The magic number

The Magic Number is another key metric used in venture capital, particularly for SaaS (Software-as-a-Service) companies. It measures the efficiency of sales and marketing spending in driving new revenue. Essentially, it shows how quickly a company can recoup its customer acquisition costs (CAC) through new revenue.

Formula:

Where:

• Net New ARR (Quarterly): The change in annual recurring revenue (ARR) in a given quarter.
• Sales and Marketing Expenses (Previous Quarter): The total amount spent on sales and marketing in the previous quarter.

How to interpret:

• Magic Number > 1: The company is efficient at generating revenue relative to sales and marketing spend. For every dollar spent on sales and marketing, the company generates more than one dollar in new ARR within a year, which is a good sign of capital efficiency.
• Magic Number between 0.75 and 1: This is typically seen as a healthy range, where the company is approaching break-even in sales and marketing spending.
• Magic Number < 0.75: This suggests that the company is spending too much on sales and marketing relative to the revenue it is bringing in. It may indicate that growth is not as efficient, and the company may need to adjust its go-to-market strategy.

In essence, the Magic Number helps evaluate how well a company is converting sales and marketing investments into new revenue growth. It's particularly useful when assessing the scalability of a business.