2020 threw us more curveballs than ever expected. Some SaaS companies have had to cut back on staff or delay the release of new products and services. Others have pushed forward with their plans. The pandemic that raged through this year will not disappear just yet, and the financial implications are likely to run well into 2021.
Even before the pandemic, raising capital is essential for SaaS companies to help manage cash flows. There are several funding methods that will enable you to raise capital for your SaaS venture. Before going into the how-to, let’s start by looking at the most popular methods of raising capital and their advantages and disadvantages.
Bootstrapping is the term used for raising capital in the form of personal savings. It can also involve credit cards or personal loans. Some people can call on friends or family to contribute to your capital raised. This is one of the most popular choices because it allows business owners to remain in control. The potential disadvantage is that you may find it’s difficult to make ends meet at the end of the month. For this type of capital, a tight budget must be in place so you can monitor recurring revenues and use the capital to increase these revenues.
Venture Capital Firms
Venture capital firms are ideal for not only financial aid but also intellectual support. This type of funding can provide tremendous capital levels depending on how much you need and what part of the business equity you are willing to hand over. Really, the negative is that you can give up anywhere from 1% to 50% of your business equity. On the positive, venture capital firms hold a wealth of information, industry-specific expertise, and potential contacts.
Public SaaS companies have performed very well; in 2019, their stocks reached record highs. The BVP Nasdaq Emerging Cloud Index, used as a barometer for market sentiment regarding the category, reported SaaS stocks’ basket to reach 1,248.21.
The name is rather appropriate because angel investors use their personal money to invest in SaaS companies. For this reason, the amount of capital you can raise is often smaller than with venture capital firms. These high-net-worth individuals tend to look at the specifics of individual projects and are, therefore, more likely to take bigger risks if they like what they see. Your pitch has to be strong enough to encourage an angel investor to part with their own money. It’s not easy to find these angels. A good place to start is searching for Business Angel Associations.
Using an incubator to raise capital is only really suitable for the early seed-stage. An incubator will provide investments as well as training and expertise to help startups grow. They will also be able to help a young company network with the right contacts.
Accelerators also work with startups but more for those in the later-stage and are looking for ways to scale up. Accelerators offer capital in exchange for equity in your company, typically up to a maximum of 10%. You could look at accelerators as growth mentors as they will also offer training, even intensive programs, and educational sessions.
Rather than taking out personal loans in your name to raise capital, you could talk to a range of financial intuitions for additional funding. These loans are called working capital loans. Funding will depend on your project, and you will need to provide a full report of the project finances and costs. While the amount of funding is normally sufficient, there are more risks, not being able to make the loan repayments, and it’s not only the company assets that could be lost.
Despite being one of the newer ways to raise capital, 2020 saw a massive year for crowdfunding. Globally, $24 billion was raised by crowdfunding, whether for an event, a cause, or a project. Equity crowdfunding, donations made in return for shares in the company, raised $2.5 billion. Crowdfunding is an excellent way to launch a new project and drum up new business while raising capital. If you prefer to maintain full control of your company, there are alternatives you can offer instead of shares. Some SaaS companies will offer membership programs or free products.
Grants are like every SaaS owner’s dream but not so easy to obtain. On the one hand, your company can give you a cash injection without having to part with shares or control. On the other hand, you will have to show your SaaS business to be worthy of the grant to the government or other institution that has grants available.
Like grants, competitions are highly appealing methods for raising capital. There are competitions all over the world for a range of different companies. Richard Branson runs one of the most famous competitions for startups. The experience is perhaps once in a lifetime. Not only is there the chance to win £1 million, but you also get to pitch your business idea to Richard Branson, and there is a lot of publicity for the winner. It’s important to focus your efforts on business competitions that you are more likely to win. Some SaaS company owners find defeat quite challenging, which can knock your confidence.
Due to the billing cycle of SaaS companies, many company owners are looking at revenue-based financing. Lenders look at SaaS’s monthly recurring revenue (MMR) and grant a loan based on the overall revenue. These figures help the lender to determine the total amount that can be loaned and the repayment amount. On the plus side, no shares are given out in return for capital, and there is no need for assets or profits (which could be difficult for startups). Some may prefer other funding types because revenue-based financing doesn’t come with the same level of support as others.
What Should You Prepare Before Raising Capital?
This will depend on the type of funding you are hoping to gain, and the guidelines set out but the investor. Bear in mind that preparing a strong pitch to present investors is not an overnight task and will require numbers, visual charts, and practice! Here are some of the core things you need to prepare as part of your pitch:
- Your service/product and why they should invest in your SaaS company instead of others
- Who your competitors in the market are
- Your growth rate so far and the projected growth rate
- The amount of capital you require to achieve your goals
There are also four crucial numbers that you should be confident with, your churn rate, MMR growth, average revenue per user (ARPU), and customer acquisition costs (CAC). Here are some things to consider with each:
Churn Rate and MMR
A SaaS churn rate represents the number of customers who have decided not to continue with their subscription and, therefore, must be kept low. The monthly recurring revenue informs potential investors about your growth as well as your commitment to providing a quality product and excellent customer experience. A good growth rate to aim for is from 9%-14% when your total MRR is below $100,000.
ARPU and CAC
The average revenue per user is a solid indicator of how much revenue your entire customer base is bringing into the business. It also shows how much you can afford on customer acquisition. From the Series A round, you will need to be able to demonstrate a CAC that reflects a successful revenue model. Ideally, your CAC should return investment within two years.
Understanding the Rounds of SaaS Funding
Rounds of funding start at pre-seed and generally go up to what’s known as Series C, although larger rounds do occur and are classified as Series D or Series E. A certain round of SaaS funding will be based on the stage or size of the company. Again, generally speaking, rounds occur every 6-12 months. The rounds of SaaS funding are classified as follows:
- Pre-Seed- At this stage, a company may need funding to develop the initial product and release it onto the market. The pre-seed investment is normally less than $1 million, and the value of the company after the investment is often over $1 million. As competition for pre-seed funding is high, it is necessary to have a team of specialists and have a well-developed project idea.
- Seed- Angel investors will probably only invest up to $1 million at this stage, but venture capital firms can go over this amount. This round enables SaaS companies to expand their teams and meet demands in production so that profits can start to be seen. To be considered for seed investments, companies usually have to have doubled in value since the pre-seed round.
- Series A- By now, you will have Key Performance Indicators KPIs), monthly recurring income, and customer acquisition goals, and as you generate more income, you look for Series A funding for expansion. As amounts are generally around $10 million, your pitch must be less idea based and more performance-based, with updated business models and evidence of long-term cash flow.
- Series B- Besides expanding in your current market, a boost in the capital of around $20 million will help you expand into other markets. So far, your strategies have played out very well, and you can demonstrate promising KPIs. Expectations from investors will naturally be higher, and you will need to show new business models that reflect your more aggressive extension plans.
- Series C- This is a significant milestone to reach as SaaS companies seeking Series C funding often means your company is worth approximately $100 million. It is also significant because you may notice the tables have turned, and investors are approaching you with offers of around $50 million. At this stage, you will most likely use your raised capital to expand into new markets or take over other businesses.
It seems an overwhelming number of options and stages for raising capital for your SaaS company. But the more informed you are about the suitable options for your business and project needs, the better prepared you will be when it comes to pitching investors. The idea of raising capital may seem like an urgent one, but that still doesn’t make it one to rush.