You have a great startup idea. You started your SaaS business, did the tough slog to win initial customers. Should you bootstrap your business or take money from investors? How does this affect optionality and financial outcomes for you? What do we recommend to founders like you?
As a startup founder, there are many paths you can take to build a successful business. The road you choose to take depends on many things:
- The destination you want to reach?
- How quickly do you want to reach there?
- Whom do you want to take with you on the journey?
- The level of risks you are willing to take?
- What will you compromise during the journey?
Most startup journeys are long and arduous, and resource requirements and plans change over time.
Money is a key resource you will need in your journey, and the big question that gets debated often is Whom should you take the money from, When, and How much?
The Dilemma: Bootstrapping Vs. Fundraising?
How long do you bootstrap? Bootstrapping is the path you choose when you build your business with your personal funds, from the money generated from your business, money from non-equity based funding sources, through creative partnerships with customers, business partners, or individuals.
VC funding is the path you choose when you take money from professional investors in return for ownership and sharing control in your company.
As long as a startup remains bootstrapped, the founder remains in control of its journey and has the choice of the path to take. A bootstrapped startup may decide to take a VC funding route at some stage in the journey.
Bootstrapping Vs VC Funding is therefore a false dichotomy!
Each startup will need to choose its route and decide when to switch from bootstrapping to VC funding. It is necessary to weigh the pros and cons of the plethora of factors involved in the transition and decide which one is a good fit.
Which path do you want to take?
Zoho, Basecamp - Both did not want investors involved in their business.
Qualtrics, GitHub - Both bootstrapped to scale successfully and then involved VCs.
MailChimp, Atlassian - All bootstrapped to profitability and scaled successfully.
Under Armour, Spanx - Both were in markets outside VC interest and built successful businesses.
Clearly, there is more than one way to build your SaaS business. The decision to get funded or remain bootstrapped depends on the nature of your business, goals, and priorities.
Unlike traditional businesses that need a significant amount of capital for long R&D cycles and field sales, a SaaS business is well suited for building with much lesser capital and entirely with recurring revenues from your customers.
Fundamental questions to decide the path
- Will you compromise independence in going after your dreams?
- Do you want to be the pilot of your plane or have a steering committee?
- Are you willing to have partners that you get married to for the rest of your journey, sharing control and ownership?
- Are you okay losing optionality to choose your success path?
2. What is your priority as a founder? A desirable financial outcome for you and your team or build a unicorn and/or take your company to IPO?
- Depending on how much you finally own in your company, you can make more money even if the overall sale outcome is considerably lesser. 90% ownership of a $50M sale of the company is $45M to you; a 5% ownership of a $500M sale is only $25M. This could even be lesser than $25M depending on liquidation preferences and terms of earlier investments into your startup. The risks of building a $500M company is very much higher than building a $50M startup.
3. Does your opportunity really demand a large investment? Is the market opportunity worth billions of dollars?
- How big can your business grow? Is it a winner takes all' opportunity?
- Do you have a short window of market opportunity, and will securing funding help you accelerate your plans?
If there is no necessary reason to raise funds, it’s better to continue bootstrapping.
Funding a SaaS business too early is a recipe for failure!
There is no ideal time to get funding. But getting VC funding too early is a recipe for failure. If you have too much money to spend before you have a high-value problem or before you identify your Ideal Customer Persona (ICP), money invested will go down the drain.
The customers you acquire through investing early in "customer acquisition" will not be ideal customers, and this will mislead your business growth. As you start focusing on profitability and reduce customer acquisition spend, the business will have significant customer churn, and can stagnate or crash your business growth over time.
If the answer to any of these questions below is a “no”, you would do better to focus on solving these problems before raising funds.
- Is your customer problem value clear?
- Are you confident that you have identified the right Customer Segment for your business?
- Have you proven the SaaS revenue Flywheel, and will investing $1 in your business give you more than $1?
- Are you able to retain and grow your existing customers?
- Have you figured out the value-based pricing model for your solution offering?
Having funds gives you a false sense of security, and you tend to overlook real business bottlenecks and unit economics during the early stages of your business.
Startup founders should use Principles of Effectuation (making the right asks and working within affordable loss), and get many of the things you need for your business in creative ways, without having to spend money.
Once you decide to raise funds, what's next?
So, once you have solved these business fundamentals and realize that you need funds to invest in your business, there are multiple choices available.
Angel investment: Can you raise money from individual angel investors who are happy to be part of your journey without the need for sharing management control?
Strategic Investment: Can you raise money from strategic folks whose domain expertise and market reach are even more valuable than the money they give you?
Debt or convertible notes: How about raising money through debt or convertible notes, where you do not give up control until a future event when your investor becomes a shareholder?
Revenue Based Financing: A relatively new and popular capital raising choice for SaaS startups today is Revenue Based Financing, better known as RBF. Because of SaaS startups' recurring revenue nature, you can now raise money based on your monthly recurring revenues. Investors such as Indie.vc, Earnest Capital, TinySeed, Lighter Capital, Flow Capital, SaaS Capital, RevUp, Clearbanc, and many others support varied forms of financing based on your recurring revenues. Most of them do not ask for management control, and if any equity transaction is involved, the shares can be bought back by the startups. This allows you to maintain the optionality of the path you want to take based on the kind of business you want to build.
VC investment: If you decide to raise money from a VC, are you and the investor aligned on your dreams and the path you want to take? Is the investor the right partner in your journey? Is the investor able to bring expertise and insights to help scale your business? How much will you have to compromise on shared control in your company?
Remember that a professional investor in your startup is a life partner, and you certainly do not want to find the wrong one.
Why is understanding the VC philosophy important?
As Rand Fishkin, writes in his book Lost & Founder:
So, Is having an investor good or bad? Isn't it great that someone puts the pressure on you to set and hit aggressive targets and continue to grow?
Success for investors means nothing less than a few hundred million dollars revenue stream and a billion-dollar valuation. VC funds have a lifetime of about 10 years, and depending on when in their fund lifecycle they invest in you, they are under enormous pressure to make their investments liquid. You may not have the choice to carry on your business as a lifestyle business in the future.
I am not against raising venture capital. I have taken money from VCs in the past and I have also been an investor in startups as an angel. While most investors are helpful and collaborative, a VC funds philosophy could be an alignment concern.
The real question is: Are you and the VC aligned?
- How big is the fund? (the larger the fund, the larger will be their investment size, and larger their exit expectations to make the unit economics of their fund work)
- Do you believe the investment amount is what you really need? What is the size of business you can realistically build?
- What are the funding terms? (how much control do you have to give up)
- At what stage of their fund lifecycle are they investing? What is the investor’s requirement on when their investment should be liquid through an acquisition or IPO? Are you comfortable losing the optionality of continuing your business if you wanted to?
- How many startups have they helped succeed in the past, and how many have failed especially in similar domains as yours? (Typically, investors play a 0 or 1 game. Mediocre performances do not help the fund, and therefore, even at the cost of strategies that may impact your business negatively, they must try and get you to be a unicorn, which may work well in few cases and fails in many).
Remember, once you bring professional investors on board, your business is really not yours anymore. You have new partners in your business who have a voice in key decisions.
We recommend Value SaaS Funding to our early stage startup founders!
Having worked with over 100 SaaS startups, we at Upekkha believe that most SaaS startups will need only about $100K to $200K of investment to get to reach their first $1 million of Annual Recurring Revenues (ARR).
Building the SaaS business in a methodical manner by first focusing on the SaaS inner flywheel (problem choice, market choice, Ideal Customer Persona, Pricing & GamePlay) is the key to utilising capital efficiently.
We recommend you to shift focus to the outer flywheel (attracting prospects, engaging and winning them, retaining & expanding them, and getting referrals to attract more prospects) only after you have achieved the inner flywheel.
You will need to fine tune all aspects of the flywheel in an iterative manner and build predictable recurring revenues from customer expansion and new customer acquisition before attempting to scale or invest heavily.
A $1 invested in your business should return you more than $1 if this process is followed systematically, and the money you need to get to this point will be an optimal spend.
Once you have predictable recurring revenues, it can fuel your growth with investment required only as a working capital.
We recommend that you should not lose optionality at least until you get to $1 Million in Annual Recurring Revenues. You will know a lot more about your business by then and if you have optionality, you can decide and choose to take a VC high scale route, or build a business for an acquisition, or build profitably as a life-style business.
To maintain this optionality, we recommend that our founders take this minimum capital through strategic angels or through funds like Revenue Based Financing (RBFs) and ensure the investors and the terms of the investment are friendly to you. We recommend that you keep full control of your business and not share management rights with others.
Strategic angels and RBF generally do not ask for management rights and many of them are okay with equity buy back at a later stage based on capital returned to them or potential returns for buyback. This in turn means you can build your business equity efficiently and chase your dreams with more independence. We believe you should be able to get your $1 Million ARR without diluting more than 10% of your equity ownership and without sharing management control with any third party.
Ideally, you can get that 10% back through buybacks and have no dilution in your ownership.
Helping our SaaS founders the Value SaaS way
To make this possible for our startup founders, we have launched a rolling fund on the AngelList platform. We will invest $100K in you. The funding terms will be similar to indie.vc v3 (Indie.vc is a program pioneered to hard code optionality into funding - https://www.indie.vc/notes/v3-terms)
True to our words, we allow you to maintain both optionality and control of your business.
We allow you to buy back your shares. The funding instrument is treated as a non-voting equity and we do not ask for management control or board position.
Value SaaS Funding is about having multiple options for however long you can and to chase your dreams without losing control and ownership of your business prematurely, and do so both capital efficiently and equity efficiently.
If you had a magic wand to get enough money from family, friends, strategic angels and through alternative funding sources that do not give away any of your management control and ownership, I am willing to bet that you would not raise VC capital ever! You will also not get carried away by funds raised and valuations as success milestones.
Whenever the thought arises ‘We should fundraise!’ in your mind, always ask follow up questions of ‘What for’, ‘Why now’ and ‘How’. The key is finding the road that is right for your startup.
You are the captain of your ship and should remain so for however long you can. Anyone you take with you on your journey should come along knowing your dreams and what you are willing and not willing to compromise!