Fundraising for SaaS Startups
Table of Contents
This article is part of the series called Founders Guide which I’m writing currently to help early-stage founders tackle the problems they face during the first year of the startup.
Founders face an abundance of costs when it comes to starting their next venture. From office space rent and equipment to staff wages and legal fees, the costs begin to mount up. Some founders have coffee can money stashed away solely for the purpose of starting their SaaS businesses, while others may not.
Whether you are fortunate enough to be able to fund the first few stages of your business or are struggling off the bat, fundraising should be considered. What is the top tool you need to grow? It’s not the next big thing or a software program that’s never been seen before. It’s money!
This section of the Founder’s Guide isn’t intended to be an all-encompassing outline of every detail you need to know about fundraising, but it can shed light on the basics. This guide is based on factual data and my personal experience that comes from being at both ends of the spectrum, from consulting founders looking for startup funds to being an investor myself.
When should you fundraise?
Investors are more likely to pull out their checkbook when you have a well-organized and compelling business idea. Foregoing to think about key factors, including customer base and target market, puts you in a weak position to obtain funding. Your potential investors need to be able to visualize your product and the impact it will make.
Think about your story and why. Is it a rag to riches? Is the goal of your business to help an underdeveloped area or class? Knowing the exact principles and goals of your business allows you to easily share this vision with investors. Once you have your why and how figured out, it’s time to fundraise.
Sometimes a compelling story and outstanding reputation aren’t enough for that signature on the check. In these cases, bring cold, hard facts about potential growth and profitability. Web apps and software developments have made it increasingly easier to build strong deliverables in a short amount of time.
Figuring out both your why and how is key to making the most impact on investors. The goal is to impress them with your story and drive the deal home with your market and operational analysis. Odds are if you have the ability to raise money, you should. I’ve seen too many founders forego funding and regret it down the road.
How much should you raise?
The goal of fundraising is to provide you with money to become profitable so you won’t have to raise money again. If the money you obtain from fundraising makes your SaaS profitable, you will have added ease when it comes to raising money down the road, promoting business continuity if competition in the funding environment becomes stiff.
Keep in mind that fundraising often comes in rounds. This creates a goal of effective utilization of funds to reach the requirements for the next round, which usually occurs 1 – 1 ½ years later. Evaluating different factors helps you pinpoint your ideal funding number, including:
- Progress – Consider how much progress a certain dollar amount will lead to. How much equipment can you purchase with $500,000 versus $1,000,000? What is the profitability impact of doubling your equipment?
- Credibility – Has your business shown growth already? Have you successfully used funding in the past? Investors are more likely to give your desired capital if you have a strong record and your business is credible.
- Dilution – How much ownership percentage are you willing to give up? Ideally, you want to choose a funding number that only transfers 10% of the ownership of your company to investors; however, some investors will require 20%. Try to stay below 25%.
One strategy for uncovering your funding number is to decide how many months of operations the money should support. Let’s say you need 3 engineers, and the average salary is $10,000 a month. If you were looking to support operations for 6 months, you would need at least $180,000 to cover these salaries not taking into consideration other operating expenses.
Be sure you factor in other costs and run different scenarios to find the ideal funding amount. To sustain operations for 12-18 months, many founders seek between $500,000 and $1.5 million. First round funding options generally rank in at the lower end; however, increased interest from investors has begun to push this number up.
There are different fundraising methods to consider
To maximize your fundraising efforts, founders need to understand the basics, including the different options. Just because one method worked for a friend or colleague, doesn’t mean it’s the right avenue for your business.
Due to the complexity of most funding methods, I can’t properly explain each one in a simple paragraph. I can outline the basics, but consultations with an expert are where founders see real success because of the personalized approach and information tailored to their situation. I do offer consultations on funding, so be sure to book a time slot if this is something you believe you can benefit from.
Let’s cover the basics before we dive into different types of fundraising. Venture financing occurs in rounds, which are deemed Series A, B, C and so on. Each round comes with different funding levels and criteria before you move on to the next round. Series A is generally an equity round where you exchange a portion of ownership for capital.
In recent years, seed rounds began being structured as convertible debt or safes; however, some beginning rounds are still done with equity, but a majority have shifted away.
Getting Convertible Debt
Convertible debt funding is done through a loan from an investor using a convertible loan. There will be a principal and interest amount assessed. Interest ranges based on the risk the investor is willing to take on and the length of the loan. The underlying goal of the note is to convert into equity when the company switches to equity financing.
These notes usually come with a discount, cap, or target valuation. A cap is the maximum that the investor will pay for the note regardless of how much the company values at conversion. This helps investors secure a lower price per share compared to outside investors. Similarly, a discount gives investors access to a lower purchase price when the business moves on to the next round.
When convertible notes mature, the principal amount of the loan is due with assessed interest. You can apply for an extension of the maturity date, but it is at the discretion of your investor. As a result, plan ahead if you have an upcoming obligation by reserving cash.
In the past couple of years, the fundraising industry has experienced a shift from convertible debt to the safe at YC and Imagine K12. What exactly is a safe? Well, a safe carries some of the same principles as convertible debt, but without a defined interest rate and maturity date. Negotiating leverage for investors comes in the form of amount, any discount, and the cap. Safes do convert like convertible debt, making it essential to understand when and how this occurs.
An equity round of financing means generating a valuation for your business and a corresponding per-share price. The cap placed on safes and notes is generally considered the valuation price.
Equity fundraising is time-intensive and more complex compared to safes and convertible debt, which is why many founders are seeking alternative options. Additionally, legal assistance is suggested for equity fundraising, further racking up the costs to obtain funds.
Let’s go through a problem to visualize how a round of equity financing works. Let’s say you have a pre-fundraising valuation of $10,000,000 and you raise $2,000,000 with 20,000,000 shares outstanding.
- $10,000,000 / 20,000,000 = $0.50 per share
- This means you will sell 4,000,000 shares
- 20,000,000 + 4,000,000 = 24,000,000 shares are your new total
- $0.50 * 24,000,000 = $12,000,000 new valuation
- 4,000,000 / 24,000,000 = 16.67% new dilution
As you can see, this is different from the 20% original pre-money valuation per share. Equity fundraising rounds can include different components, such as liquidation preferences, protective provisions, and incentive plans. If this is the avenue of funding you are looking to go with, you will need to understand each component to avoid making costly mistakes.
SaaS businesses that don’t have tangible assets have a hard time uncovering the true value of their business. There’s no formula for calculating a valuation that will give you a precise answer. This is where being prepared comes in. Investors are more likely to value your company higher when you create perceived value. This could be by displaying the uniqueness or market demand for your business.
Nevertheless, it can be difficult for investors to uncover what your business is truly worth. Market research provides answers on potential valuations as you can compare your business size, setup, and complexity to other established businesses in the SaaS realm.
The ultimate goal of creating a valuation for your business is to find a value you are comfortable with, obtain funding sources, and grow your business. A higher valuation does not guarantee your business success.
Going to Investors
A popular fundraising method that I see amongst my clients and other businesses is from angel investors and venture capitalists. The primary difference between these two groups is that angel investors are amateurs while venture capitalists retain more experience. Think of angel investors as hobby investors with a majority of the sources being from family and friends. On the contrary, venture capitalists often make investing their primary job.
You can expect funds from venture capitalists to come with additional meetings, a longer time frame, and multiple individuals involved in the final decision. However, if you are looking for a quick capital infusion, angel investors might be the right avenue. Keep in mind that angel investors are less experienced and carry more emotions within the decision-making process.
As the angel investor and venture capital realm begin to grow, additional categories of investors appear, such as super-angels or micro-venture capitalists. These individuals target businesses in a specific industry or with certain components.
Founders’ needs will dictate which investor type works best for their business as angel investors are usually limited on the funds they have to offer. Moreover, founders need to find potential investors and build a relationship before being able to present their business idea and secure funds. Networking is a powerful tool. Use it.
Last, but not least, is crowdfunding. Crowdfunding sights are used not only to launch a product, but to also run campaigns and secure funding. Some founders utilize these sights to increase consumer demand while others find viable avenues of funding through these platforms.
Having a presence on crowdfunding sites gives you exposure to different investors, providing an alternative source of funds when traditional avenues are exhausted. Effective business differentiation is essential to make a lasting impact on crowdfunding sites.
Fundraising comes in steps
Despite what you may believe, fundraising isn’t as simple as applying for funds and receiving them. In fact, multiple other steps are needed before you are able to secure the funds your business needs. I’ve seen founders try to skip critical steps in the fundraising process, resulting in lower amounts received. Don’t let this be your case.
The first area you want to tackle as a founder looking for funding is to understand what documents you need to gather. Investors will ask for qualitative and quantitative information to help them make a decision. Some of the common pieces of information you will need include:
- Executive Summary – This includes the basic information about your business, so be sure the following items are present:
- Company logo
- The problem consumers are facing
- Who your customers are
- How your business solves the problem
- The market size available for your business
- Trends and financial insight on the market
- How your business will generate revenue
- Who is involved in the business
- How much you have already raised and the amount you are seeking now
- Presentation – You are presenting your company to investors, so be sure you slide deck is appealing and contains the necessary graphics and charts.
If an investor asks for more in-depth information, they are generally someone you want to avoid. Founders seeking capital are in the startup phase and many investors realize that and won’t bombard you for extensive due diligence and financials.
Meeting the investors
Once you are properly prepared, you will meet investors and run through your presentation. When meeting investors on an investor day, the goal isn’t for them to open their checkbooks that day, but rather set up a meeting to talk more in-depth about your business.
Not all investors will be interested in your business. This is why it’s important to set up multiple meetings with various investors to increase your likelihood of receiving funds. Remember that the hardest part of fundraising is often the first step. As a result, focus your time and efforts on investors who are likely to close.
When it comes to investor meetings, do your due diligence about who you are meeting with. Too often founders walk into meetings blind and it hurts their chances of receiving funds. Research your audience and optimize your pitch to only include the basics. After you have presented your company, listen to what the investors say. This can be great feedback to take into future meetings.
Storytelling can be one of the greatest tools to have on your side during investor pitches. Talk about who you are and why you believe in your business. Investors are more likely to write a check when they see compelling founders that are driven to make their business succeed. Moreover, don’t come off as arrogant, but try to find a happy medium between confidence and humility.
Closing the deal
Seed investments have the ability to close sooner; however, the rapidness of closing depends on the use of standard documents and terms the investors are familiar with. You may have to go through a negotiation phase depending on the cap or discount investors are looking for.
Investors that express their interest right away should be secured by using handshake protocol. If you miss out on a deal because you neglect this critical step, that’s on you.
Advice for proper fundraising
There’s no complete set of rules when it comes to fundraising. This means you will need to adapt to your situation and make changes along the way. However, there are top tips to keep in mind as you engage in the process.
Have a technical co-founder
This is a standard practice. Many startups lose momentum because they run out of money. Those that have a co-founder with a strong understanding of financial accounting and reporting reduce the risk of failure due to lack of funds. Theoretically, startups with unlimited money can last forever, making it essential to have a co-founder well versed in finances. Not to mention that investors look for a technical co-founder as well!
Look for warm intros
Warm intros help founders start a stronger relationship with venture capitalists or angel investors. Narrow down your list of individuals you want associated with your company, then make your first impression.
Creating an investor list can easily be done based on criteria you decide, such as previous investments, potential check size, or fund theme. Next, utilize social media platforms, like LinkedIn, to find common connections you can use for a warm intro.
When a warm intro isn’t on the table, turn to cold emails
Sometimes founders find that warm intros aren’t possible. In these situations, a cold email might be the next best course. Keep these emails short and sweet. You don’t want to lose investor interest or explain your entire business operations. The goal of these emails is to set up a meeting to get into the nitty gritty.
Hopefully, this section of the Founder’s Guide provides you with additional insight on fundraising for your SaaS business. If there was a one-size-fits-all approach, everyone would be applying for funding, but unfortunately, this is not the case.
Choosing the right fundraising method for your business is critical not only to retain favorable equity, but to also obtain the funds needed to grow. Whether you are a new founder or an experienced one tackling a new industry, working with a consultant is recommended to avoid making costly mistakes.