Benchmarks for what to Avoid, what is Acceptable, and what is Ideal.
You’ve just closed a big new client or firmed up that large renewal and shared the news on Slack.
The responses come in quickly from peers: ???? ???? ???? ????
Then the Finance leader clicks on the order form in Salesforce and reads the pricing and terms. His internal response: ????
WHY CONTRACT TERMS MATTER:
Cash is the lifeblood of any start-up or scale-up. Customer payments are the cheapest source of financing. Much cheaper than investor capital.
My advice to start-ups: Getting paid quickly and upfront by customers matters more than ARR, at least in the near term.
HOW TO CREATE GOOD OUTCOMES
Align interests through transparent contract terms and compensation plans.
Create opportunities for all the parties involved to win — the customer (paying less), the employees working on sale or renewal (rewarded more for favorable terms), and the company (getting cash sooner).
CONTRACTS TERMS THAT CFOs CARE ABOUT
- Invoice Frequency
- Payment Terms
- Contract Length
- Discount Methodology (applied to Price)
- Proof of Concept Structure
- Auto Renewal Clause
- Services Bookings
I offer thoughts below on how the revenue organization can increase alignment with the finance team, increase customer happiness, and get paid fairly for their efforts.
A CEO recently asked me to put together a short presentation for his Revenue Org. His request was:
‘Present a simple table with the equivalent of “GOOD, BETTER, BEST” for common deal terms or negotiation points involving pricing.’
All my recommendations are derived from the following two principles.
- Align Interests. Create positive sum interactions. Align interests between the company and its customers, as well as between the company and its employees.
If interests are aligned in both these areas, then the employee <> customer interaction will have a great likelihood of being successful when it comes to pricing and payments.
- Build Trust. Be as transparent as possible with clients on pricing. Make it easier for them to do business with you. Be willing to offer opt-outs and trials, under certain circumstances.
Insist that both sides have some ‘skin in the game.’ Enterprise sales involves set-up, customization, onboarding, training and sometimes extended proof-of-concept periods. If you value your product, don’t give it away all the upfront set-up work for free. Ask the customer for a payment to ensure they are serious about the engagement. You can then choose to make some or all of it creditable towards the first paid contract term.
Cash is King.
As an advisor to cash constrained early stage start-ups, I focus a lot on cash, cash flow and runway months. With the cost of capital having risen in the last year and the availability of financing (debt and equity) having shrunk, cash runway is more important than ever.
The cost of capital for most start-ups is at least 25% per year and probably well north of that.
The cost of capital for most enterprise buyers is ~10%.
This large spread creates opportunities to align interests through discounting and early payment that is beneficial to both parties.
A Visual Example: How Invoice Frequency Affects Contract NPV
Annual in advance payments are significantly more valuable to a start-up than quarterly or monthly payments.
This specific case assumes a $216,000 1-year contract ($12,000 per month for the first 6 months and $24,000 per month for the second 6 months) assuming a 30% cost of capital and payment 60 days post invoice.
Key Pricing-Related Terms: Avoid, Acceptable, and Ideal
|Invoice Frequency||Monthly (in advance) or anything more delayed||Quarterly (in advance)||Annual (in advance)|
|Payment Terms||Net 60 days or higher||Net 45 days||Net 30 day or less|
|Contract Term||< 1 year||1 year||Multi-Year|
|Discount Methodology||Flat % Discount||Free month(s) in initial term||None|
|Proof of Concept Structure||Free PoC||Paid PoC with full credit towards contract upon conversion||Paid PoC with partial credit towards contract upon conversion|
|Opt-Out||At any time, with short notice period and pro-rated refund||None post PoC; once if there no PoC, at the 90-day mark||None|
|Services||Not charged but provided||Included and paid at a discounted rate||Included and Paid at List Price|
Two items are worthy of a little further discussion.
Discount Methodology: I prefer offering free months to a flat % discount because the former leaves the base monthly price intact. That must be communicated to the buyer and set as the expectation at the renewal. When offering free months, extend the initial contract terms by the number of free months offered. If necessary, wait to send the invoice until after the free period, but ensure payment is annual in advance.
Services: Founders/CEOs have learned from investors that recurring software revenue is critical. That leads them to bundle services into the software. Putting accounting considerations aside, I still believe this is a mistake. Almost all enterprise software products require some level of customization and potentially a free test period.
Companies should insist on billing for services to make clear their time has value. For early adopters, these services might be waived in exchange for something else of value (e.g. a case study or something equivalent).
Enterprise software buyers are accustomed to paying for services. The touchpoint created by the services interactions will likely ensure the buyer is better trained on the software and thus more likely to use it, find value quickly, ultimately leading to increased likelihood of renewal and expansion.
Base Pricing and Additional Incentives
I recommend setting pricing based on the expectation of a quarterly payment schedule with a net 45 day payment expectation.
Then transparently offer discounts that are valuable to the buyer and beneficial to the seller. The specific % of the discounts can be tailored to your company’s situation.
|Additional Incentives||With Customers|
|Annual in Advance||Additional 5% Discount|
|Early Pay Discount||2% Discount if Paid within 10 Days of Invoice|
|Multi-Year Discount||% Based on Challenge to Renew
(Start with 5% for 2 year deal and 8% for 3 year deal)
Alignment between the Company and its Revenue Organization
When the company benefits, its revenue organization should share in the good fortune. While I generally dislike complex incentive plans, I firmly believe in aligning incentives inside the company.
|Additional Incentives||With Employees|
|SPIFFs or Incremental %
Commission Offered for:
|(i) Annual in advance; (ii) Multi-year deals; (iii. Net 30 terms)|
A commonly asked question is about the approval process. What can sales people do on terms without approval and what approval processes should exist.
My recommendation is as follows:
- AEs should always pitch the ‘Preferred’ or ‘Ideal’ terms and show the discounts that are included.
- Sales Leaders should be allowed to approve change up to the ‘Acceptable’ level.
- Finance leadership (or the founder/CEO, if no finance leader is in place) should approve any further changes below ‘Acceptable’.
Be Practical and Fair: Look Out for the Company and the Employees
Every finance leader should communicate to the revenue organization that their hope is for everyone to beat their targets and earn as much as possible. The goals are to maximize billings and revenue leading to both company success and individual performer success.
The reality is that finance leaders will have to accept some “sub-par” deal terms. So be willing to compromise. Have a set of walk-away criteria. And apply your rules uniformly so everyone knows you are even-handed and don’t play favorites.