The top 3 things investors are looking for in SaaS startups

What does it take to raise capital, in SaaS, in 2018? (2/3)

In the first part of this series I shared the quantitative data that I collected in my recent survey among more than 60 SaaS investors. Today I’ll write about the answers to the survey’s free-form question:

“What are the top 3 things you’re looking for when you assess a potential SaaS investment?”

Despite the fact that the question was optional, almost everyone answered it and I got lots of great responses. I’ll start with a summary, followed by a number of selected quotes that I think are particularly useful.

(Almost) all you need to know, in one word cloud

The first thing I did was to dump all answers into a word cloud tool, which created this visualisation:

I think the algorithms did a remarkable job grouping related terms, removing stop words, and scaling each word in proportion to its importance. So I could stop here, because the word cloud contains pretty much all you have to know. :-)

Team, TAM, moat

I of course wanted to dig in deeper though, so I went through all comments and grouped them into major themes. The categorisation is, of course, a bit subjective, and I’m sure there are other (and maybe better) ways to do it. Based on the themes that I picked, here’s the result, sorted by count, i.e. by the number of respondents who mentioned the theme in their answer:

The clear winner is, not surprisingly, an excellent founding team, followed by a large TAM (Total Addressable Market), moat (i.e. defensibility), a great and highly differentiated product, a repeatable sales model, and a dollar retention rate of over 100%, i.e. negative ARR churn.

If we look at the breakdown by stage and the top comments for each stage, we can make a few interesting observations:

The quality of the team gets the highest number of votes from both seed and Series A investors. Seed investors also pointed out that they are looking for great products that solve a massive pain point and that the team should have a convincing go-to-market plan. As you move to the Series A stage, investors start to care more and more about repeatability, retention, and defensibility. At the Series B stage, dollar retention got one of the top votes.

While we got more than 70 comments from Series A investors, the sample sizes for seed and Series B are quite low, so those results need to be taken with a grain of salt. That said, the results make perfect sense to me: In the beginning, it’s all about the team and getting to Product/Market Fit. Over time, the focus shifts to a repeatable sales model and healthy unit economics, and eventually it’s all about defensibility and the size of the market.

What’s maybe surprising is that moat came in as the #2 theme among Series A investors. I’m not sure if moat would have been mentioned so frequently five years ago, but today most SaaS investors believe that being a workflow tool with a nice UI isn’t enough to create long-term defensibility – hence the focus on building moat, usually through some kind of data assets or network effects. Another surprise is maybe that product didn’t get more mentions from Series A investors, but the data doesn’t tell us if it’s because they don’t care so much about product or because they take a great product for granted (as in, if the company didn’t have a great product they wouldn’t have gotten this far).

“Good revenue growth is worthless if the company gets huge adoption initially but doesn’t drive fundamental change.”

This I thought was one of the best, thought-provoking comments from the survey, but there are many more. Here is a selection.

There were many great comments about what investors are looking for in the founding team. Here are some of the best ones:

“Some anecdotes or observed behavior that reflects a deep intensity and competitive personality, which comes across in how they react to and watch competition in the market. We really like conversations where the founder has a deep understanding of all the competitors (not just surface level trashtalking based on what they can gather publicly), educated by actual proprietary intel from their networks. It shows an ability to get information and convince people to be on their side.”
“Some type of specialized domain knowledge that leads to an unexpected and unconventional insight.”
“Speed (time it took to get where they currently are, time to make decisions)”
“Founders that are driven, expert, team-oriented and create a vision that others want to get behind.”
“Exceptional product centric founder”
“Hungry & talented teams that can grow into CEOs”
“Insiders to the pain / outsiders to the market”
“Mission driven founders”
“Management that can handle 20x the size of today”
“Thought leadership: great understanding of where the market is going and being able to share this to their clients/the market.”

I also liked this one on the “why now” question …

“A compelling “why now” argument that explains how multiple trends are converging at a specific point in time to make this business likely to succeed now (but not in the past). Factors could include impending regulatory change, dramatic changes in the price of some IT component that impacts the economics of downstream businesses, the proliferation of smartphones, etc.”

… and this one on competition:

“Fat incumbents”

Customer references are important for many investors …

“Super positive customer references. We try to introduce a few portfolio companies to get unbiased feedback on the product and quality of customer support.”

… as is a sticky product:

“Deep embedding in software stack or workflows”

Some good comments about product quality …

“Differentiation — 10X better than existing solutions in markets that are already proven”
“Customers who preach about the product”
“I’m trying to assess is why this is going to make a transformative difference for the user of the product and the organization it serves. Good revenue growth is worthless if the company gets huge adoption initially but doesn’t drive fundamental change.”

… and the need to address a massive pain point:

“Massive pain point in the market with identifiable customer that has the wallet to pay for it.”
“Products solving problems which people have but the market is not yet clear on.”
“Product that solves some ‘hair on fire’ pain.”

Interesting points regarding financeability and investor/company fit:

“Financeability — do we have a sense of which 5 firms could do the Series A for a seed opportunity, based on their typical interest and the fact that they have not invested in the space yet.”
“Proximity to our team so that we can be helpful.”

“Moat” was a huge topic, as mentioned above:

“Increasing defensibility as the company grows, typically leveraging proprietary data”
“Competitive moat, ideally via usage-driven proprietary data”
“Defensibility in the technology or business model. Using data to generate intelligence rather than simply managing processes.”

What investors say about repeatability in sales and sales efficiency:

“Consistency in reasons why customers buy”
“At least one scalable marketing channel”
“Evidence of repeatable sales model (vs. founder lead sales)”
“Less than 12 months CAC payback on a gross margin basis (18 months OK if lots of upsell and true enterprise SaaS)”

Last but not least, an interesting comment on valuation:

“Size vs. Growth Rate vs. TAM vs. Post-Money = opportunity to make 5x+”

That leaves us with only one thing: putting all of this on the back of napkin. Stay tuned!

UPDATE: The 3rd part of this post and the napkin has been published.