Understanding SaaS Finance as an Essential Source of Funding
SaaS finance is one of many tools for SaaS company growth. SaaS companies must do an immense amount of research, dig deep into the customer psyche, and execute faster than you can say iterate. It is up to the CEO to peer beyond the walls of the SaaS business to look for ways to grow faster and provide greater value. One of those ways is SaaS finance.
Each SaaS finance option fits best based on what stage the SaaS company is in and whether there are opportunities that justify the use of a SaaS finance tool. A SaaS leadership team must weigh the pros of increased runway, ability to hire, and marketing spend with the cons of equity loss and increased pressure to perform. We provide information below that increases your ability to assess and decide what is best for your SaaS company.
What is SaaS?
Software as a Service (SaaS) companies provide software on a recurring subscription service model. The subscriber can access the SaaS product from any location with an internet connection. The software instance and user data is stored on a remote server, also known as the “Cloud” which brings costs down for the SaaS company and the users. Think of Netflix and their ability to provide a show or movie to you from their servers at any time as long as you pay a monthly fee.
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Stages of SaaS Companies
There are several stages of a SaaS company: problem-solution fit, product-market fit, optimizing beyond early adopters, scaling, and maturation.
1. Problem-solution fit
At the initial stage, a SaaS startup must seek a problem worth solving. Many early SaaS startups might have a general idea of what they want to solve, but it takes speaking to customers through customer discovery interviews to hone in on the specific problems that could be solved.
A SaaS startup at this stage is often a part-time, low expense endeavor with a focus on research in both the problem space and the relevant industries or markets. At the end of this stage, a SaaS startup will have an idea for a Minimum Viable Product (MVP) and early mockups and presentations for how the idea will unfold.
2. Product-market fit
According to Andressan Horowitz, product-market fit is,”A value hypothesis identifies the features you need to build, the audience that’s likely to care, and the business model required to entice a customer to buy your product.” Often this starts out with a beta group of customers that get to try the SaaS product for free or low-cost for a set period of time. SaaS companies may also need to make their first hires at this stage.
A SaaS company must take the MVP from the problem-solution fit stage and prove that the solution is a product enough customers vind value in and are willing to continue to use after their initial trial or beta period. SaaS companies measure as much as possible to formulate evidence of a willing market. It is not uncommon to see early SaaS companies discover something unexpected and pivot into an adjacent solution or problem space.
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Optimizing beyond early adopters
Sir Geoffrey Moore coined the term “early adopters” in his seminal book Crossing the Chasm. There is often a dip or trough after a SaaS company finds an initial product-market fit with their early adopter customers who are inclined to try new things and take risks on emerging technologies. SaaS companies will need to optimize their product and go-to-market strategy in order to make it from the early adopters to the mainstream market.
1. Scaling
Scaling is often associated with quick expansion by a SaaS company into the mainstream. SaaS companies often look for hyper-growth or “Blitzscaling” by burning large amounts of cash to gain market share using the strategy created in the optimizing beyond early adopters stage. This stage will often require additional hires at a rapid pace and quick understanding of new geographies and even new business verticals.
2. Maturation
As rapid growth slows, a SaaS company starts to establish itself as an entrenched market leader. SaaS companies have to decide on new products and additional value they can offer their current market or adjacent markets. Often there are new competitors and partnership opportunities.
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Important SaaS financing options
SaaS Financing options exist for each company stage. With each stage, the SaaS financing looks for different indicators for potential return on investment. SaaS companies have to decide at each stage of their growth if they need financing and if they are funded, how best to use those funds.
Seeds and Angels
In the problem-solution fit phase the SaaS financing is often split into pre-seed and seed funding. The typical investors at this stage are friends and family, or another class commonly called “Angel Investors.” SaaS companies can find Angel Investors at startup meetups or online through sites like AngelList. SaaS companies should be careful at this stage not to give aaway too much equity, but also understand the high risk the Angel Investor is taking on an early stage SaaS company.
Series A
Though seed funding has grown in value and delaying Series A funding to later in a SaaS company’s growth, it is still a milestone mark for many SaaS companies as they find product-market fit and seek to enter into optimizing beyond early adopters. Often investors will want to see a cap table without major equity holders outside of the founders. SaaS founders should be prepared with due diligence materials like their financials and ready to give up around a third or more of their equity.
Some important data points you need to show to potential Series A investors:
- Traction: are you growing, even at a slower rate than you would like, is a key data point indicating if you reached product-market fit.
- Scalability: What is your path to growth and how do you scale what you are currently doing along the way? This can be illustrated by showing your sales pipeline as an illustration of demand for your SaaS solution.
- Build a Narrative: Take the above data points and weave together a story that includes your vision, your team, and the momentum you are building towards increased market share.
Series B and beyond
As a SaaS company gains market share there is pressure by the Series A investors to scale as fast as possible. SaaS finance options after Series A become an option for the SaaS board and leadership if there is a reasonable shot to taking the majority of a market. At each funding event, there is dilution of shares for employees and a loss of equity from the founders. The trade-off is market dominance and a chance to IPO.
Debt financing
When your SaaS company is cash flow positive and can show a stable customer base, then debt financing might be a useful way to bridge yourself to the next financing round. Often founders who want to continue bootstrapping their business will be interested in the cheaper alternative to a Series A or B by using debt financing.
Revenue-based financing
Revenue-based financing provides a SaaS financing option for product-market fit SaaS companies and later that is based on SaaS monthly recurring revenue (MMR) without diluting the cap table. SaaS companies may have issues with consistent cash flow and revenue-based financing provides money quickly.
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Final Considerations
You should first ask yourself: “Do I need funding?” If you cannot answer with a confident yes then you might want to reserve your time for building your business and team. Fundraising takes a CEO and co-founders away from value creating activities and onto the fundraising treadmill. Remember that SaaS finance options are a tool. Each tool has a specific application, time, and place for use. You want to choose the correct tool for the job don’t you?