Fair game: why investing in SaaS startups can be easy, even for outsiders
A couple of founders wanted to catch up on how their startup was doing. ‘We’ve had a few rough patches, but I think we’re now finally seeing more customers come in.’, they say. I look around the coworking space the two founders have invited me to. It has the vibe of one of those early coworking spaces in which all the furniture was randomly collected from other office spaces, what I deem a ‘pre-WeWork coworking space’. Each piece of furniture adds to the odor of the space as it brings the smell of the original office it was taken from. I burst my lip open a bit as it touches the mug. It’s a random, slightly chipped mug with some lukewarm coffee in it.
It’s probably been a year since I invested. We chat a little on the direction they’re taking and use some of the typical jargon founders use, like ‘pivot’ and ‘product/market fit’. I give them my input, and as we talk, we come across the subject of whether they will keep their heads above water as they might be out of runway in the near future. ‘We’re like cockroaches. We’ll never die.’ — an interesting way to reassure your investor, but nonetheless true. They’re a designer and a developer, so they can run this company by themselves if they really want to.
The story above is about one of the very first investments I made in a Dutch SaaS startup after I sold my own software company. Many would follow. Today, almost all of the investments I do happen to be in SaaS startups, for good reasons. I want to write about it in case you’re considering investing in startups too, even if you have no idea how that’s done and why that can be a safe category, which looks riskier than it actually is.
Risk comes from not knowing what you’re doing
Initially, I spread my investments across multiple categories: stocks, real estate, cryptocurrencies, and startups. I planned to spread, but I also wanted to invest a substantial amount in startups. The first advice you’ll come across when you have to deploy capital is to spread, and so I did.
Spreading your portfolio is always sound advice, but it was no longer working for me. That’s because it was conflicting with another piece of advice I took from Warren Buffet: “Risk comes from not knowing what you’re doing”. I gradually realized that with both stock and cryptocurrencies; as I was effectively not knowing what I was doing and in order to become knowledgeable, I would have to turn into a day-trader.
The result was the daily — no, hourly — anxiety in which you check your investments to see if you either have to take a loss or capitalize on your gains, while you’d never know if you’d be doing the right thing. I gradually started to shift my attention to categories I understand better, and I can actively influence for positive outcomes.
I realized that since I’ve been the founder of several software companies myself, I understand very well what it takes to build a startup. As such, I shifted my focus to investing in startups that I had a good connection with. Also, I knew I could apply to investing what I applied to run a startup: fail and learn.
Investing with what you know + what you have
The first lesson I learned is that investing in tech in the broadest sense and doing many small tickets turned out to be wrong in my case as well. Tech comes in many different forms and flavors. I invested in: electric scooters, SaaS, umbrellas, marketplaces, e-commerce companies. The downside of this is that — once again — I knew too little about all of these categories to be certain that some of them would end up successfully. After all, how can you compare the growth of a software company to that of a hardware company or e-commerce business? — I certainly couldn’t. As a result of that, I wasn’t really contributing to the success of these startups either. After a few years, I noticed that mostly the SaaS startups were doing well.
The second lesson I learned is that you can take a risk and go for a small portfolio as long as you’re focused and can substantially help these startups by both leveraging your knowledge and network. The network part is crucial here. As my portfolio grows, I get more emails and calls with ‘quick questions’. I’ve developed the general practitioner strategy: I’ll triage, and then I’ll connect the founder with a specialist who can help them best the challenge. This keeps my attention span short, while the founder gets useful advice, very often from one of their peers in my network, who I also invested in. It’s always worth my time as the average investment I made leads to a substantial share in the company. As such, this leverages investment outcomes as I help the startups fix their problems and grow as a result of that.
Apples to apples
This brings me to the third lesson I learned and which is the reason why I think investing in SaaS startups is accessible to anyone who has a reasonable risk appetite. SaaS startups, especially in B2B, all grow in the same way and have the same performance indicators. As such, the performance of a portfolio of SaaS startups is transparent. This means that you can compare apples to apples when it comes to each startup inside your portfolio.
All SaaS startups I know have monthly recurring revenue (MRR), which gradually increases over time. Most SaaS startups I invested in have very sticky relationships with their customers. This means that even a small amount of revenue can reflect a huge amount of goodwill. It’s one of the reasons why the valuations of publicly traded SaaS companies are so ‘outrageous’.
The heuristic behind most successful B2B SaaS startups is simple: the product is deeply rooted in the operation of their customers. As long as the team understands this, can win deals, and onboard customers successfully to their product, they will create shareholder value. Thanks to this effect, a reasonably sized portfolio can already yield great returns over the long run. In my experience, B2B SaaS companies who successfully lift off tend not to crash that fast, so the average startup failure rate does not apply here.
It doesn’t mean that investing in startups is for the faint of heart. It’s still much riskier than investing in government bonds, trackers, real estate, or such categories. However, in my experience, it’s less risky than buying stock on the stock exchange. Other than putting your money in publicly traded stocks, the money you put in startups will be locked up for a long time. There’s also a good aspect of that. Since you can’t do anything, you can’t have the daily anxiety of whether you need to pull out either. Once you’re in there, you’ll just have to let it be. The scope of investing in SaaS startups is ten years on average across a portfolio.
Right now, there are only a few events in which an investor can exit from a startup. The three most common exit events are acquiring another company, an IPO, or a secondary sale in a large follow-up investment round. In the near future, I expect that investors can make secondary trades of their shares on platforms. This is already emerging — examples are MicroAcquire.com and Tiny Capital in the US.
Transparent performance in the portfolio
This brings me to the last part. I’m in a position in which I can help and advise SaaS startups. By doing so, I contribute to their success. Outsiders lack the knowledge and experience to help founders in individual companies but can still build portfolios by joining syndicates. These syndicates can then do more deals which by itself spreads the risk for everyone who joins. AngelList Syndicates are an example of that. As mentioned, the performance indicator of the portfolio is transparent, unlike what happens on the stock exchange or in cryptocurrencies from time to time.
Recently, these past lessons have brought me to a new edge: deliberately forming B2B startups as part of Builders. Based on my experience with the first teams I invested in, I’m bullish on the model in which we discover promising ideas with startup founders and compose a great team around it. Since I’ve joined, we’ve done this with Obeyo, and although the verdict is still out there, I’m seeing the first signs that this will work. The best part of it is that I can do more than what I’m used to when helping startups as a business angel. With Obeyo, I helped with all aspects of the startups, ranging from customer discovery work, product management, and even coding. Now I get to be both the co-founder and the investor.
