contract renewal rates and customer lifetime duration.

Recurring and Consumer Purchases

Companies that have products that are recurrently purchased align best with standard retention analytics. From subscription services like Netflix and Hulu to consumable goods like food, cosmetics, and office supplies, metrics like NRR, churn rate, and CRR are directly applicable and relevant. Investors can research the drivers of churn, the cost of re-acquiring a customer if they fail to repurchase, and the elasticity of demand for the product. Investors may want to understand if a product is becoming a “staple of life”, or a habitual repurchase.

Key Considerations

As investors evaluate retention metrics during due diligence, the following are some key considerations to keep in mind.

Align Metric with Model

A good starting spot is to align retention metrics with business or revenue models. Which metrics are most relevant based on the startup’s repurchase cycle?

Seek Qualitative Context

Metrics can indicate what is happening, but insight from founders and customers can explain why things are happening the way they are. Investors may want to investigate the reasons for churn, drivers of expansion, and factors that influence repurchasing decisions.

Benchmark Against Peers

Retention rates can vary significantly by industry, market segment, and product stage. A 10% churn rate may cause significant impacts to a mature software company, while it may be expected for an early-stage consumer mobile app that is still attempting to find product-market fit. Context can be helpful for accurate interpretation.

Final Thoughts

Customer retention can serve as an indicator of a startup’s core value proposition and a picture of current and short term future position. For investors, assessing retention metrics involves aligning retention metrics with business model, interpreting them within its respective context, and using retention metrics as a part of the overall due diligence picture.

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Want to learn more about industries to keep an eye on? Check out the following MicroVentures blogs to learn more:

• The Growth of Supply Chain and Logistics Tech
• Understanding Startup Revenue Models
• MicroVentures’ Portfolio Company: Stripe’s History and Milestones
• Understanding and Assessing Term Sheets

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.