Six Paths to Financing a SaaS Business
SaaS C.R.E.A.M
Hi there, we’re Point Nine Capital a VC firm focused on SaaS and marketplaces.
The paths to financing a SaaS company are getting more diverse than ever. I regularly have discussions with early-stage founders about how they should fund their startups and what is the best option in respect of their experience, ambition, personal aspirations, type of product and the market they target.
I summed up many of the aspects discussed on a map (see below) where you’ll find six paths, broken down into four stages (Idea, MVP, Revenue, Scale). Following the map, you’ll find first a brief description of each scenario, and then I share a framework of questions that you can use to choose your way.
The paths
A mature ecosystem
Before jumping into covering the different paths, and in order not to repeat myself throughout the post, I briefly want to describe the current SaaS environment. We’re operating in a mature environment at several levels (nothing new here):
- To build: from a technical point of view, plenty of tools make building a SaaS product faster (from APIs to frameworks). From a business pov this is also the case, plenty of proven playbooks (HR, sales, marketing, product, tech…) are available.
- To distribute: there are plenty of mature distribution channels to distribute SaaS products.
- To generate revenue: the market size is increasing, and there’s almost no market education to be done anymore.
- To finance: there’s plenty of capital available and the options to finance a SaaS company are more diverse (VC, debt, startup studio,…).
It’s important to keep this context in mind because it explains a lot of the recent evolutions that I cover below.
Bootstrapping + VC
A “classic” journey to building a SaaS company: you have an idea, create a MVP and then go and see VCs to fund your journey.
What has changed in the past years?
#1- A higher bar. A first noticeable change is that the bar to raise at the “Revenue” stage has increased quite a bit. There’s more and more competition among startups and VCs are more and more demanding. If a couple of years ago a simple MVP was enough to convince them, now you need to show more traction, more revenue and better product metrics to raise at that stage. It’s getting tougher.
#2- Skipping the seed round. The second noticeable change is an increasing number of companies skipping the seed round to raise their first VC round at the Scale stage. Because of the maturity of the market, it becomes more common for SaaS companies to reach the $5M — $10M ARR range without taking any VC money. They can then raise at much better conditions.
Full Bootstrapping
Many founders prefer not to take VC money. The key here is to have a short path to monetization to self-finance this journey. Bootstrapping a SaaS has always been possible, but due to the market maturity, it’s more viable than ever.
What has changed in the past years?
A wider spectrum. First, there’s a broader variety of bootstrapped companies nowadays: from “side project” types of company that will generate a couple of hundred dollars per month to medium-sized companies with tens of employees, and companies at the Scale stage with hundreds of employees and making tens of millions of ARR. There’s an explosion of such businesses (look at the listing on Indie Hackers), and it will continue.
A stronger community. Second, a robust “bootstrap community” has emerged. From Microconf to Indie Hackers or Stripe Atlas, the number of high-quality projects and communities to support founders is impressive.
Fundstrapping
First of all I didn’t coin this term; I read it first on Colin Nederkoorn (customer.io CEO) article. “Fundstrapping” means that a company has raised money (for equity and from a couple of hundreds of thousands of dollars to $2M / $3M max) early on, generally at the MVP stage or when they generate a bit of revenue. However they operate like a bootstrapped company: they don’t focus on growing as fast as possible, but rather on building a business that generates enough revenue to be self-financed as soon as possible. They raise money to help start the business, but don’t go on raising subsequent rounds as it is the norm.
What has changed in the past years?
- More fundstrapped SaaS. I cannot say that I see an explosion of them, but I have to admit that it’s a scenario I now encounter on a regular basis. I’m still not sure what are the reasons behind this trend.
It is the trickiest paths of all, and I wouldn’t advise people to go down that road. Why? Because it can result in a lot of frictions if both parties are not aligned. Most VCs’ business model is to invest in companies in the hope that they’ll grow fast and become the winner of their category (or get acquired). Which can lead to problems if the founders decide to focus on profitability too early.
This is not a value judgment, and I’m not saying that it’s something bad “per se”. I’m just saying that founders should be very cautious if they want to avoid potential problems down the road. There are a few success stories with this scenario out there, but I also know that several of the founders in that situation became frustrated with their investors once they started to generate significant revenue (a.k.a they would like to get rid of their investors but it’s not so easy).
I think it’s an option to consider only if you:
- know very well the investors and trust them 100% or if it’s a VC firm which has business model adapted to this scenario.
- are both aligned with this path: from day one they know that you want to focus on profitability rather than on growth.
- agree on some sort of “exit mechanisms” once you reach the later stages.
Full VC
This path is not common. It mainly happens:
- when an entrepreneur with a successful track record starts a new company.
- for capital intensive SaaS (e.g: a product targeting the Enterprise segment).
What has changed in the past years?
I haven’t noticed significant changes there.
Bootstrapping + Debt
The past years have seen the emergence of debt financing. It can be explained by the nature of the SaaS model (metrics driven + relatively predictable once you have a running business, so a good target for debt) and by the new “gaps” in the market which have appeared.
What has changed in the recent years?
Debt at the Revenue stage. I see an increasing number of SaaS companies taking debt at the Revenue stage. It can be either because they couldn’t secure money from VCs or because they just need some cash upfront to invest in their product or sales and don’t want to sacrifice equity for that.
Debt at the Scale stage. This scenario is also more common: instead of taking VC money at the Scale stage founders prefer to keep their equity and take debt instead. They grow nicely but are not interested in the “hypergrowth” mode.
I expect both scenarios to become more common. As we saw previously, the bar to raise VC money at the Revenue stage is getting higher. VCs are more demanding, but at the same time, there’s an increasing number of SaaS companies which are not “VC compatible” or founders that don’t want to sacrifice equity for cash. It creates a gap in the market that debt providers are filling.
Bootstrapping + Debt + VC
Bootstrapping, debt and venture capital are not incompatible. In the past months, I saw several companies going down that path. Especially in “crowded” software categories where VCs are less willing to bet on companies at the Revenue stage, but ready to back the emerging champions once they reach the Scale level.
Maybe you’ll ask yourself what’s the point of taking VC money once you’ve managed to reach that stage. Well, it’s because VCs also bring much more than money (network, branding, recruiting execs, etc.) that are valuable at that stage.
A framework of questions
If you’re unsure of which path to follow here are some questions that can help you in your thinking process. The list is not exhaustive, please let me know in the comments other questions that should be added.
Idea Stage
- [Philosophy] What kind of entrepreneurial path and company do I want to build? VC style or bootstrap style?
If you want to bootstrap:
- [Finance] Can I afford to bootstrap my company until I generate the first revenue? Should I start it as a side project first?
- [Market] Is there a lot of market education to be done? Does the paint point/need I want to address is proven? Do I have some proof that people are ready to pay for my product?
- [Business model] Is the path to monetization clear?
If you want to raise:
- [Team] Do I have a strong track record or unique expertise?
MVP Stage
If you want to bootstrap:
- [Product] Is it clear what the features of my MVP should be? Or do I need to conduct an exploration phase of unknown length (customer discovery)?
- [Team] Do I have the skills to build the MVP with the founding team only?
- [Market] Can I test the different hypothesis about my MVP quickly? Can I quickly test whether people are willing to pay?
If you want to raise:
- [Market] Do I feel a very strong “market pull” when I do customer discovery? Am I in a “hyped VC category” (e.g: bike sharing at the moment) or in an established / crowded space with winners already?
- [Product] Does my MVP receive amazing feedback / generate strong interest?
Revenue Stage
If you want to bootstrap:
- [Team] Is my company a “solo-founder” type of company? Can I grow a team? Do I want to grow a team? Can I hire people? (financial pov)
- [Marketing / sales] Did I find a sustainable and healthy growth engine (a.k.a good unit economics)? Do I grow organically (without constantly investing in new marketing actions)?
If you want to raise:
- [Marketing / sales] Am I growing fast enough for VC standards? Did I find a promising growth engine?
- [Product] Do I have great product metrics (retention, usage…)? Is my product a “feature” or a “product”? Is the transition from feature to product obvious? If I grow my product (in terms of features) do I suddenly compete with big incumbents?
- [Market] Is my market “hot” for VC standards?
If you want to take debt:
- [Product] Are my main metrics “stabilized’ (you know them and they don’t change drastically from one month to the other)?
- [Finance] Is it clear where I want to invest this money and what results I’m expecting?
Scale Stage
If you want to raise:
- [Market] Is my TAM (Total Addressable Market) big enough so that I can grow beyond $10M ARR (market ceiling)? Are there complementary markets/use cases where I can find pockets of growth?
- [Marketing / sales] Can my engine of growth scale?
- [Team] Am I ready and able to hire an exec team?
- [Product] Does my product have clear defensibility / moats?
