The healthy life cycle of any business depends on its ability to raise capital and manage cash flows. SaaS businesses are no exception.
Types of SaaS funding
There’s no one-size-fits-all solution to SaaS funding and each type varies according to a number of criteria, like the investment amount needed, the structures used for providing it and the expectations attached to it. So, let’s take a look at your SaaS funding options.
Venture Capital SaaS Funding
As demand for SaaS products continues to grow, investors are paying close attention to the growing number of opportunities. Public SaaS companies are performing well, as in 2019 their stocks reached record highs, with the BVP Nasdaq Emerging Cloud Index reporting the basket of SaaS stocks reaching 1,248.21.
These figures represent a steady and growing demand for private SME SaaS businesses. What’s clear in the eyes of investors is a wave of broad opportunities to invest in the digital space. This willingness to invest translates into a clear pool of potential funding for emerging SaaS businesses. SaaS funding has never been so compelling.
The strong demand from public markets means SaaS companies will have no problems when it comes to attracting investment from venture capitalists. Since venture capital operates with the goal of investing in businesses to see high returns, often in the form of an acquisition or IPO; the incentive to invest in promising SaaS companies is unquestionable. The SaaS industry generates high yields and is forecast to have low investment risk – ticking all the VC boxes.
Venture capital is a great way to raise capital. It comes with knowledgeable venture capitalists, who in turn come with connections and a nurtured network of contacts. However, it takes a lot of hard work. It may see you part with a significant portion of control over your SaaS and largely depends on specific expectations being met. During the process of negotiating with your VC, be sure to provide comprehensive answers to the following points to secure the best deal.
- Why should the VC fund your SaaS?
- Who are your competitors?
- What is your growth plan?
- How much capital do you need?
Angel investors invest in startup companies in exchange for an equity stake in the business. Typically, angel investment ranges between $25,000 to $200,000 but can be much higher. Angel investors generally care about the quality of the management team and the scope of opportunity in the market. The best way to land a willing angel is to make these two points crystal clear.
(Graph showing the management and technical abilities of the founder to be an important factor for angel investors. Image: Medium)
Capital here is provided by an individual rather than a firm or fund. This personalises the transaction, bringing the angel closer to the SaaS’s cause. Most startup SaaS businesses are looking for an angel for the seed round of their fundraising. But thanks to the demand in the public sector, angel investors have begun to play a decisive role in later funding rounds too.
Relying on angels in later rounds of fundraising is particularly effective when the SaaS’s business mission aligns with the angels own. It can mean giving up less control as the investor stake will come in the form of convertible debt or ownership equity.
Incubators and Accelerators
These are appropriate methods of funding for SaaS’s across the entire scale spectrum. Incubators, specifically, are designed to assist the growth of early seed-stage startups. This assistance largely takes the form of making a financial investment in your company- but will also assist in training, knowledge and expertise and networking during a business’s early days.
Accelerators, on the other hand, are often run by private funds that provide assistance to startups at the later-stage of scaling up. As incubators work with founders over an indefinite period, accelerators are focused on and across teams. They provide fixed terms for funding to pay for group programs like training and mentorship. They essentially become the companies ‘growth mentor’.
AlphaLab is a software accelerator helping early-stage tech companies to evolve through their intensive four-month program. In addition to funding, which is largely why many SaaS companies chose accelerators over alternative finance, the program also includes an extensive mentorship network and educational sessions.
The Rounds of Saas Funding
Seeking SaaS funding comes in rounds, and depending on a company’s goals, there are often as many as 5 and sometimes more. The rounds are graded in accordance with the size of the company, For example, pre-seed funding would be needed by the smallest start-up to kick the business off the ground. The latter round, Series C funding, is reserved for the larger companies in preparation for an IPO, acquisition or larger business ambition. When funds in Series C aren’t sufficient, or when expectations aren’t met, companies can go into Series D and E funding too.
From pre-seed to seed funding, a company’s preliminary targets are met. After these stages, companies will often boast valuations of $1 million or more. Following this, Series A funding is made when a company has begun to grow in scope and revenue and wishes to expand.
Series B funding, also known as market-reach funding amounts, on averages to $20 million or more. Most angel investors are out of the game by this point and Seris B funding is accommodated for by Venture capitalists. Cash injections are given to help companies meet rising demand and to reach new market segments.
By the Series C stage, funding amounts to $50 million on average but varies. At this stage, banks and hedge funds will be interested to chase out VC’s and provide you with investment.
What investors want and how to prepare for SaaS funding
Investors have more reason now than ever to be discerning about who they financially back. Businesses with the right metrics and who meet specific benchmarks across all of them will be the first on the investor’s list.
Investors predominantly want to see a low churn rate – a key metric across the SaaS industry and one that will make or break a business. The churn rate determines the number of customers who leave service over a given period of time. Retaining customers means retaining payments and saves money on customer acquisition. Attract investment by keeping your churn rate below 1%. This will not only attract investors but will help you retain your growth trajectory. There’s no single solution to driving down your churn rate – but tools like ProfitWell tracks millions of metrics to identify the cause of churn and helps to improve recovery rates.
Recurring revenue is extremely important for any SaaS and is what makes the industry so appealing. Investors will be particularly interested in your MMR as it indicates viral growth potential and demonstrates the efforts you make to maintain customer relationships. Its margins ultimately prove the product-market fit of your Service.
Understanding your Customer Acquisition Costs (CAC) is critical for later rounds of funding. By Series A and onwards, investors want to know that you have proof that your revenue model is successful and that you have an efficient sales team. For example, a CAC payback of 2 years or less shows that you’re able to offset CAC with satisfied customers who provide you with subscription revenue over the long term.
The cost per acquiring a customer goes hand in hand with your average revenue per user (ARPU). These figures set a benchmark for how much you can afford to spend on acquiring new customers. It gives you an idea of how much capital you need to raise and also shows the investor that you have an efficient business model.