SaaS Fundraising Handbook

Parsa Saljoughian
May 27 · 22 min read

Be Fully Prepared for Your Company’s Next Fundraise

This post was jointly written with Michael Miao. The original post can be found here: https://www.ivp.com/saas-fundraising-handbook/

INTRODUCTION

Our process of getting to conviction has both quantitative and qualitative elements. Our quantitative analysis is primarily centered around exploring a company’s growth rate and sales efficiency as key drivers of product-market fit and go-to-market fit. In this handbook, we highlight key formulas and share proprietary benchmarks, while also providing handy templates to illustrate how best to structure and present data. On the qualitative side, we’ll spend time with management, as it is critical that we believe we are backing leaders who can clearly articulate and execute against a compelling vision. We’ll also speak to customers to understand satisfaction levels and size a company’s addressable opportunity. Part of our overall assessment centers around believing whether a company can be 3x, 5x, 10x, or 25x larger on its key fundamental metrics and ultimately whether it can return one-third, half, or potentially the entire fund.

While it used to be that all of this work would kick off during a formalized 1–2 month fundraise process, rounds are now coming together much faster than before. Speed to term sheet is being seen as a competitive advantage and investors have inverted the sequence of diligence, doing a fair amount of this market-related work on their own in order to 1) move quickly during a future process or 2) to preempt a round. Every investment firm has its own approach to diligence and every company can choose to run its own fundraising playbook. Our focus at IVP is to be company-friendly while doing the highest leverage work we need to gain conviction. While no fundraising process is the same, we believe that it is critically important to understand how investors will evaluate your business, which is why we created this handbook to arm you, the CEO, COO, or CFO with all that you need to be prepared for your next fundraise.

FINANCIALS

Annual Recurring Revenue (ARR)

The main components of ARR are as follows:

For companies with consumption-based pricing (vs. seat or license-based pricing), the way to calculate ARR is to take monthly recognized revenue (i.e. consumption revenue) * 12. Calculating churn can be tricky with these models as a decrease in spend is not necessarily true churn. We’d recommend that companies distinguish between true churn (i.e. customer has left the platform) vs lower consumption.

For a SaaS company with consumption-based pricing, the best way to express the components of ARR is as follows:

A helpful way to illustrate how the components of ARR change over time is to show a stacked column chart that is broken down by quarter. See below for an example of how to graphically represent the different components of your company’s ARR over time.

Growth Rate

IVP analyzed the year-over-year growth rate for all of the private SaaS companies we’ve evaluated over the last few years. A company’s growth rate naturally decelerates as it achieves greater scale, so it’s important to keep scale in mind when benchmarking growth. We will note that these growth rates are not representative of all SaaS companies. The companies in our set have prior venture funding from top-tier firms and would be considered best-in-class in today’s market. See below for how your company stacks up against companies we’ve recently evaluated.

As an example to help you best interpret the chart, let’s assume your company is at $10M ARR. If the year-over-year historical growth rate was 250% ($2.8M to $10.0M ARR), this would be close to the 75th percentile. Conversely, if the year-over-year growth rate was 100% ($5.0M to $10.0M ARR), this would fall below the 25th percentile.

The Power of Hypergrowth

Financial Statements

Below is an example of how to most effectively lay out your historical and projected financials. Start by highlighting ARR and then by including a traditional P&L that goes from revenue down to operating income and EBITDA. Including a balance sheet and cash flow statement are helpful but not required. At a minimum, it is helpful to also include an estimate of Free Cash Flow (Operating Cash Flow minus CapEx) and ending cash balances by quarter. In the P&L, breaking down Operating Expense (OPEX) into S&M (Sales & Marketing), R&D (Research & Development), and G&A (General & Administrative) is important because it allows the investor to diagnose where your burn is coming from and to calculate sales efficiency. Earlier stage companies won’t have the accounting infrastructure in place to properly categorize OPEX, but you can approximate the breakdown based on headcount. Lastly, investors will often request that you provide monthly or quarterly detail so they can assess recent momentum and also understand any potential seasonality.

With this data, investors will conduct numerous analyses and likely schedule a financial diligence call to better understand the key assumptions. The level of detail behind these questions will vary based on the maturity of the company and sophistication of the investor, but expect investors to focus on growth, margins, unit economics, and burn. See below for questions that investors commonly ask during financial diligence calls.

For most startups, the question of whether to add a VP Finance comes up around the Series A / B stage and we typically see this hire as one of the most delayed hires. We’d recommend that SaaS companies bring on a VP Finance or Head of Finance by the Series B at the latest as it is important to have a solid financial foundation at this stage of the company’s maturity and investors will want to be able to review financial information that they can comfortably rely on.

Churn / Retention

Net Dollar Retention

IVP benchmarked the NDR of every private SaaS company that we’ve evaluated at $10M ARR as well as the NDR of 50+ publicly traded SaaS companies. We’d note that a company’s NDR can vary dramatically depending on the size of its customers. As a rule of thumb, a good NDR for an enterprise SaaS company is 120%+ with best-in-class companies above 130%. For companies selling into SMBs (small and medium businesses), a good rate is 90%+. See below for how your company compares.

Gross Dollar Retention

Quick Ratio

Cohort Data

Layer-Cake Chart

Spaghetti Chart

When evaluating cohorts, investors will look to answer four key questions:

  • Are the newer cohorts increasing in size? If revenue cohorts are increasing in size, this means that each month, your new customers are spending, in aggregate, more dollars with you. Increased new business is a powerful lever for growth.
  • Is each individual cohort showing expansion over time? If cohorts are showing expansion, this means existing customers are increasing their spend over time. Increased expansion is another powerful lever of growth.
  • Are the cohorts relatively consistent? One of the benefits of a SaaS business is its inherent predictability. If there is consistency among the cohorts, this means the business is quite predictable. Companies with transactional pricing or seasonality may show some volatility in cohorts.
  • Are new cohorts improving relative to others? If recent cohorts are improving, this means customers are spending more, faster in their customer lifecycle. This is a signal that the company’s product is resonating well and a signal for accelerating growth.

Evaluating cohorts is an incredibly important way to measure customer retention and engagement over time.

GO-TO-MARKET

Sales Efficiency

Magic Number

The 1.0x Magic Number benchmark is just that, a benchmark. IVP has seen many companies be very successful with a Magic Number below 1.0x and unsuccessful with a Magic Number greater than 1.0x. Your company’s Magic Number is just a shortcut for investors to assess sales efficiency and there is often a lot of nuance behind it. Investors will also use the Magic Number calculation to sanity check the assumptions behind your forecast. If your company has historically operated with a Magic Number of 0.7x but your financial projections imply a Magic Number of 2.0x next year, you should have a well-reasoned explanation for why this will happen.

IVP benchmarked the Magic Number of every private SaaS company at $15M ARR that we’ve evaluated in the last few years as well as the Magic Number of 50+ publicly traded SaaS companies. See below to see how your company compares.

Gross Margin Adjusted Magic Number

CAC Payback

Top Customers

While we discussed cohorts above, it is particularly important to understand the spending habits of your largest customers. Investors will look at your top 10 customers to see how much they have increased spend over the last year. This can be biased so investors will also take a snapshot of top customers from the year prior to see how much they are spending a year later.

Sales Organization

Investors will commonly ask to see historical quota attainment by sales rep and will want to see consistent attainment across the entire sales organization, not just from a small handful of reps driving the bulk of the revenue. Having the majority of quota coming from a small handful of reps means that the company doesn’t have a repeatable GTM motion that can scale. Investors will also check to see if reps are consistently overperforming their quota attainment. If that’s the case, it’s a sign that quotas are too low and the company isn’t setting aggressive enough goals for the team. Investors typically expect to see ~75% of fully ramped reps hitting 100%+ of their quota. This demonstrates both productivity and consistency across the sales organization.

Sales Pipeline

Conventional wisdom says that a healthy Sales Pipeline Coverage Ratio is 3x but that varies based on the type of company. For companies with very long sales cycles, they typically need a much larger pipeline (i.e. 5x+) to confidently hit their ACV target for the quarter. For companies with very short sales cycles, it can sometimes be lower. A Sales Pipeline analysis is only relevant for companies with an inside or field sales driven business. SaaS companies with a self-serve GTM motion are more likely to be paid marketing driven making a pipeline less relevant. See below for an example of how to lay out your sales pipeline.

MARKET RESEARCH

Market Sizing

Market Potential

Total Addressable Market (TAM)

  • Top-down market sizing uses industry research from Gartner and Forrester as an input that includes your market and other similar markets. Through a variety of assumptions, you’ll break this down into an amount that represents an estimate for your specific market.
  • Bottoms-up market sizing is calculated by multiplying the total number of customers by an average selling price (or estimated future selling price). It is called bottoms-up because you start with the building blocks (number of customers, price, etc) to formulate a view on the market opportunity.

It is worthwhile to estimate a market size using both the top-down and bottoms-up methodologies. The benefit of this approach is that it can help triangulate the estimates. If the results are far off, it is worth thinking through the assumptions some more. We typically favor the bottoms-up approach as it is more granular. When sharing your view of market size to investors, it is helpful to paint a picture of analogous markets that you could expand to as you scale up your product and go-to-market. It is also important to share details on the assumptions you used to estimate market size.

Served Addressable Market (SAM)

Customer Calls

Management Team

VALUATION

Private Comparables

  1. Enterprise Value (Pre-$ Valuation less Cash) divided by current ARR
  2. Enterprise Value divided by NTM (Next Twelve Months) ARR *

*NTM ARR refers to annualized recurring revenue that you expect to generate 12 months into the future.

The multiples that investors are ultimately willing to pay for a company is influenced by several factors that drive their conviction in the company’s long-term performance. This includes the company’s growth rate, capital efficiency, and strength of its core SaaS metrics (NDR, GDR, Magic Number, etc.), as well as the size of the market opportunity and the strength of the team. It is important to note that private software company ARR multiples are at an all-time high. There are risks of raising at too high of a valuation, including the potential for a future down-round if there is a market correction or if your company fails to grow into the valuation before you need to raise more capital. This all being said, it is near impossible to forecast future market conditions.

Public Comparables

Returns Modeling

CRAFTING YOUR STORY

CONCLUSION

AUTHORS

parsa.vc

Investor at late-stage VC firm, IVP.