The Financial Impact of Monthly SaaS Renewals
How moving from annual contracts to month-to-month renewals affects valuation, cash flow, and retention.
DEAR STAGE 2: We sign customers to one-year contracts on their initial deal, but upon renewal, we bill them month to month. It works for us, churn is low, and we avoid a renewal sales effort. But I’m wondering, what are the trade-offs with this model that I should consider? Could this impact valuation when we go to raise funding? ~QUESTIONING CONTRACTS
DEAR QUESTIONING CONTRACTS: I’ve certainly seen annual and month-to-month, and companies who shift from monthly to annual contracts over time, but I have to be honest - this is new to me. To go through the effort of selling an annual contract and THEN shifting back to month-to-month is not something I’ve encountered. It’s an interesting renewal strategy—one that eliminates the friction of a renewal process (I have to assume the monthly billing is based on an auto-renewal) but introduces some key financial and strategic considerations. While your approach is working well now, the long-term impact on valuation, cash flow, and customer commitment is worth thinking through.
I asked Stage 2 LP and CRO at Spark Hire, Gary Schwake, to weigh in on this approach.
Let’s break it down:
Valuation Considerations: Predictability vs. Flexibility
From a valuation perspective, investors *typically* prefer the predictability of contracted ARR over extrapolated MRR. If your month-to-month renewals behave similarly to annual contracts in terms of retention, your valuation may not take a big hit. But there’s always a perception risk:
If churn stays low and revenue remains stable, your model holds up well. Investors can build forecasts based on historical retention rates.
If market conditions shift or churn increases, the absence of contractual commitments means future revenue is harder to predict. Investors—especially in private equity, where leverage is involved—tend to prefer annual contracts for cash flow predictability.
Many SaaS investors measure future ARR based on a customer’s exit ARR at the end of their contract. When contracts renew month-to-month, confidence in that number is lower than if there were a signed commitment.
Cash Flow and Working Capital Impact
Annual contracts provide upfront cash, which improves working capital and runway. Monthly renewals reduce the lump sum payments that come with annual deals, which can impact cash flow planning:
Annual contracts provide capital early, which is helpful for reinvestment in growth.
Monthly renewals spread revenue out over time, leaving less cash in the bank upfront and potentially creating financial constraints.
As Gary Schwake noted, in times of economic uncertainty where sudden changes arise that can impact your business (e.g., a sudden downturn like March 2020, the recent tariffs’ impact on the market), having annual contracts in place can serve as a hedge against short-term shocks. Without them, you're more exposed to sudden churn or customer budget cuts.
Customer Commitment and Retention Risks
Giving customers an easy out may increase churn risk in the long run. When a company signs an annual contract, they’re making an implicit commitment to seeing the value of your product over time. When they’re on a month-to-month plan, a single issue—downtime, leadership change, a competitor discount—can make them more likely to churn.
Annual contracts encourage deeper customer investment. If they’ve already paid, they’re more likely to work through small bumps in the road.
Monthly contracts give customers an easy exit. A minor inconvenience could lead them to switch providers without much thought.
This becomes more important as customers get larger. The bigger the account, the more stakeholders are involved, and the easier it is for a single change (e.g., a new CFO looking for cost savings) to lead to churn.
There’s no single “right answer” on your go-forward model —it depends on your company's goals and risk tolerance. If retention remains high and cash flow is strong, your model works well. But if you want to optimize for valuation and predictability, consider a hybrid approach:
Offer incentives for annual renewals (or charge more for the flexibility that month-to-month contracts offer – however, you choose to look at this tradeoff). Discounts or value-add services can encourage customers to re-commit rather than default to month-to-month.
Use data to segment customers. If larger customers are more likely to churn month-to-month, push them toward annual contracts while keeping flexibility for smaller accounts.
Monitor market shifts. If competition intensifies or customer budgets tighten, reconsider whether the lack of contractual commitments puts you at risk.
Until next week!