The Rise of Non “VC compatible” SaaS Companies

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If there’s one aspect of the SaaS landscape that I saw changing tremendously the past 10 years, it’s definitely the rise of bootstrapped SaaS companies.

Financing a SaaS business with VCs or by bootstrapping is a topic which is more and more discussed. Not only an increasing number of founders shares their experience growing their SaaS business without outside funding but an increasing number of them shares their disillusion going the VC way as well.

Since it’s a topic that I discuss quite often with early stage founders, and which impacts VCs too, I want to address it properly and share my point of view in this post.

Four different types of SaaS companies

For the purpose of this article I’ll distinguish four types of SaaS companies:

  1. Funded SaaS: companies which finance their business with VCs a.k.a equity against money. From early stage startups with no revenue to companies going public with hundreds millions dollars of ARR, the range is extremely wide.
  2. Bootstrapped “scaling” SaaS companies: SaaS companies which manage to pass the $10M ARR threshold without VC money. Ex: Mailchimp or Atlassian (which raise VC money but at a very late stage) have reached the hundreds of millions dollars of ARR without VC money. These “unicorns among unicorns” are very rare.
  3. Bootstrapped SaaS companies: bootstrapped companies which manage to reach the $300k — $10M ARR range without VC money.
  4. Bootstrapped Micro SaaS: “1 to 3” people companies which operate in the $1k — $300k ARR range, without VC money.

What’s important here are not so much the different ARR ranges, which can be discussed and adjusted, but the trends for the different categories:

In the category #1 for the past couple of years the trend is toward an increasing number of SaaS companies being funded but it’s linked to the capital available and the will of VCs to invest or not. For category #2 I also think we’re seeing more of these companies but they are still very rare and we cannot say that there’s an explosion of them.

If there’s an explosion which is changing the SaaS landscape it’s definitely happening in the categories #3 and #4. When I entered the SaaS world 10 years ago (building a product on top of flash…) I knew very few founders running bootstrapped SaaS companies. Raising money was the main way to go. But this has changed and I now encounter, almost on a weekly basis, awesome bootstrapped software companies and micro SaaS.

Why bootstrapping a SaaS to several million dollars of ARR is an increasingly viable path

The available market is getting bigger: more and more businesses buy SaaS products and don’t need to be educated anymore. From SMBs to enterprise customers.

Building and distributing a SaaS product is easier, faster and less expensive: thanks to developer tools, APIs and the emergence of software platforms (e.g: SalesForce, Zapier, Segment…).

Advice from people “who have done it” is widely available online: as Jason Lemkin wrote in a tweet: “It’s possible there is now sufficient startup advice on the internet

All these factors make bootstrapping a SaaS company beyond several million dollars of ARR, without raising VC money, a more and more viable and proven path.

The rise of the non “VC compatible” SaaS companies

An important characteristic of this growing trend of companies is that a big chunk of them are not “VC compatible”. For various reasons:

  • The founders want to bootstrap their business — very often because they have previously worked in VC backed companies and don’t want this model anymore (and being experienced helps tremendously when bootstrapping).
  • The company operates in a crowded category where it’s almost impossible to scale but where it’s possible to run a lean and profitable SaaS business.
  • The company is more a “feature” than a “product” that can be monetized on SaaS platforms (Salesforce, Zapier etc…).
  • The company addresses a “niche” or a very specific need that is not replicable / scalable.
  • The TAM (Total Addressable Market) is not big enough for a VC return but big enough for a very profitable bootstrapped company (read Prasanna K comment for more details).
  • The company has a strong “local” component which is hard to expand.

The majority of these companies have their sweet spot in the tens to hundreds thousands dollars of MRR. Once reached they’ll continue to grow but more slowly and they won’t scale to millions dollars of MRR. A minority will enter category #2 and become the new Mailchimp or Atlassian.

I by NO MEAN suggest / imply that non “VC compatible” companies are inferior or less prestigious to VC compatible ones:

  • These bootstrapped companies can be equally, or even more, life changing for their founders and employees.
  • Like bootstrapped businesses the vast majority of VC backed companies won’t scale to tens of millions dollars ARR.
  • Growing a bootstrapped or a VC backed company is equally hard. But for different reasons.

Some words on “VC Compatible”

Without going into details the aim of a VC is to invest money in companies in order to get a return on investment (ROI) through exits (the startup gets acquired or goes public etc…). In general the faster and bigger a company grows the better the return on investment for the VC is. And this is why we are chasing this kind of companies and why financing a company with VC money makes no sense if the founders are not aligned with this aim.

Consequences

  • VCs must be aware that they’ll see an increasing number of non “VC compatible” companies in their deal flow.
  • Founders must increasingly be aware that going the VC way might not be the best solution for them and that bootstrapping 100% or finding alternative ways of financing their company can be healthier.
  • The line between VC compatible and non VC compatible companies can be blurry and even change over time.
  • There’s currently a clear gap in early stage financing for these “non VC compatible” SaaS and this is why we’re witnessing the multiplication of debt / cash flow / crowdsourcing based financing vehicles and also of startup studios / specialized funds that build portfolio of lean SaaS companies.

Edit: For those interested in the alternative financing aspect here are some data points from Tom TunguzA Spike Of Venture Debt In Startups

A “VC Compatible” checklist

As an early stage founder if you have no idea on which side you’re leaning toward here are some questions that you can ask yourself :

About your aspirations:

The very first thing to clear out is whether the VC model fits your personal aspirations as an entrepreneur or not:

  • Is your aim to build and scale a very fast growing company at the cost of giving up some control along the way? (a.k.a speed versus control)
  • Or do you value more building a company which might not be as fast growing but which destiny is controlled 100% by you and your other co-founders?
  • Are you sufficiently aware of what it means to work with VCs?
  • If yes, are you ready for the constraints and benefits it implies?
  • If no, do reference calls with VC backed founders first.

About your business:

The characteristics of your business / product / market positioning also play a role:

  • Is your SaaS a feature or a product?
  • Can you monetize quickly your first users with an early version of your product?
  • Do you need a lot of capital up front to build the first version of your product? (ex: heavy tech)
  • Do you need a lot of capital up front to acquire your first customers? E.g: you target the enterprise segment from day one or you need first to educate your market.
  • Is your product in a crowded category and if yes, do you have an unfair advantage to break out at scale? (The unfair advantage can be on the tech or distribution side).
  • If you’re a niche product can you expand to other problems / bigger markets?

Again, the line between VC compatible and not compatible businesses can be very thin and change over time — especially at early stage. There are plenty examples of awesome startups which started as a “feature” to later evolve to big businesses. However it’s a tiny, tiny minority and in the majority of the cases they could show huge traction without raising at first.

Conclusion

As a conclusion I want to emphasis, again, the fact that the VC path is not better or more prestigious than the bootstrap one. Working on the VC side myself my first aim is to be aligned with the founders we work with.

If their aim is to build fast growing companies with the help of VCs then it makes sense to work together. But if they prefer to do so by financing their business purely thanks to the revenue they manage to generate from their customers it’s fantastic too.

There’s no “evil” or “angel” here, these are just two different approaches to building a business and everyone (founders as well as VCs) should chose its path wisely.