Get a headstart in 2023 with a snappy guide to fund your SaaS scale-up. We will look at Venture Capital, Private Equity, and Private Debt; how they complement each other, their pros and cons, and which might be best according to the current market performance.
Introduction
It is June 2023, and you are a SaaS company at series a, b, or c of funding. The overall carefulness of the market brought by a modern iteration of the ten plagues of Egypt, has left investors cold. In this framework, funding barely profitable SaaS companies doesn't seem to be everyone's priority; whether or not you have the next ChatGPT baking in the oven.
However, that does not mean that all hope is lost. There are still options for you out there, whatever stage you find yourself in. It just means that certain opportunities more clearly fit your needs than others.
Well, it depends on many factors. First of all, it depends on what series you are in.
Maybe you are bootstrapping your way to success and hit a wall. Maybe you’ve exhausted your investor pipeline and need some cash to fund the next big step. The list goes on.
Secondly, it also depends on a simple question: What do you want your exit to look like? A SaaS company can not only become extremely profitable but also a consistent source of revenue when set up correctly. One example of smart exit consists in appointing a new CEO and keeping it as an annuity. In that case, equity is the multiplier, and you want to have diluted as little of it as possible.
Just as importantly, your options will depend on the market’s health. Right now, Venture Capital (VC) fundings’ overheating has just started to cool down, following a year of incessant high valuations that finally came to a stop.
Traditionally the place to go for high-return, ambitious SaaS companies in need of capital to upgrade, this deceleration in VC is not uniformly shared among other funding options, as you will find out later. It’s still spearheading SaaS funding today, so let us start with them anyway.
Main SaaS funding models:
Venture Capital, or VC, is an excellent option to start with. They have a wide portfolio of start-ups to invest in and will not be diluting too much of your equity. Because they are not looking to take complete ownership of your company, they can manage taking small calculated risks when they see fit, even for pre-profit companies.
Their involvement in your project will typically represent 10-25% of your equity in the series a, b, or c of your expansion. On top of that, venture capitalists will always try to sneak in clauses in your round to try and get more oversight on operations i.e. what the lent funds can be used for.
Another inconvenience is their occasional implementation of preferential dividends, which you must honour before paying dividends to anyone else in your company.
On the flip side, the VC experience can bring about two positives. Venture capitalists have raised money and helped successful businesses before, and therefore have valuable experience managing your company. Secondly, very successful funds can help you with networking and are a great signalling asset for your company.
However, expect long due diligence, and make sure to look into other options, as deals do not always close. Make sure to understand your numbers: communication about your figures and projections is key in securing the round you need.
In 2022, VC funding has seen a steep decline. This is because venture capitalists rely a lot on the market's health to inform their decision, as their portfolio's health is immediately tied to it. If inflation and recession hit at once, opportunities are more sparse. Take it into account.
Private equity investing is similar to VC, in that they acquire shares of your company. However, they might be a less tantalising option, for many reasons.
First off, they tend to pass on smaller start-ups, for which they prefer bigger, more stable companies. Investments from PE start around 50M$. They're really not for early-stage companies.
Private equity funds will restructure your company through all sorts of financial engineering and eventually aim at owning a majority of shares, up to 100%. They use both equity and debt as opposed to VC, which uses only equity.
Due to their larger involvement in your project, and therefore increased risk, they will conduct long, painstaking due diligence and evaluations which will more often than not result in a no-deal situation.
Make sure you're willing to devote most of your time to an endeavour that might leave you as dry and needy as you were 3 months ago. Ever tried courting someone you feel thinks they're too good for you? Well, it's similar. Maybe it is not worth your while, or maybe it is too soon to think about it.
However, if you are at least a stage-c company, you think you have what it takes to pass due diligence, and you have accepted the idea of ultimately renouncing your equity, it is definitely an option to consider.
Private debt funds will loan you money in return for a set credit at set times. They are risking more than a traditional bank, since they cannot put your house as collateral, if, God forbid, you were to go bankrupt. Logically, the interest asked is higher than banks ).
You are however much more likely to secure a deal with a private debt fund than with a bank. The aftermath of the financial crisis of 2008 saw an increase in legislation getting in the way of Banks giving loans to start-ups. Private Debt funds really emerged from that gap in the market.
Because banks have more built-in securities to fall back on, in case their investment goes south, they have a higher risk appetite than Private Funds.
There are a couple of advantages to Private Debts as an alternative or addition to VC. The most relevant of these advantages is that you will not lose control of operations, nor further dilute your equity in the process.
There are usually far fewer strings attached to private debts than with VC. Far fewer contract clauses, which let you steer your ship as you please. And remember the potential exit plan mentioned earlier: more equity means better multiples and a great annuity when you pass on the reins.
While you may not profit from the guidance of VC consultancy, nor the aforementioned oversight, there’s a tax upside to Private Debts. Simply put, it costs less to pay your credit back to your lender than to pay taxes on dividends to shareholders.
Finally, private debt investors like to help seed companies that have already gone through a round of VC. It means due diligence was done: VC funds trusted this company enough to get involved, and that is a reassuring sight to your future lender. In this sense, Private Debt greatly complements VC funding and allows you to extend your cash runway with little to no strings attached.
Since, in a case of bankruptcy, it is mandated by law that all remaining assets are to be distributed in priority to creditors, Private Debt funds are less impacted by bad market performance.
That's it! Here are the three main ways to fund your SaaS company. Others exist and will be touched upon in later articles. Let's take the pros and cons of the three we have now and bullet point them out!
Venture Capital
Pros:
Cons:
Private Equity
Pros:
Cons:
Private Debt:
Pros:
Cons:
What are your options if you're pre-profit?
Pre-profit companies can forget about Private Equity for now. Try to stretch pre-funded growth as much as possible, and prepare a plan for how you are going to spend the money you want to raise. That doesn't mean you should get caught up daydreaming about it either.
But a clear plan in mind will show dedication and forecasting skills to your future suitor. SaaS companies are easily scalable, due to their low marginal costs.
However, you will have to know your figures like the back of your hands, inside and out. Make a great impression on potential investors. Communicate accurate figures about your company's health and potential quickly. Get acquainted with your Customer Acquisition Cost (CAC), and the Lifetime Value (LTV) of your product. These and other KPIs will come in handy during due diligence.
Find the Right Investors:
Obviously, everyone wants the perfect fit. The classic Cinderella story. Assess the needs of your company against the backdrop of your personal philosophy.
What are your preferred exits? How much equity are you willing to lose?
A great option to consider is a mix of Venture Capital and Private Debt. They will usually complement each other, allowing for flexibility and opportunity. Additionally, Private Debt funds can use convertible notes, which are bonds invested in your company as money, that convert into equity once certain benchmarks have been hit. They allow for even more flexibility.
Conclusion:
The current poor market performance since Q2 2022 seems to have brought VC funding back to its pre-pandemic figures. That's good because most believe their surge came from a global, public misrepresentation of the market.
In reality, SaaS Scale-ups have just as many funding opportunities as is reasonable. However, some of them could be less overtly impacted by bad overall market performance. If you have read carefully, you should be able to tell which one.
Review your preferred exits, and long, mid, and short-term goals. Make sure to study how well different approaches harmonise on a legal basis if you decide to mix and match. Plan ahead for the time your team and yourself will spend on paperwork, building your case for future investors