SaaS Businesses and Funding
The truth is: Your SaaS business will not get off the ground and thrive without funding. No matter how good your idea is, how well it solves a pressing issue for your target customer, or how unlike any other product on the market it is, it will not be successful without financial backing. However, there is no need to panic when reading this. There are many ways to raise capital to support the development of your SaaS product, and chances are, starting out small is the way to go. In this article we will walk you through the various recommended approaches and highlight the pros and cons of each so you can make the most informed decision regarding the best way to raise capital for your SaaS business.
In order to determine what funding you will need, you will want to ask yourself questions such as: What is my timeline? How long can I operate my SaaS business before I will need access to additional funds? What milestones do I hope to reach in the next few months, six months and year? How much funding will I need to achieve these goals? If you will need to bring on additional support, how many people and what functions will they serve? In addition to individuals with technical expertise, do not forget about people knowledgeable on website design, marketing and social media. How much would this cost? What would the next iteration of your product look like? How much funding would you need to reach this next phase? Once you have thought through these questions, you will have a better idea of how much money you will need to bring your ideas to fruition and realize success.
You also will want to think long and hard about your long-term goals for your business. What would success look like? How important is retaining control of the business to you? Depending on your answer, this may help you narrow down your options as some funding methods will allow you to retain full control while others will not. Furthermore, are you considering an exit down the line? If so, know that the actions you take in the early days of building your SaaS business can help set you up for a smooth divesting process when you are ready to embark on that journey.
Determining if Your SaaS Business Needs Funding
When it comes to funding, you should carefully consider your plans – both short-term and long-term – because you do not want to have to change the trajectory of your business because the type of funding you have secured does not allow you to follow your original and preferred course. It is important to reiterate that determining if you need and selecting a funding approach is not a decision that you should make impulsively or take lightly.
The question, “How to raise money for a business?” has many possible answers. They include bootstrapping, receiving contributions or loans from family and friends, applying for a loan, seed funding, Series A, Series B and Series C. We will talk through these options in depth below.
In most instances, we do not recommend seeking out venture capital funding because of the limitations this type of investment puts on you and your business. To raise capital, you will want to explore methods that will give you the most flexibility and allow you to sell down the line if you so choose. Start out by bootstrapping (self-funding) first, prove out your concept and get traction. Once you have made a solid effort you can reflect on your progress and determine what makes the most sense in terms of next steps.
You should only look to receive venture capital funding if you are building a $50+ million business. There are several reasons why we make this recommendation including the fact that you will have new forced management, reduced control and decision-making opportunities and the decision to divest would not entirely be in your hands. The loss of independence and need to answer to others may not be the best fit for you, your personality and your work style. Also, the venture capitalist’s plans for your business’ growth, returns and expectations may not align with your own. Given these restrictions, it typically only makes sense to go this route if you are willing to give up control and have confidence that you are building a $50+ million business. Otherwise, taking on this type of funding for your SaaS business early could negatively impact your business’ valuation and salability to buyers later on.
Benefits and Drawbacks of Raising Capital
If you are looking to grow your business and help pave the way for its success, you will want to raise capital. Earlier we discussed how a great idea can hit a major roadblock due to a lack of funding. Having ample money for your SaaS business means that you can keep the lights on and your employees paid. Funding helps you stick to your set schedule for development and maintain a steady pace. If you progress too slowly there is a risk that your competitors will swoop in with a comparable product and steal your customers.
However, funding has its downsides as well. Preparing for meetings with potential investors is time-consuming. When you take time to craft convincing slide decks and other materials, this is time away from making substantial progress toward your next development goal. Exploring how to raise money for a business can be stressful as well. The process of securing venture backed funding is competitive. Investors meet with numerous entrepreneurs and choose to fund just a handful of projects. Although you may think that you need to go with whichever investor selects your business, you should not rush into this relationship. Who you partner with matters and your choice could have serious implications down the road when you are interested in divesting of your business on your own terms.
We have spoken with countless entrepreneurs who have raised capital for their SaaS businesses, inquire about exiting and effectively cannot do so because of the funding they previously received. For instance, if you raise $1 million through venture-backing at a $10 million valuation, then your business is only worth $8 million. This illustrates that actions early on can impact your chances of selling, or at the very least, influence your SaaS business’ valuation when you are ready to sell.
Preparing for Funding
Before you start your preparing for meetings with potential investors it is important to know what your business is already worth. SaaS valuations are calculated based on a multiple of SDE, EBITDA or revenue. Most small businesses valued at under $5,000,000 are valued using a multiple of seller discretionary earnings (SDE), or sometimes also called seller discretionary cash flow. This is the case particularly if the business is relatively slow growing and does not have a management team in place. SDE is the profit left to the business owner once all costs of goods sold and critical (i.e. non-discretionary) operating expenses have been deducted from the gross revenue. Crucially, any owner salary/dividends can be added back to the profit number, too.
FE International has extensive experience calculating valuations of SaaS businesses. Get a free valuation before embarking on the path to secure capital. You may be surprised by your business’ valuation and this information may influence your next steps for your SaaS business.
If you do decide that you want to secure funding you will want to take note of best practices that will set you up for success as you go into meetings with potential investors. Regardless of who you will be asking for funding– whether it be a friend, an angel investor or a venture capital firm, you should thoughtfully prepare a pitch deck. This presentation should focus on the most attractive elements of your business and spark the investor’s interest. To do this, you will need to keep what is most important to your investor top of mind and highlight the problem facing your potential customers, your solution, the competition and your business and revenue model. This pitch deck does not need to reveal every single detail of your business. There will be time to delve into specifics later if the investor is interested.
Ways to Raise Capital for Your Business
When it comes to funding your SaaS business there are many approaches you could take and all have their advantages and disadvantages. Most entrepreneurs that we work with start off by self-funding but there may come a time when you wish to explore how to raise money for a business, and when that time comes, there are several paths worth considering. First, we will talk through bootstrapping before looking at other options.
Bootstrap Your Venture
The vast majority of entrepreneurs that we work with at FE International have bootstrapped their SaaS businesses. Most bootstrappers save up a set amount, say $10,000, before starting their project and this initial investment funds their effort from day one until they have a minimum viable product (MVP). From that point, the entrepreneur can determine if they want to explore other ways to raise capital, or continue bootstrapping.
There are many benefits to founding a SaaS business without seeking external funding. You can set plans without being influenced or pressured by others. Your business will grow organically with you in the driver’s seat. This independence is what draws many entrepreneurs to this type of work. Jon Gaulding, founder of Trotto, noted, “Going bootstrapped can give you more agency and potentially allows you to build a great team over time and then you can use that engine to create other things and experiment.” Bootstrapping also pressures entrepreneurs to bring in revenue sooner than they would if they raised capital, since the business cannot survive for long without it.
Bootstrapping is not without downsides, however. The first of which relates to speed of growth. Your business may not progress at as quick a pace as it would with capital from outside sources because in many cases, the funds you have set aside are not as substantial in size as the capital you would receive through another means. Additionally, there is greater personal risk financially, especially if your SaaS business is not bringing in enough profit to cover your bills. Many entrepreneurs embark upon their new SaaS projects part-time to start and rely on another job to pay their bills. Even with these drawbacks, we recommend that entrepreneurs start their SaaS businesses by bootstrapping since this allows for the most flexibility and the benefits outweigh the drawbacks.
Apply for a Loan from a Working Capital Company
When it comes to loans, there are several different options including loans from friends and family, co-founders or others in the form of convertible debt, funding from online lenders and revenue-based financing. We are going to focus in on revenue-based financing from working capital companies since this is an option that entrepreneurs with steady revenue may wish to explore. With revenue-based financing, you do not have to give up ownership of your SaaS business and monthly payments are based on a percentage of your monthly revenue, so the required payments fluctuate as your revenue does. This model was built with SaaS businesses in mind. However, your SaaS business must have steady revenue to qualify for this loan option and the amount of capital given is often significantly less than venture backed capital, so this type of loan is not for every entrepreneur and every business.
Crowdfunding
Another method to raise capital is crowdfunding whereby you request funds from the masses online. Crowdfunding campaigns can be set up in different ways however one common approach is reward-based crowdfunding where the individual provides a financial contribution in exchange for the end SaaS product. Using this method has its benefits. Your ownership stake in your SaaS business remains unchanged, you don’t have to dip into your savings or take on debt and a crowdfunding campaign can help you jumpstart your marketing efforts and get prospective customers excited about your new product. Although also keep in mind that developing a compelling crowdfunding campaign can take a good deal of time and there is a risk that a competitor who sees your idea online could copy it.
Seed Funding, Series A, Series B and Series C
If you are going to look to raise capital by taking on outside investors, seed capital will likely be your first equity funding option. After receiving this initial funding, you may choose to explore additional venture-backed options like Series A, Series B and Series C funding. Although the seed round and subsequent venture-backed options will likely give you access to more capital than the other techniques mentioned in this article, these approaches are not without disadvantages, so it is worthwhile to consider carefully before going down this path. When you take on funding from angel investors or venture capital firms, you enter into a partnership where you will have reduced control of your SaaS business and this could have implications throughout the lifecycle of your SaaS product. Investors can dictate how you run your business and crucially, with venture-backed funding you may not be permitted to exit on your own terms.
However, there are early-stage founder-aligned funding companies out there that you may wish to look into, such as Calm Capital. Although the programs these funding companies run are selective, they offer access to capital along with mentoring and access to a community of like-minded entrepreneurs building businesses alongside you.
How Funding May Impact the Sale of Your Business
Exploring how to raise money for a business can be overwhelming but it is important to consider your options carefully since your decision could have serious implications down the line. Even when your SaaS business is in its infancy, you should be thinking about your end goal, knowing that the decisions you make today can impact your later steps. We strongly recommend finding out what your business is worth before embarking upon the journey to raise capital as having this knowledge may shift your plans. It is best to go into this process with the most information. This way you will be most confident that the decision you make regarding funding your SaaS business is the right one.