Customer churn is bad.

As a statement, that’s uncontroversial. But for all its truth, it’s also pretty unhelpful. As any SaaS founder knows, some degree of churn is unavoidable — there’ll always be customers that cancel their subscription, because of failed payments, cashflow crises or plain unhappiness.

That leads into an obvious question: how much churn is too much?

Most of the studies into SaaS churn rates are confusing or contradictory, so to simplify matters, I’ve put together a meta-analysis of the 6 best SaaS churn rate studies I could find.

The results aren’t what I expected.

P.S. This is a pretty long post — if you’d rather read it in PDF format, click here for a free download.

THE MYTHICAL 5% BENCHMARK

There are lots of opinions about “ideal” SaaS churn rates, and most commentators seem to share the same view:

When you look at the maths involved, the logic behind this opinion becomes immediately obvious.

If we assume a startup has 1,000 customers, a 5% annual churn rate would result in the loss of 50 customers over the course of a single year — not ideal, but easy to compensate for with new customer acquisition.

If we compare that to a 5% monthly churn figure, the same startup would lose 460 customers over the course of a year — making it necessary to replace almost half of their entire customer base, each year, just to “break even”.

MONTHLY VS ANNUAL CHURN

The stark difference stems from the fact that monthly churn compounds over time. Whereas 5% annual churn is measured over the entire year…

…5% monthly churn reduces the customer count by an additional 5%, each and every month:

Both annual and monthly churn show the same information (customers lost), but over different time periods. To add to the confusion, there’s no standardised way to report churn rates: many of the surveys here report annual customer churn, while others report monthly churn.

THEORY MEETS PRACTICE

To simplify things, we can use the following formulae to convert annual to monthly churn, and vice versa.

Using the formula above, our “ideal” annual churn rate of 5–7% is equivalent to a monthly churn rate of just 0.4% — a loss of roughly 1 in every 200 customers.

But ask any SaaS founder about their churn rates, and chances are, they’ll have a monthly churn rate far higher than 0.4%. So does that mean there’s a churn epidemic, sweeping through the SaaS world?

Or is our “ideal” churn target simply unrealistic?

Pacific Crest’s annual survey is the go-to SaaS metrics data set, and their 2016 survey offers insight into the performance metrics of 336 SaaS companies — 177 of which reported their churn rates.

To get an idea of the types of SaaS companies featured, Pacific Crest also provide a few representative statistics. The companies in their survey have a:

• Median yearly revenue of $5 million.
• Median of 50 full-time employees.
• Median ACV (Average Contract Value) of $25,000.

REPORTED CHURN RATE

Looking at the study itself, customer churn rates (referred to as “unit churn”) are reported in different “bands”, ranging from 1–3% up to greater than 15%.

Pacific Crest reported the median annual churn rate across the entire sample as 10%, or 0.87% per month.

This figure is higher than our “ideal” churn rate, but that’s to be expected: an ideal figure is a benchmark that not all companies will achieve.

Though the use of banded data makes it hard to pinpoint the exact number of companies that fell without our ideal range of 5–7%, we can say that a maximum of 78 of the 177 respondents (44%) had churn in (or better than) this range.

Though the “greater than 15%” churn band was the biggest, our ideal figure still sounds plausible.

Like Pacific Crest, Totango also put out an annual SaaS metrics report.

Their survey targets a broader range of businesses (“ranging from early-stage startups to established businesses with over $100M in revenue”), but the majority of respondents (60%) fell between $1 and $50 million yearly revenue.

REPORTED CHURN RATE

Totango looked at annual churn rates across three different “types” of company:

• High growth (those that saw a greater than 75% year-on-year revenue increase).
• Medium growth (25% — 75%).
• Low growth (less than 25%).

Churn was then reported across three broad categories:

If colorful pie charts aren’t your thing, here’s a handy table of their findings:

Like the Pacific Crest survey, big and vague churn bandings mean solid conclusions are few and far between (both 11% and 99% churn would be reported in the “greater than 10%” category), but it’s fair to say that:

• Churn rates of less than 5% annually are not uncommon, particularly in high-growth SaaS companies. Roughly one third of respondents were in this category.
• The majority of SaaS companies (65%) reported churn rates of 10% or less annually — in keeping with the findings of the Pacific Crest survey.

Early last year, Blossom Street Ventures analysed 40 publically traded SaaS companies, in an attempt to learn about their churn rates.

The companies ranged from $75 to $382 million in trailing twelve-months revenue, and featured the likes of HubSpot, Zendesk and Box (in other words, about as big as SaaS companies come).

REPORTED CHURN RATE

Only 16 of their chosen companies reported churn figures. Of those that did, the majority seemed to report revenue churn (explaining how the median retention value was 105% — only possible as a result of negative revenue churn).

Of those 16 companies, only 6 reported retention of less than 100% (making it possible that they were referencing customer churn, instead of revenue).

Of these, the lowest figure reported was 99% monthly retention. Assuming this to be customer churn (it’s hard to tell from the data alone), the company in question would have 1% monthly churn, or 11.3% annual churn.

Though it’s hard to draw conclusions from the data, we can at least say that the highest possible annual churn rate reported was just over 11% — with all other companies reporting lower churn. This seems to corroborate Totango’s and Pacific Crest’s findings.

So far, the story has been relatively consistent: most SaaS companies seem to have a churn rate in the region of 10% annually, equivalent to less than 1% monthly.

Unfortunately, this is where things start to deviate.

Baremetrics is an analytics platform designed for SaaS companies. On it’s Benchmarks page, the company uses its insight to pool together real-time dashboard analytics from over 600 small-to-medium sized SaaS companies — including customer churn rates.

REPORTED CHURN RATE

Baremetrics focuses on monthly customer churn, and reports on average monthly churn rates across cohorts of companies with similar ARPA (Average Revenue per Account) values.

If we average across these cohorts, we find a monthly churn rate of 7.5%.

Annualised, that’s equivalent to 61% churn — roughly six times higher than the average reported by Pacific Crest, Totango and Blossom Ventures.

That’s a huge discrepancy, and completely at odds with a 5–7% annual churn target — but crucially, these findings are backed-up by a few other data sources.

Back in 2013, Groove conducted their own research into the SaaS industry. Their survey focused on small businesses, garnering responses from 712 SaaS companies, all post-Product/Market Fit and between $1,000 and $500,000 in MRR.

REPORTED CHURN RATE

I can’t find any mention of the raw data, but Groove reported the average monthly churn across the entire sample: 3.2% monthly churn, or annualised, a 32.3% churn rate.

Though roughly half the size of the average churn rate reported by Baremetrics, this result is still of the same order of magnitude, and a far cry from the sub-1% monthly churn rates we’ve seen reported in the other data sets.

To dig one step further, we can turn to the individual SaaS startups that use Baremetric’s reporting functionality.

Of the 600 companies that use Baremetrics, 18 companies currently make their dashboard data public, and they range in size from $447 in MRR (Helpman) to $1,078,560 (Buffer).

REPORTED CHURN RATE

Buffer are the most high-profile users of Baremetrics, and their latest figures report 5.1% monthly churn (or ~46% annual churn).

Buffer is a big, successful SaaS company, so the idea that they’re losing 46 out of every 100 customers each year seems shocking, especially when contrasted with the average churn rates reported by Pacific Crest and Totango.

But it’s a statistic that’s borne out by their own cohort analysis:

According to their actual cohort data, only 62% of the customers that signed up in January 2016 were still customers at the start of 2017. For this particular cohort, that’s an annual churn rate of 38% (and February’s cohort looks to be worse).

These figures are echoed across the board, making the Baremetrics’ average of 7.5% monthly churn seem very plausible:

• Baremetrics themselves report 5.8% monthly churn (51% annually)
• Time-tracking SaaS HubStaff show 5.6% monthly churn (50% annually)
• Email marketing tool ConvertKit report 8% monthly churn (63% annually).

Six studies in, and we have a clear churn dichotomy: one set of studies seems to suggest that a 5–10% annual churn rate is common; another, a 5–10% monthly churn rate.

So what’s happening?

1) COMPANY SIZE

The different data sets fall into two categories: less than $1,000,000 MRR (Baremetrics, Groove, Open Startups), and greater than $1,000,000 MRR (Pacific Crest, Totango, Blossom Ventures), or broadly speaking, big and small.

The “ideal” churn rate of 5–7% annual churn does seem to hold true for the larger SaaS companies, but smaller companies seem to have much higher churn.

This is probably because most “big” (and definitely most public) SaaS companies target enterprise customers, which has a huge impact on churn:

• Annual billing and longer contract lengths make it harder to churn.
• Higher ACV means decisions are generally viewed as more “long-term”.
• Enterprise companies are less price sensitive than smaller companies.

Compare this to the SMBs that most smaller SaaS companies target, and the huge differences in churn become understandable:

• Monthly billing and shorter contracts make it much easier to churn.
• Lower ACV makes it easy to switch between products.
• Cashflow volatility can lead to frequent cancellations.

2) INDUSTRY-SPECIFIC PRICE SENSITIVITY

In the same way that certain types of customer are more prone to churn, different types of software will have different predispositions to churn.

Look through your own tech stack, and you’ll likely see some products you view as essential, and others deemed “nice-to-have”. It’s likely that a finance or sales tools will be less susceptible to churn than a marketing tool, simply because it’s perceived to be more directly responsible for revenue.

The same is true of niche tools, or those with few competitors — the more expensive it would be to change to another tool, the lower your churn rate will be.

3) INCONSISTENT DATA

There isn’t a whole lot of churn data available — and the information I did find isn’t always that clear-cut.

There’s a simple reason for that: high churn rates are bad, literally recording how many customers are up-and-leaving your service each month. Few companies are as brave as Buffer and HubStaff, and those that do agree to share churn rates will likely only do so if it’s anonymous, and the exact data is hidden away with a range.

4) INTENTIONAL OBFUSCATION

Public companies have an even greater incentive to hide “bad” metrics: it can impact their stock price.

By law, public companies have to report on their performance. Adopting industry-standard measures (like GAAP) would make it easy to compare between similar companies, leading many to develop “proprietary” reporting methods that make it next-to-impossible to directly compare between competitors.

And despite its importance, there are no legal requirements to report on churn rates — leading to the low response rate and the dozens of different churn rate calculations used in the Blossom Ventures report.

If you’re a big, established SaaS company, on track for IPO or some other type of exit, your churn rate targets are crystal clear: you need to hit 5–7% annual churn.

It’s a consistent hallmark of big, successful companies, and we’ve seen good reason to suggest you’ll need similar to reach their heady heights.

But if, like most SaaS companies, you’re earlier-stage, things aren’t so clear. Even a successful SaaS company like Buffer still battles with 5% monthly churn rates, and if you’re new to the world of Product/Market Fit, there’s reason to believe those churn rates will be higher.

Though it’s hard to give a precise benchmark, the six studies I’ve analysed suggest the same thing: a 5% monthly churn rate is pretty common, and as evidenced by the likes of Buffer, Baremetrics and Convertkit, not a clear-cut barrier to growth.

KEY TAKEAWAYS

• Churn is bad but inevitable, so it’s important to track and improve your churn rates over time.
• 5–7% annual churn is a great benchmark to aim for — if you’re an established, mature SaaS company, primarily targeting the enterprise.
• If you’re earlier-stage, or targeting SMBs, expect churn to be closer to 5% per month.
• As your product continues development and your business model matures, you should get better and better at closing and retaining good fit customers. In other words, your churn rate should improve over time.
• Absolute churn rates aren’t as important as changes in churn rates, and you’re heading in the right direction if your progression looks something like this:

A Meta-Analysis of Churn Studies was originally published in The SaaS Growth Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

The most remarkable people I know are also the least happy.

These are people that have dreamt-up, built and sold businesses. They’ve created careers for themselves, and those around them; people that had the self-belief to go all in when their hand was strong, and the courage to keep playing when it wasn’t.

They’re high achievers, in every sense of the phrase. And yet they’re still unhappy, still unsatisfied.

And why?

Because they think success is binary.

That it’s building a billion-dollar business. That it’s patenting some world-changing invention, or becoming a household name. That it’s doing something that no-one else has ever done…

…and that anything less doesn’t count.

But the truth is, most of the people I know that strive so hard for success already possess it — along with the admiration and respect of everyone that knows them.

And when other people conjure up visions of success, it’s their face that they see; their hard work, their determination, their unwavering grit that serves as inspiration.

But because they live their lives by someone else’s yardstick, they never see their success for what it is.

They hold-up billionaires and gurus as their benchmark — a microscopic fraction of the world’s seven billion people, people whose achievements can be attributed as much to timing, chance and luck as it can their intelligence and drive — and find themselves forever living in their towering shadow.

Some will argue that it’s exactly this unattainable definition of success that keeps them pushing, that enables them to achieve remarkable things.

But is their misery really a prerequisite to achievement? Do they have to spend their whole lives striving towards something they’ll never achieve?

Or is our myopic definition of success all wrong?

So here’s a message for all of the dedicated, driven, and downright inspiring people I know: success isn’t binary.

Instead of chasing your vision to the ends of the earth, look around. Take stock of all the little victories (and the big ones), and bit by bit, you’ll realise you’re already living the dream you’ve worked so hard for.

In my eyes, you’re a success. In time, you’ll feel the same.

Success Isn’t Binary was originally published in Thinking, Slow on Medium, where people are continuing the conversation by highlighting and responding to this story.

This is part nine of nine of my big ol’ series exploring every imaginable aspect of startup funding. From funding rounds to valuation methodologies, get ready for a complete crash-course in funding.

Click to read all nine parts as a complete post, or download as a PDF.

We work with startup founders from around the world, including countries like India, Belgium, and our native UK.

Some of these founders have successfully raised funding in their home nation, but others have already set their sights on countries like the US and Canada — places they perceive as being far friendlier to the startup cause.

In this guide, I’ve focused on the US funding market for one very simple reason: it’s the biggest and most established, and lessons learned from the US are applicable across the world. But what about startups from outside the US?

Even within the US, cities like Boston and Chicago are learning lessons from San Francisco and the Silicon Valley. Globally, they’re joined by the likes of Berlin, Paris and Bangalore, cities full of fresh-faced startup founders keen to emulate the success of their US counterparts.

Each of these cities is a hotbed of startup activity, but crucially, they differ from the Valley in several key ways. So how is startup funding different outside of the US?

1) THERE’S LESS INVESTMENT TO GO AROUND

The US has large and established networks of investors, with thousand of people and institutions willing to invest anywhere from a few thousand dollars to a few billion. Outside of the US, these networks simply don’t exist in the same way — and that has a stark impact on investment.

Data from CB Insights shows that for every dollar available to a European startup, there are six dollars available to their US competitors. Worse still, there are simply fewer deals being done: in the last quarter of 2016, Europe and Asia saw 468 and 323 deals respectively; small fry compared to the 1,127 deals that completed in the US over the same period.

Source: CB Insights

2) THERE ARE FEWER LATE-STAGE DEALS

Of the investment opportunities available to non-American startups, the vast majority fall into the category of Seed and Series A investment.

The institutional investors that fuel the rampant US economy through Series B and above are fewer and farther between in Europe and Asia, and those that do exist seem to be more risk averse. Though we’ve seen a big increase in angels, startup accelerators and incubators (particular in Western Europe and India), these changes are yet to filter through to the big-money investors.

3) UNICORNS ARE A RARER BREED

Overall, this means that there are fewer success stories coming out of non-American countries.

Of the latest batch of 182 unicorns, a full 102 are US born-and-bred (with China accounting for the second most, at 37). In 2014, just 0.15% of funded startups became unicorns, and it’s safe to say that those odds are even lower outside of the US.

This is leading many international startup companies to follow a similar pattern: raising a Seed or Series A round in their home country, before using the investment to establish themselves in the fertile soils of the US startup economy.

Source: CB Insights

THE FUTURE OF STARTUP FUNDING

But it’s not all doom and gloom. Though US investment growth significantly outstrips its international counterparts, there are still hugely promising signs of growth in the global startup economy.

Established economies like Germany, France and the UK have seen steady growth in startups and investment deals (especially in software-as-a-service), and relative latecomers like China and India have seen their own huge surges.

This translates into a steady and significant positive growth trend for the startup economy as a whole.

Source: Tomasz Tunguz

So why the big difference?

Silicon Valley has had a head-start over other burgeoning startup hubs, with the current gold-rush of innovation and talent tracing its route back to innovators of their time, Hewlett Packard, setting-up shop in the valley in the 1930s.

It’s had decades to build up its current concentration of experts and specialists, from developers to investors to lawyers — but there’s no reason that phenomenon should be exclusive to the valley.

Other cities are hot on the heels of the Valley, building up their own startup communities to provide capital and expertise to those who need it. Though smaller in absolute terms, these startup economies are growing, and growing quickly.

Though the valley rules for now, it won’t always be so clear-cut.

RECOMMENDED READING

• The difference between raising early-stage capital in the US vs. Europe: A founder’s perspective — Mathilde Collin
• Just How Global Is The SaaS Startup Phenomenon? — Tomasz Tunguz
• What Still Makes Silicon Valley So Special — Harvard Business Review
• The Venture Pulse Report, Q3 2016 — CB Insights

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The Valley vs the World: How Startup Funding Varies by Country was originally published in The SaaS Growth Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

This is part eight of my big ol’ nine-part series, exploring every imaginable aspect of startup funding. From funding rounds to valuation methodologies, get ready for a complete crash-course in funding.

Click to read all nine parts as a complete post, or download as a PDF.

Starting a business is inherently risky, and there are serious risks associated with raising investment.

However, you’re an entrepreneur — the type of person that starts a business when 90% are destined to fail. Armed with a suitable warning, you’ll be able to side-step the risks we’ve covered, and make funding work for you.

But risks aside, there are good ways to raise funding, and there are great ways. To get the most out of every funding round, it’s important to approach your investors with a game plan, to pre-empt their expectations and raise investment in the best way possible.

1) RAISE BEFORE YOU NEED IT

It’s easy to get capital when you don’t need it; when growth is ramping up and revenue is turning from a trickle into a torrent. But leave it too late, and try to raise capital when you’re relying on it for continued growth, and you’ll have a much harder time convincing investors.

2) DON’T LEAVE IT TOO LATE

Securing investment is usually a long, slow process.

A study by DocSend and Harvard Business School found that startups need an average of 40 investor meetings to close a funding round. Seed rounds take an average of nearly 13 weeks to complete, and given the increasing levels of scrutiny and due diligence expected as you raise further funding, expect those timescales to increase through Series A and beyond.

3) DON’T GET GREEDY

Investment should never be a goal in its own right. If that sounds trite, it shouldn’t: early company valuations are largely driven by the amount you raise, so the more money you secure, the more valuable your company appears.

But investment is designed to be spent. No matter how much money you raise, you’ll likely spend it at the same rate — and not always in the smartest way. As Mark Suster argues, over-funding can even stifle creativity, allowing founders to spend their way out of a problem instead of thinking their way clear.

Over-raising also makes it harder to raise subsequent rounds. Any investor wants to see the value of your company increase between rounds, but if you’ve inflated your valuation from the get-go, you’ve made it much harder to justify your next stratospheric valuation, and the next.

4) PRE-EMPT DUE DILIGENCE

Due diligence is a necessary evil of the startup funding process, but that doesn’t mean you should bury your head and passively endure it.

Most investors will seek out similar types of information, so you can ease the process by preparing data in several core fields:

• Key performance metrics
• Financial plan
• Customer acquisition channels
• Current sales pipeline

5) VET YOUR INVESTORS…

It’s hard to find great investors: in DocSend’s study, their participants reached out to an average of 20–30 good-fit investors before closing their round.

But the laborious process of finding investors doesn’t mean you should settle for just anyone.

Your investors will be involved in your business for the long-haul. Their ideas and willingness to contribute will shape the direction of your startup in ways you can’t even imagine — and as your company grows, their support grows more and more important.

With each additional round, you increase the number of people vying for control, so the more investors you have aligned with your vision, the better.

6) …AND THEIR FUND

Ethos and attitude aside, it’s also essential to dig into the mechanics of any investor’s fund.

Different types of fund require different sizes of exit to generate a suitable return, and their needs will have a direct impact on the direction they encourage your business to go.

If you work with a smaller fund, a more “modest” exit will be acceptable, but partnering with the biggest funds can seriously up the pressure to hit vaunted unicorn status.

7) DON’T ASSUME IT’S A DONE DEAL

Finally, even if you survive the meetings, pitches, scepticism, scrutiny and final due diligence, don’t assume that the deal is done.

When Christoph Janz surveyed 110 founders, a significant percentage had experienced VCs backing-out at the final stages of the fundraising process.

RECOMMENDED READING

• A closer look at the 6 things to pre-empt 90% of Due Diligence — Christoph Janz
• Why Raising Too Much Money Can Harm Your Startup — Mark Suster
• The New Rules of Startup Fundraising — Mehul Patel

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7 Smart Ways to Approach Startup Funding was originally published in The SaaS Growth Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

This is part seven of my big ol’ nine-part series, exploring every imaginable aspect of startup funding. From funding rounds to valuation methodologies, get ready for a complete crash-course in funding.

Click to read all nine parts as a complete post, or download as a PDF.

From signalling risk to the startup graveyard, fundraising is a perilous path for startup founders to walk. But with high risk comes high reward.

Securing investment can provide the resources you need to scale, and many of the biggest pitfalls faced by founders are well understood. With a bit of preparation prior to seeking investment, these can even be side-stepped.

1) SIGNALLING RISK

Being a seed investor grants privileged access to a startup’s inner workings.

So, when the time comes to raise a Series A, if your investor chooses to lead the round, that sends a powerful signal to the market: something good is happening behind the scenes of Startup X, and it’d be a smart move to get involved.

But what happens if your investor doesn’t follow on?

Regardless of their specific motivations, the market gets the same message: the people with the best insight into Startup X’s performance haven’t lead their Series A, so we need to stay away. If they won’t put their capital at risk, why should we?

The average VC-backed seed company raises a Series A 35% of the time, or 51% of the time if it’s a smart money VC (a VC that provides strategic guidance, and not just capital). But if that smart money VC doesn’t follow-on, the chances of raising a Series A round plummet to 27%. This is the signalling risk of VC seed funding.

2) BECOMING AN “OPTION”

If we look at the biggest macro-trends in startup funding, it quickly becomes apparent that:

1. More startups are founded each year.
2. Investors are willing to invest more than ever before.

This is creating a real problem for investment-hungry startups: VCs are increasingly happy to make small, speculative investments on the off-chance they’ll succeed, allowing the VC to lead a much more lucrative Series A.

These speculative investments bring with them two kinds of risk: signalling risk if the VC then declines your Series A, and the opportunity cost of taking capital from someone unwilling to advise your startup, instead of an investor who would be more hands-on.

3) LOSS OF CONTROL

Capital comes at a cost: equity.

Even if you start out looking for modest amounts of capital, many startups find that the more investment they raise, the more future investment they need, as their burn rate increases and their swelling panel of investors demand ever-faster growth.

This makes it extremely likely that come the latter stages of fundraising, you, the startup founder, will no longer be the majority shareholder of your business. Even if you’re happy sacrificing your majority stakehold for the good of the company, the loss of board control can leave you powerless to veto the issuing of further shares, diluting your stake even further.

• At their time of IPO, Box CEO Aaron Levie owned just 5.7% of the company he founded.
• After losing control over the company, Sandy Lerner, co-founder of Cisco, was fired by one of the company’s early investors.
• When Groupon reported a larger-than-expected quarterly loss, founder Andrew Mason found himself out of a job, issuing a memo that read: “After 4 1/2 intense and wonderful years as CEO of Groupon, I’ve decided that I’d like to spend more time with my family. Just kidding — I was fired today.”

4) THE STARTUP GRAVEYARD

Investors (particularly VCs and financial institutions) will perform rigorous due diligence, and scrutinise every aspect of your business model prior to investing. Securing investment could even be considered a vote of confidence, suggesting that your business is in good shape. But, crucially, investors are fallible, and investment doesn’t always increase your chances of success.

Only 41% of Y Combinator’s portfolio companies are still funded and in operation — greater than the 90% failure rate predicted for startups as a whole, but far from ideal.

If we stretch our definition of success even further, and look at only those companies that have gone on to exit, that success rate drops down to 13% (and just 4% for 500 Startups). VCs will be more discerning with their investments, but high failure rates are still part-and-parcel of their portfolio.

5) THE FORCED EXIT

But what happens if you don’t fail?

VCs, angels and almost every other type of equity investor need an exit to make money from their investment: an opportunity to cash-in their shares at a profit.

VC funds also have a shelf-life: most are designed to offer returns over a ten year period. As that deadline looms, your investor needs to steer your company towards an exit.

This is fine for long-time founders that set-out to scale and sell their company. But what if you don’t want to go public or sell your company? And what if you joined the VC fund towards the end of their ten year cycle? Even though you don’t want to sell or IPO, your investors will.

When combined with the loss of control almost all founders experience, that can mean full steam ahead for an exit, even if you’d rather stay the course.

RECOMMENDED READING

• Seed Funding and Signalling Risk: How to Avoid Killing Your Series A — Cobloom
• Should you take small checks from deep pockets? — Christoph Janz
• Understanding the Risks of VC Signaling — Mark Suster
• How startup funding works, and why we’ve decided to bootstrap — Tyler King, Less Annoying CRM

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5 Ways Investment Can Kill Your Startup was originally published in The SaaS Growth Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

This is part six of my big ol’ nine-part series, exploring every imaginable aspect of startup funding. From funding rounds to valuation methodologies, get ready for a complete crash-course in funding.

Click to read all nine parts as a complete post, or download as a PDF.

Whether it’s the capital on offer, the equity investors demand, or simply their willingness to invest, every aspect of startup funding is tied together by one seemingly inscrutable concept: valuation.

The perceived value of your startup is the linchpin of every investment negotiation you’ll ever have, and understanding exactly how investors value your startup is the first step in securing great investment terms.

With that in mind, we’re exploring the most common methods of startup valuation, and looking at how they impact your equity, ownership and investment options.

EARLY STAGE VS LATE STAGE VALUATION METHODS

Many of these valuation methods are extremely subjective, and even those that rely on bona fide accounting principles still have a subjective element built-in, for one very simple reason: value is subjective. Even with an inscrutable data-set, a startup’s value is determined by the amount somebody is willing to pay for it.

It’s for that reason that startup valuation methods are often blended together, edited and altered to reach a particular conclusion. This is never more evident than in the case of early-stage startup valuations.

Large, established startups have the benefit of tangible revenue, and valuations can be driven by their past performance. But investors often invest before companies make profit, or even generate revenue. In these instances, the startup valuation methods used are incredibly subjective, relying on heuristic stand-ins for revenue.

As you’re about to see, there’s no such thing as a truly objective valuation. So if you find yourself on the wrong end of a low valuation, dust yourself off, work out how the investor reached their conclusion, and try again.

1) THE COMPARABLES METHOD

The comparable method of startup valuation is probably the simplest: find a comparable company to the one you’re trying to value, and use its valuation as a stand-in for the new startup.

In the same way that two houses might have their size, layout and outside space compared, two startups might have their MAU, churn rates and MRR growth compared to create a stand-in valuation:

“Startup X is worth $4 million, and Startup Y is comparable to Startup X, so the same valuation applies”.

There are obvious problems with this methodology — few startups are likely to be similar enough to warrant this approach as a sole method of valuation — but for many investors, this offers a starting point for assessing the value of early (pre-revenue) stage startups.

2) THE CONFORMITY METHOD

Startup accelerators like Y Combinator are incredibly oversubscribed, and that affords them the freedom to set their own valuation methodology: a one-size-fits-all approach that massively simplifies investment.

This usually takes the form of a fixed investment in exchange for a fixed equity share. To be accepted into the program, the investor’s terms need to be accepted — and if a founder doesn’t like the deal they’re offered, there are a few hundred other founders queuing behind them to take their place.

Y Combinator has done a lot to ensure the fairness of their particular deal, and their approach completely removes the problem of valuing early-stage startups. Each startup is offered the same amount, for the same share, giving all Y Combinator companies a pre-money valuation of just over $1.7 million.

3) THE SCORECARD METHOD

The scorecard method is a variation on the comparison method detailed above. It’s commonly used by angel investors to compare a new investment opportunity to an “average” startup in a given region and industry,

Let’s assume that a typical early-stage B2B SaaS startup, in London, is valued at $1.5 million. An angel would create a list of desirable characteristics, outlining the factors they believes impact startup success (things like founder experience, sales & marketing expertise, and industry competition).

These factors are then subjectively weighted according to their perceived impact on success:

The investment opportunity is then scored across each of these categories, with its score determined by its superiority or inferiority compared to an “average” startup.

If a particular criterion is determined to be average, it scores 100%; better than average and it’ll score over 100%; worse than average, less than 100%. These scores are then added together for a final scorecard valuation.

Returning to our average valuation of $1.5 million, we can see that this particular investor believes the new startup to be more valuable than the average (by 5%), and worth $1.575 million (1.5 * 1.05) as a result.

4) THE VENTURE CAPITAL METHOD

Whenever investment is offered in exchange for equity, the investor needs an exit to recoup their money (and hopefully profit).

Both angels and VCs will have a particular return they need their portfolio companies to generate, and the Venture Capital method allows investors to work backwards from their intended return, and calculate the value and equity requirements of a particular deal.

Imagine an investor that’s looking to invest in your startup, with the intention of an exit in three years.

Three years from now, you’re forecasting that your company’s post-tax earnings will be $2 million. In order to work out how much your company could feasibly be sold for (its terminal valuation), we need to multiply those post-tax earnings by the company’s revenue multiple (we’ll explore this later). For this example, we’re using a multiple of 15:

Most investors have an expected return (their Internal Rate of Return, or IRR) they need their portfolio companies to generate: in this instance, let’s assume the startup needs to grow by 30%, year-on-year.

Assuming an initial investment of $150,000, the investor needs an exit value (the amount their shares will be worth upon sale) of roughly $330,000:

We can then work out the percentage of the company the investor would need to own to generate that return when the company is finally sold (at its terminal value of $30 million):

To sell their equity for the required amount, the investor needs to own almost 11% of the company.

However, subsequent rounds of investment will serve to dilute their ownership, so to finish on 11%, they’ll need their starting share to be higher. With an expected dilution of 25% (a common figure for VC investments), we can work out what their starting equity stake would need to be: in this instance, closer to 15%.

Lastly, we can use these figures to work out the company’s current valuation. Assuming the investment of $150,000 is worth 14.6% of the company, the startup’s post-money valuation is just over a million dollars…

…and its pre-money valuation is about $870,000:

5) DISCOUNTED CASH FLOW

The Discounted Cashflow Method values a startup by predicting its future cashflow, and then discounting it to reflect:

• A. the time value of money (typically the risk-free interest the investment could yield over the same time period)
• B. the risk of that cashflow failing to materialise.

In order to predict future cashflow with any degree of certainty, it’s necessary to have a stable history of revenue: something which most startups lack. As a result, this type of valuation (and many of the other late-stage valuation methods that follow) is used in conjunction with other methodologies as a starting point for valuation.

6) REVENUE MULTIPLES

Revenue multiples are another form of comparative valuation, using data from public companies to draw comparisons to earlier-stage startups.

Investors begin valuation by looking at public companies similar (in terms of industry vertical, revenue growth rate, etc.) to their target startup. As these comparison companies are publicly traded, it’s possible to find out two important pieces of information:

1. The company’s Enterprise Value, an approximation of the cost of buying it.
2. The company’s earnings.

It’s relatively simple to work out a target startup’s earnings, but it’s much harder to calculate its potential sales value. Instead, we can look to comparable businesses to find the relationship between their earnings and their valuation, and extrapolate that relationship to our own startup.

Their are several ways of doing this, each with their own pros and cons:

• Price to Earnings Ratio
• Price to Sales Ratio
• Enterprise Value to EBITDA Ratio

We’ll stick to one of the most common methods: Enterprise Value (EV) to EBITDA.

For example, let’s assume a public company has an Enterprise Value of $220 million, and an EBITDA of $44 million:

Applying the formula, the company has an EV/EBITDA ratio of 5:

In simple terms, this means the company is valued at 5x its earnings. By calculating this ratio across a broad range of similar companies, we can calculate the median revenue multiple for businesses of this type, and use that to value our own startup:

Changes to the median revenue multiple for startup companies reflect changing market trends and levels of investor confidence.

From a relatively stable market of 5x revenue between 2004 and 2011, the valuation of SaaS startups exploded to an all-time high of between 12x and 20x revenue in 2013. Since then, multiples have settled back down, but despite talk of a “bubble”, SaaS startups are still worth significantly more than they were a decade ago.

RECOMMENDED READING

• Valuation of Venture Capital Deals — Ricky Ng
• The Venture Capital Method
• Scorecard Valuation Methodology — Bill Payne
• How Much Is Your SaaS Startup Worth? — Tomasz Tunguz

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Startup Valuation Methods, Explained was originally published in The SaaS Growth Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

The next time you meditate, imagine if your thoughts were trees.

Your most fleeting thoughts would be small, no more than saplings. Maybe your life-long dreams and aspirations would be huge, towering trees, with thick boughs and thicker leaves.

Some of your thoughts would be healthy and positive; trees strong and supple, pulsing with life. Others would be a tangle of dead branches and decaying leaves, rotting from the inside out.

In no time at all, your mind would be a forest. No matter where you looked, you’d see trees, hemming you in. To get anywhere, you’d have to climb over gnarled roots and brush aside thick leaves.

In times of stress, and worry, you find yourself running deeper and deeper into the forest. At times, the forest would be dark enough to blot out all of the light. You might even get lost.

Most people never escape the forest. They become so used to the trees that they forget there was ever anything there before. They become part of the forest, instead of the forest being part of them.

But what happens if you sit down and stare into the forest?

You look long and hard at the tangle of branches. You stare and stare, seeing nothing but bark and bracken, leaves and lichen. Then, in a heartbeat, you catch a glimpse: you see a clearing through the maze, a little pool of open space, empty, serene. And then it’s gone.

But from that point, you know it’s there. No matter how dark the forest gets, you can call back that fleeting image of peace. You begin to unweave the rainbow.

You won’t always see the clearing through the trees. In the beginning, you might not see it at all. But you practice.

And each time you catch a glimpse of that clearing, when you see a tree for the intrusive, impulsive thought it really is, you make the clearing bigger. Not by much — you’ll barely notice it happening — but bigger it gets.

Inch by inch, you carve out a path through the tangled forest, one that becomes easier to find each day. Every time you sit and stare at the trees, you’re clearing the borders of the path, making it a little wider, a little easier to navigate.

Now, in times of stress and worry, you aren’t always thrown into the dark forest. Sometimes, you can see the clearing ahead of you. You’ll still get lost, but the bigger that path becomes, the easier it is to find.

One day, you realise that you can slip into the clearing whenever you call upon it.

It becomes a path well-worn by practice. You realise your perspective has changed. You no longer see an island of calm, lost in the forest: you see a fringe of trees, bordering the bright, open spaces of your mind.

With this distance comes peace. You can appreciate each tree in a way you couldn’t the forest, the swirls in the bark, the sunlight playing through the leaves.

At times, you’ll still find yourself wandering, lost, through the forest — but it’s never quite as dark.

And even in those moments of loss and confusion, you find yourself feeling grateful for the shade, the smell of pine needles underfoot — safe in the knowledge that the clearing is just the other side of the treeline.

Your Mind, the Tangled Forest was originally published in Thinking, Slow on Medium, where people are continuing the conversation by highlighting and responding to this story.

This is part five of my big ol’ nine-part series, exploring every imaginable aspect of startup funding. From funding rounds to valuation methodologies, get ready for a complete crash-course in funding.

Click to read all nine parts as a complete post, or download as a PDF.

Most founders start out owning their company.

But to grow as quickly as possible, you’ll need investment, and to secure the capital you’ll need, your investors will want to own a part of your company.

The faster you grow, the greater your burn rate becomes, and the more capital you’ll need. You move from pre-Seed to Seed to Series A, but with every cash injection you’re forced to give up another slice of your company. Offer too little, and the investment dries up — offer too much, and you’ll soon find yourself without a share in your own company.

THE PROBLEM OF DILUTION

Company ownership is determined by shares. In the early days, it’s likely you (and your co-founders) will own 100% of your startup’s shares:

But in order to give equity to investors, your startup needs to issue new shares. If an angel invested an amount equal to 20% of the value of the company, you’d need to issue shares to reflect his ownership stake: in this case, an additional 25 shares.

You still own your original 100 shares, but now, the company’s ownership looks like this:

Jump ahead to the next funding round. This time, a VC invests an amount equal to half the value of the company.

Assuming equal dilution (which might not always be the case), you’ll need to issue 125 shares to reflect the VC’s ownership stake.

As a result of just two rounds of investment, you’ve gone from owning 100% of your company, to 80%, to just 40%. If you aren’t careful, subsequent rounds of investment can leave you so diluted that you’ll lose control of board seats, and even the company’s direction.

ANTI-DILUTION PRACTICES

This apparent horror story leads many founders to take staunch anti-dilution measures. But dilution serves a purpose: to attract skilled people and resources to your startup.

Whether it’s incentivising a respected VC with a sizeable ownership stake, or luring top talent with an options pool, offering equity is beneficial to your startup, and attempting to hold on to as much equity as possible could limit your growth. Taken to an extreme, anti-dilution practices could leave you as the majority shareholder of a worthless company.

A balance needs to be struck, between incentives and control, investment and ownership: but how do we find that balance?

PRE-MONEY AND POST-MONEY VALUATION

Let’s assume both you and your investor have valued your early-stage startup at $100,000. Your investor is willing to contribute $25,000 to fund the growth of your company. How much equity should they get?

This depends on the nature of that $100,000 valuation. If the angel’s $25,000 investment is included in the valuation (known as a post-money valuation), they’ll own 25% of the company, reducing your share to 75%:

POST-MONEY VALUATION

If that $100,000 is a pre-money valuation, the company is valued at $100,000 before the investment. That means that the angel’s investment actually serves to increase the value of the company to $125,000, reducing their share to 20% and increasing yours to 80%:

PRE-MONEY VALUATION

In both instances you’ve gained the capital you need to grow, as well as the expertise of a seasoned angel; the only difference is how their investment has affected your ownership. In the first example you’ve lost 25% ownership and $25,000 in valuation; in the second example you’ve lost 20%, and maintained the valuation.

EQUITY AND VALUATION

Jump ahead to the next investment round. This time, promising growth has your company valued at $1 million. Given your current equity split, the value of your ownership stake looks like this:

You’re talking to a VC who’s looking to invest $500,000, for a post-money valuation of $1.5 million. That gives the VC a one-third share in your company, diluting both your shares and the angel’s shares proportionately:

But valuations try to account for future value. If your startup is doing particularly well, you may end-up in a bidding war, so what happens if a VC thinks your company is actually worth $2 million?

After all, the only real valuation of a company is whatever someone is willing to pay for it, and a VC will pay huge amounts if they think you’ll be worth a whole lot more in the future.

Let’s work through the same example with a $2 million pre-money valuation. In light of this valuation, the value of your existing shares has doubled:

That same $500,000 investment now creates a post-money valuation of $2.5 million, reducing the VC’s share from one third of the company to one fifth.

In this instance, your equity has been diluted by 16%; but 64% of $2.5 million is larger than 80% of $1 million. Despite the dilution, the value of your share has doubled:

Better still, you’ve gained a VC, and the capital required to grow further. This is the basic premise of investment done right: even though your overall share of the company decreases, the company grows enough from the investment to increase the value of that share.

THE EQUITY EQUATION

Investment decisions can become incredibly complicated, and in the case of successful startups, minute changes to ownership stakes can equate to millions of dollars. Thankfully, there’s a simple rule of thumb we can use to work out whether or not we think an investment opportunity is worthwhile.

An investment deal is worthwhile if you believe the deal will increase the value of your shares in the long-term by more than it reduced it in the short-term. Put another way:

Though there are no hard-and-fast rules for separating out a good deal from a less-than-good deal, these heuristics can be useful for understanding what you stand to gain… and lose.

As a final word on startup equity, remember: dilution is normal. By the time they exit, successful founders often own as little as 10% of their company — and owning 10% of a billion-dollar startup is better than 100% of nothing.

RECOMMENDED READING

• Understanding How Dilution Affects You at a Startup — Mark Suster
• The Equity Equation — Paul Graham
• How much should you raise? An economics approach — Pierre Entremont

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This story is published in The Startup, where 263,100+ people come together to read Medium’s leading stories on entrepreneurship.

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Demystifying Startup Equity was originally published in The Startup on Medium, where people are continuing the conversation by highlighting and responding to this story.

This is part four of my reaaaally big nine-part series, exploring every imaginable aspect of startup funding. From funding rounds to valuation methodologies, get ready for a complete crash-course in funding.

Click to read all nine parts as a complete post, or download as a PDF.

Your startup needs funding.

To secure it, you need to stand-out from the hundreds of other startups that also need funding, and convince investors that you aren’t destined to fall into the 90% of newly-founded companies that eventually fail.

But big-name angels and VCs find themselves overwhelmed with investment opportunities. You’ll need to convince associates and analysts before you reach the decision makers. Even then, you’ll have a matter of minutes to make them fall in love with your company and open their chequebook.

To help separate the donkeys from the unicorns, most investors rely on a simple tool: the pitch deck. This short slide presentation is designed to convince potential investors that your startup represents an unmissable opportunity.

PRINCIPLES OF PITCHING

It’s important to remember the driving force behind your presentation: you’re not telling your life’s story, or providing a blow-by-blow account of every customer you’ve ever closed. Instead, your only objective is to stimulate enough interest to secure a second meeting.

The principles of great presentations are pretty universal, but there are a few fundraising-specific best practices that should be incorporated into your pitch:

1) KEEP IT SHORT, SWEET AND SIMPLE

Data from DocSend found that investors spend an average of just 3 minutes and 44 seconds viewing your perfectly crafted pitch deck. That means brevity is critical: stick to one idea per slide, and between 10 and 30 slides in total (the average deck in DocSend’s study was 19.2 pages long).

2) LESS TELLING, MORE SHOWING

This means using less wordy copy, and more diagrams and visualisation; less conjecture and more data. Stick to big font sizes and simple concepts, and be prepared to add context and clarity when asked.

3) BE HONEST

Your startup isn’t perfect, and investors know that. Instead of whitewashing your success, be honest about your strengths and weaknesses. Steer into areas that need work and frame them in your own terms, and double-down on the areas where you excel.

4) IF YOU FOCUS ON FINANCES, MAKE THEM INSCRUTABLE

Only 57% of the decks studied actually included a finances slide, but for those that did, it was their most scrutinised slide. If you’re going to brave it, make sure your numbers make sense (and don’t talk about exponential growth rates with only a few months of data).

5) SELL YOUR PEOPLE, NOT JUST AN IDEA

Angels and VCs invest in people: they want to know they’ll be funding highly-skilled, deeply-committed founders, and your presentation needs to sell your team as much as it does your product. With that in mind, it’s a great idea to have 2–3 people in attendance, and involve them equally in the pitch.

10 SLIDES TO INCLUDE IN YOUR PITCH DECK

True to the spirit of creating a pitch deck, we’re going to wrap up the writing in favour of some showing.

I’ve analysed the best pitch decks available, from companies like Buffer and Mixpanel, and pulled out a simple, universal framework that crops-up again and again. Using these 10 slides as a starting point for your own pitch deck will help you learn from the multi-million dollar successes of the world’s brightest startups, and maximise your chances of securing that much-needed second meeting.

(It’s also a great idea to check out those successful pitch decks in full: they’re linked to below).

Get the deck: 10 Essential Slides to Include in Your Startup Pitch Deck

RECOMMENDED READING

• Mixpanel — Our pitch deck that we used to raise $65M
• Canvas — The 10 most interesting slides that helped our SaaS company raise 9 million
• Front — Series A pitch deck
• Buffer — The slide deck we used to raise half a million dollars
• Lessons from a Study of Perfect Pitch Decks — TechCrunch
• Going to Raise VC? Here’s a Primer on Process, People & Powerpoint Deck — Mark Suster
• Pitching a VC — Dealing with Competition — Mark Suster
• How to Pitch a VC (or Angel Investor) — Dave McClure

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5 Principles of Successfully Pitching Startup Investors was originally published in The SaaS Growth Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

This is part three of my big ol’ nine-part series, exploring every imaginable aspect of startup funding. From funding rounds to valuation methodologies, get ready for a complete crash-course in funding.

Click to read all nine parts as a complete post, or download as a PDF.

From the world of startup incubators to the glamour of the New York Stock Exchange, startup fundraising is fuelled by a diverse array of investors.

From philanthropic ex-founders to massive financial institutions, your choice of investor has far-reaching consequences for the capital, guidance and direction you can expect from each funding round.

So to help you understand the different types of investor (and their different agendas), it’s time to separate out the incubators from the accelerators, and the micro-VCs from the super-angels.

STARTUP INCUBATORS & STARTUP ACCELERATORS

Famous examples: Y Combinator, 500 Startups, Techstars, AngelPad

A startup incubator supports new ventures during the idea stage, providing access to the infrastructure and environment required for developing a Minimum Viable Product (MVP). With no offer of funding (and no expectation of equity in return), proven performance isn’t a prerequisite, with incubators collaborating with their participants for anywhere from a few months to several years.

In contrast, startup accelerators are a fast-track towards further funding. They offer capital in exchange for equity in your company (usually up to a maximum of 10%), and for a period of several months, provide a crash-course in growth and fundraising designed to accelerate your existing growth. After “graduation”, an accelerator’s alumni are expected to have honed their performance metrics and pitch, and be ready to raise a full seed round.

PROS OF STARTUP INCUBATORS & ACCELERATORS

• Mentorship. The best accelerators and incubators provide advice and guidance from some of the smartest startup minds around.
• Access to future investment. Accelerators offer a direct and reliable route to investment, with many backed (and mentored) by VCs, angels and seasoned founders.
• Credibility and social proof. Acceptance into Y Combinator or 500 Startups’ latest batch is guaranteed to boost the visibility of your startup.

CONS OF STARTUP INCUBATORS & ACCELERATORS

• Hugely over-subscribed. The best incubators and accelerators are incredibly popular: both Y Combinator and Techstars only accept 1 to 2% of applicants.
• Varying quality. With the top names so over-subscribed, newer incubators and accelerators open all the time. While some offer great value guidance and support, others offer a fast-track to the startup graveyard.
• Expensive. Equity is an expensive commodity to trade for relatively low amounts of capital.

ANGEL INVESTORS

Famous examples: Jeff Bezos, Paul Graham, Kevin Rose, Dharmesh Shah

Angel investors are wealthy individuals that offer capital to early-stage startups, in exchange for an equity share in the company. Given the relative volatility of angel investing (it’s hard to pick a winner at such an early stage), many angels pair financial motives with a philanthropic bent — often resulting from their own entrepreneurial background.

Angels, like most types of investor, need an exit to make their investment work: in order to “free-up” the money they’ve spent on you, and unlock their profits, they need you to A. sell your company, or B. go public.

PROS OF ANGEL INVESTORS

• They’ll take risks other investors won’t. Angels have a higher tolerance for risk than most other investors. If your fledgling startup needs someone to take a chance on it, chances are, angels will be the ones to supply the capital.
• Flexibility. Angels don’t operate to the same limitations as VCs and financial institutions (one of the pros of investing your own money), and can often flex investment terms for the benefit of both parties.
• Experience. Many of the best angels are former founders, and bring their own experience (and network) to the table.
• Quick Decisions. Without other investors or a board to answer to, angels can make investment decisions extremely quickly — perfect if you’re running out of runway.

CONS OF ANGEL INVESTORS

• It’s still expensive. Giving away early-stage equity can be extremely costly, especially if you’re trying to court a big-name angel with preferential investment terms.
• Not all angels are created equal. Without other investors to be accountable to, it’s easy for an angel to take advantage of a naive founder. There’s also huge variance in the time, energy and expertise individual angels will be willing to invest in your startup.
• Pockets aren’t always deep enough. Though wealthy, angels will still have less capital available for investment than VC funds or financial institutions. At some point, you’ll outgrow their support.
• They need a big return. Early-stage angel investments are high risk, and future investment can heavily dilute an angel’s equity. The best way to compensate this? A 10x return on their investment.

VENTURE CAPITAL FIRMS

Famous examples: Andreessen Horowitz, Sequoia, Point Nine, Redpoint

Unlike an angel, venture capital (VC) firms invest using a fund: a pool of money provided by the company’s own investors (typically referred to as Limited Partners) and the fund’s managers (or General Partners).

The VC’s job is to invest that money into promising new startups, often over the course of a decade, and generate a return for both themselves and their investors. VCs offer their capital in exchange for equity, and like angels, require an eventual “exit” (usually an IPO, merger or acquisition) to generate a return on their money.

The size of the VC’s fund will determine the size of return required, impacting both the amount they’ll invest, and the types of companies they’ll invest in.

PROS OF VENTURE CAPITAL FIRMS

• Advice and experience. VC’s have a (literally) vested interest in your success, and that often translates into more guidance and advice than angels would be willing to offer.
• Access to a ton of capital. VCs have far deeper pockets than the average angel (or even super angel).
• Network effect. Working with a big-name VC offers credibility, social proof, and most important of all, access to their personal network of experts.
• Clear path to follow-on investment. Most VCs are in for the long-haul, and will lead subsequent rounds of funding (more on this topic later).

CONS OF VENTURE CAPITAL FIRMS

• They need massive returns. Venture investments are risky, and there are huge amounts of capital at stake, both of which translate into the firm’s Limited Partners expecting pretty serious returns. If we dig into the maths of how large VCs operate, it quickly becomes clear that “successful” investments won’t cut it — they need mega-successes just to survive.
• They need control. With investors to appease and investments to justify, VCs don’t just want more control over the direction of your company — they need it, usually in the form of board seats.
• They’re more risk averse than angels. VCs are after proven performance and water-tight metrics, and their due diligence process can take a seriously long time.
• Conflict of interests. What you want to do as a founder doesn’t necessarily align with what your VC investors want.

EQUITY CROWDFUNDING

Famous examples: Indiegogo, CrowdCube, Crowdfunder, Seedrs

The “traditional” crowdfunding model operated by companies like Kickstarter is known as reward crowdfunding — allowing people to pre-purchase goods and services, in exchange for select rewards. Though great for hardware startups (like the Pebble smartwatch), without a physical product to sell, this type of fundraising wasn’t viable for SaaS startups — until equity crowdfunding appeared.

Equity crowdfunding allows individuals to invest small amounts of capital in exchange for a small share in equity. While many equity crowdfunding platforms allow anyone the chance to invest, others offer the opportunity to contribute to angel- or VC-lead rounds, providing a hybrid funding model that combines expert experience with crowd-sourced funding.

As with other types of equity-based funding, for investors to make any money, they require an eventual exit: selling their shares in the event of a merger, acquisition or even IPO.

PROS OF EQUITY CROWDFUNDING

• Set your own terms. Equity crowdfunding affords you the freedom to raise what you want, how you want, without the added complications of investors trying to steer your ship.
• Relatively fast. Most equity crowdfunding platforms give startups 30–60 days to raise investment.
• Democratise investment. Startups like to disrupt, and take-down big, inefficient businesses, so it’s no surprise that the idea of democratising investment would prove to be a big attraction for many founders.
• Crowdfunding is evolving. This type of fundraising is in its infancy, but as more companies facilitate crowdfunded investment, more options appear: affording founders never-before-seen flexibility to raise capital in a way that suits them.

CONS OF EQUITY CROWDFUNDING

• Capital is pretty restricted. As it stands, regulations on crowdfunding are pretty tight, with restrictions imposed on the number of investors you can have, and the amount of capital you can raise (currently capped at $1 million in the US).
• Hidden fees. It’s common practice for equity crowdfunding platforms to charge fees for facilitation and payment processing. Though relatively small, these charges can quickly add up.
• Easy to trivialise. Without lengthy due diligence or a drawn-out fundraising process, it might be easy to underplay the impact of equity crowdfunding. As with all investment types, it needs to be approached with caution and planning.
• Lack of guidance. For many fledgling startups, expert guidance from experienced VCs or angels can prove to be as valuable as the capital they provide. With most types of equity crowdfunding, you’re on your own.

IPO (INITIAL PUBLIC OFFERING)

Famous Examples: Facebook, LinkedIn, Workday, HubSpot

When a company reaches a certain size, continued growth requires a serious injection of capital: too much even for VCs to contribute. It’s here that some companies will consider an Initial Public Offering, and transform into an organisation that anyone can invest in.

Often called a stock market launch, in practical terms this means transforming from a privately held company into a public one, selling a portion of shares to institutional investors (like banks, insurers and hedge funds) who then make the shares available for purchase on the public stock exchange.

So what does an “average” startup look like at IPO? Data from Equityzen has the answer:

PROS OF AN INITIAL PUBLIC OFFERING

• Massive funding potential. Big angel and VC investments can net a growing startup millions of dollars in investment — but an IPO can raise billions.
• Liquidity. IPOs often make it possible for founders and other investors to sell their shares. As well as rewarding the startup’s long-standing investors, this helps free up liquid capital for the company to spend in other areas of growth.
• Attract talent. Raising an IPO also makes it possible to offer stock options as incentive for top talent.
• You did it. For many people, hitting IPO is the ultimate hallmark of success.

CONS OF AN INITIAL PUBLIC OFFERING

• It’s expensive. The average cost of an IPO is $3.7 million, and with a whole plethora of regulatory commitments to adhere to, it’s estimated to cost $1.5 million per year just to function as a public company.
• Loss of control. Public companies often have thousands of shareholders, each with voting rights. Performance needs to be reported, each and every quarter, and poor performance will need to be answered for.
• It’s a different job. Running a public company is a very different job to the one most startup founders sign-on for.

RECOMMENDED READING

• How to Fund a Startup — Paul Graham
• Accelerators vs. Incubators: What’s the Difference? — MicroVentures
• Should You Join a Startup Incubator or Accelerator? — Cobloom
• Angels vs. Venture Capitalists — Ben Horowitz
• Why VCs Need Unicorns Just to Survive — Jason Lemkin
• The Day I Had to Wear Pants to Ring the IPO Bell — Dharmesh Shah

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From Incubator to IPO: Understanding the 5 Types of Startup Investor was originally published in The SaaS Growth Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.