12 Key Issues for SaaS Startups Seeking Financing

By Mitch Zuklie and Richard D. Harroch

SaaS (Software as a Service) companies, are attracting some of the top talent and funding in technology today. The most notable SaaS companies occupied seven of the top 10 verticals by venture capital deal activity recently, and three of the top 10 by investments. Venture investment is running ahead of last year’s pace, which was more than double the volume of each of the prior three years.

SaaS is being applied to solve all kinds of problems, such as monitoring and security, business intelligence analytics, accounting and finance, healthcare, HR and workforce management, customer relationships, and advertising, sales and marketing. Altogether, revenue for SaaS companies is predicted to grow 17%, generating an $85 billion market.

From an investor perspective, there is a lot that is attractive: scalability, ease of approach, recurring revenue streams, and high gross margins.

So, what does it take to stand out from the pack and get your SaaS company financed? The following is a checklist to help you succeed in raising venture capital, seed, or angel financing.

1. A Great Investor Pitch Deck Is Essential

Raising capital from investors is difficult and time consuming. Therefore, it’s crucial that a SaaS startup absolutely nails its investor pitch deck and articulates a compelling and interesting story.

Here are some pitch deck tips:

Tell your story in 15 to 20 slides. (If you can’t tell the story with brevity, you can’t tell it well.)
Explain why the market opportunity is large–and where you fit in.
Describe the talent on your team. Many investors are skeptical of single-founder startups. While there are notable exceptions, they are rare. Startups are a team sport. SaaS is no different in this regard.
Where possible, tell your story visually.
Don’t provide excessive financial details. Hit the key indicators and save the rest for follow-up.
Don’t try to cover everything in the pitch deck. Your in-person presentation will give you an opportunity to add and highlight key information.
Use plain English–jargon or acronyms distract from your story.
Don’t underestimate or belittle the competition.
Make sure your information and metrics are up to date.
“Look and feel” matters. Think of it as your investor interface, and consider getting professional graphics help.
Review other pitch decks for ideas on presentation.
Be sure to include the following wording at the bottom left of the pitch deck cover page: “Confidential and Proprietary. Copyright (c) by [Name of Company]. All Rights Reserved.” This helps protect your intellectual property.
Send the pitch deck in a PDF format to prospective investors in advance of a meeting. Relying on Google Drive, Dropbox, or some other online service just puts up a barrier to the investor actually reading it.

For additional guidance, as well as templates, see How to Create a Great Investor Pitch Deck for Startups Seeking Financing.

2. Can You Get Angel Investors for Your SaaS Startup?

Angel investors invest in early stage or startup companies in exchange for an equity ownership interest. The typical angel investment is $25,000 to $200,000 but can go much higher.

Angel investors particularly care about the quality of the management team and how big the market opportunity is.
Angel investors want to understand the big problem you are attempting to solve. They like to see a clearly articulated elevator pitch for the business, an executive summary or slide pitch deck, a beta version of the SaaS offering, evidence of early traction, and support as to why there will be a large demand for the service.
Angel investors run the gamut from friends and family to professional angel investors.
You can find angel investors through attorneys, other entrepreneurs, angel investor networks (such as AngelList), venture capitalists, investment bankers, and crowdfunding sites like Kickstarter and Indiegogo.
Don’t bother asking angel investors to sign a non-disclosure agreement—most won’t do it, and it will only slow down the process.

There are a number of good articles on the subject of angel investing, including:

Angel Investing: 20 Things Entrepreneurs Should Know
50 Questions Angel Investors Will Ask Entrepreneurs
The 10 Commandments for Obtaining Angel Funding for Your Start-Up

3. Venture Financing for SaaS Startups

After a round of angel financing, SaaS startups often seek the financing and support of a venture capital firm. VC firms provide capital; strategic assistance; introductions to potential customers, partners, and employees; and much more. In exchange, venture investors will typically obtain a preferred equity position in the company, seats on the Board of Directors, veto rights, anti-dilution rights, and a say in how the business is to be run.

Here are some key things to know about venture capital financing:

Venture capitalists typically focus their investment efforts on specific industry sectors, on stages of a company’s life (early stage seed or Series A rounds, or later stage companies that have achieved meaningful revenues), and geography (e.g., Bay Area, Southern California, New York, Boston, or Santa Monica). Know the firm’s focus before you approach it.
Valuation of the company will likely be one of the main issues and it is negotiable; there is not one “correct” valuation methodology or formula to rely upon.
A venture capitalist who is interested will submit a non-binding “term sheet,” which will set out the key terms of the proposed investment. Experienced corporate counsel should be engaged to help navigate and negotiate on the issues.
The amount of control and Board seats will be important for both the entrepreneurs and the venture capitalists.
The venture investors will insist on anti-dilution protection and the right to participate in future rounds of financing.
Venture investors will perform extensive due diligence before consummating the investment (a venture financing process could take 30 to 90 days to close).
The venture investors will want to make sure the founders have incentives to stay and grow the company and will likely request that the founders’ shares become subject to vesting based on continued employment (and then become “earned”).
After a financing is completed, venture investors will often hold a minority interest in the company. However, they will typically insist on “protective provisions” (veto rights) on certain actions by the company that could adversely affect their investment or their projected return.

There are a number of comprehensive articles on the venture capital financing process, including:

A Guide to Venture Capital Financings for Startups
65 Questions Venture Capitalists Will Ask Startups
28 Mistakes Entrepreneurs Make When Pitching to Investors

4. Show That the Market Opportunity Is Substantial

Investors want to invest in big opportunities with large addressable markets. Make sure you are able to:

Define the initial market you are in and its dollar value.
Show that your company will be positioned to capture a large part of the total addressable market.
Consider other markets that your company’s services can address beyond your initial market.
Consider markets your service can “unlock” for strategic partners in other industries.

Phil Dur, the co-founder of PeakSpan Capital, a venture capital firm investing in SaaS companies, states:

“One of the more significant determinants of company value obviously is market opportunity. If you are performing well, and in a rationale competitive dynamic in a market that ‘matters’ to a lot of customers, you’re likely to see this reflected back in the valuation ascribed to your business. Don’t hide the ball! Be forceful and clear about the attractiveness of the market opportunity you are pursuing.”

5. SaaS Business Model Issues

Investors are particularly sensitive to a number of key business model issues inherent in SaaS companies, including:

With so many SaaS offerings out there, how can you get noticed and be differentiated?
How long is the sales cycle?
How easy is the onboarding process for new customers?
Can the company find a scalable way to acquire users?
How can churn be mitigated?
Can the long-term value of the customer be increased over time, while decreasing the cost of acquisition of a customer?
Is the service user-friendly enough?
What level of customer support is necessary to ensure customers are satisfied?
What ongoing product improvement costs will the company face?
Can the company manage a significant growth in users from a technical standpoint with acceptable financial consequences?

Is the subscription management/fees process easy and efficient? (Some companies build their own subscription management solution; others use a third-party platform such as Apptus.)

6. Intellectual Property and Technology Issues for SaaS Companies

SaaS investors are particularly interested in a company’s software, technology, and underlying intellectual property. The questions the investors will pursue include:

How differentiated is the company’s software?
What competitive advantages will there be over existing SaaS offerings?
How easy will it be to replicate the company’s offering?
How costly will it be to fully build out, maintain, and enhance the offering?
What key IP does the company have (patents, patents pending, copyrights, trade secrets, trademarks, domain names)?
How was the company’s IP developed?
What comfort is there that the company’s IP does not violate the rights of a third party?
Is the IP properly owned by the company, and have all employees and consultants assigned the intellectual property over to the company?
Would any prior employers of a team member have a potential claim to the company’s IP?
If the IP was developed at a university or through government grants or with open source technology, does the company have the right to use the technology?

See 10 Intellectual Property Strategies for Technology Startups.

7. Make Sure You Understand the SaaS Competitive Landscape

The company’s competitors will always be an issue for investors, as some investors believe the SaaS marketplace is oversaturated in some subsectors. You will need to be prepared to answer the following questions:

Who are your company’s chief competitors?
What gives your company a competitive advantage?
What are the key differentiating features of your offering?

You must show a thorough understanding of the current competitive landscape and be prepared to answer questions about your competitors. If you don’t fully understand your key competitors, the investor may conclude that you really don’t understand the market. Your competitors will often be large, well-capitalized companies, so expect the inevitable question about how you can reasonably compete with bigger players.

8. What Traction Have You Obtained?

A company that has obtained early traction will be more likely to obtain investor financing and with better terms. Here’s how you can demonstrate it:

The creation of a beta or minimally viable offering
Initial or pilot customers
Strategic partnerships
Customer testimonials
Admission into competitive programs such as Y Combinator or other technology accelerators or incubators
Early press or social media buzz

An investor will probe into what has driven these successes and how they can be accelerated and scaled.

Andy Thompson, CEO of the San Francisco SaaS company Safehub, which monitors the structural integrity of buildings and gives real-time alerts to building owners, states:

“We found it extremely important in our presentation to investors that we were able to show them a working demonstration of our SaaS dashboard, and that we were able to show initial customer pilots. Plus, we were admitted to the accelerator program at Bolt in San Francisco. This allowed us to raise a significant first round of financing.”

9. The Key Financial Metrics for SaaS Companies

Here are the important financial metrics for SaaS companies:

Monthly Recurring Revenue (MRR)—For SaaS companies primarily with monthly subscription contracts, show MRR. It has the following three components:

New customers added in the month
Existing customers that have terminated their subscription
Increased revenues from existing customers who have expanded their subscription

Annual Recurring Revenue (ARR)—If you offer yearly or multi-year subscriptions, the primary focus is on ARR.

Annual Contract Value (ACV)—Annual Contract Value is the average annualized revenue per customer contract. For example, if the company had one customer under a three-year contract for a total of $30,000, the ACV would be $10,000. This is the average across all customers.

Lifetime Value of a Customer—What is the lifetime value of a customer? Obviously in the early days of a startup this will be hard to quantify. But it is important to project the potential lifetime value of a customer to assess marketing costs and customer profitability.

Gross Margins—Gross margin is the company’s net sales revenue minus its cost of goods sold. This represents the amount of sales revenue left over after the company has incurred the direct costs of producing the SaaS product.

Cash and Cash Flow Burn—SaaS companies often face significant losses in the early years, resulting in an associated cash flow problem. And the faster the growth, the greater the cash flow problem. So, SaaS companies have to carefully consider their burn rate and capital requirements. Entrepreneurs must continually monitor their cash position and changes in cash position.

EBITDA—Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is often used to measure a company’s operating performance, without factoring interest costs, taxes, or accounting adjustments.

Customer Churn—The churn rate is the rate at which the company is losing customers. A high churn rate can show that customers are not satisfied with the product or not finding enough value for the cost.

Customer Funnel Metrics—How many raw leads or inquiries for the product is the company getting a month? How many of those are converting to paying customers? What lead sources are the most profitable? How does the company increase leads?

Customer Acquisition Cost—What is the average cost to acquire a customer? Be careful not to underestimate these costs.

Ideally, you will develop an online dashboard that allows you to easily monitor and report these key metrics.

And make sure you are learning from these metrics—and learning fast. Boards and founders often are very slow to react to slowing sales traction, taking a few sales cycles to diagnose a problem, and then more time to find a solution. The problem is typically the product, the sales team, or marketing. It’s best to figure out the solution very quickly.

Dean Stephens, the CEO of San Francisco-based SaaS health company Talix, Inc., states:

“SaaS financial and operating metrics provide powerful insight into product and company performance. Without such knowledge, leadership teams are blind. With it, we can make timely changes in sales, marketing, product, and other investments. And this metrics tracking should not be an expensive overhead cost to maintain. Today’s off-the-shelf reporting tools should link accounting, budgeting, contracts, sales and marketing activities, and customer success into a lean, smart reporting infrastructure.”

10. Are the Company’s Financial Projections Realistic and Interesting?

If a SaaS company presents investors with projections showing the company will achieve $3 million in ARR or revenues in five years, they will have little interest. Investors want to invest in a company that can grow significantly and become an exciting business. Alternatively, if you show projections in which the company predicts to be at $500 million in three years, the investors will just think you are unrealistic, especially if you are at minimal revenues today. Avoid assumptions in your projections that will be difficult to justify, such as how you will get to a 400% growth in revenue with only a 20% growth in operating and marketing costs.

In order to believe your financial projections, investors will want you to articulate the key assumptions you have and convince them those assumptions are reasonable. If you can’t do that, then the investors won’t feel you have a real handle on the business. Expect that investors will push back on the assumptions and that they will want you to have a cogent, thoughtful response.

11. The SaaS Customer Agreement

Investors will want to see your customer agreement. It should include:

A limited non-exclusive right for the customer to use the service in compliance with the terms of the agreement
The term of the license (month-to-month or year-to-year is the typical term)
Pricing for the service
How the contract gets renewed (such as by auto renew)
Termination rights by the subscriber and the company
Intellectual property rights ownership retention by the company
Limited representations and warranties by the company, and disclaimer of any other representations and warranties
Service levels
Maintenance and support obligations
Limitations and exclusions of liability
Data security and privacy provisions
Limited indemnification protection
Dispute resolution procedure (such as by arbitration and excluding the right to bring class actions)
Force majeure clause

This is an area where a tech transactional lawyer can provide real value—and help you sleep at night.

12. Legal Issues for SaaS Startups

Finally, investors will look at several more questions to ensure your house is in order from a legal perspective:

Has the company been properly organized? (Most investors prefer investing in corporations, not LLCs.)
Is the company paying attention to data privacy and cybersecurity issues? Is it in compliance with GDPR and other applicable federal and state laws? Is it CCPA ready? If it’s healthcare-focused, is it HIPAA compliant?
Has the company complied with applicable securities laws when issuing stock or options in the company?
Has the deal with co-founders been made clear, especially if one founder were to depart the company?
Is the company in compliance with employment laws? Does it have appropriate policies in place, such as those prohibiting sexual harassment? Has it obtained all appropriate employment documents from employees?
Are all employees and contractors required to sign Confidentiality and Invention Assignment Agreements?
Is the company taking appropriate steps to legally protect its intellectual property?
Are key tax considerations taken into account?
Does the name of the company or its service pose any trademark issues, domain name problems or other issues?
Should the company implement an employee equity plan to incentivize employees?

For relevant articles, see:

10 Big Legal Mistakes Made by Start-Ups
How Employee Stock Options Work in Startup Companies
Key Issues with Confidentiality and Invention Assignment Agreements With Consultants
12 Tips for Naming Your Startup Business

Conclusion

SaaS startups have enormous potential, and the sector has attracted significant interest from investors. It’s important for SaaS entrepreneurs to learn from others in the industry. A great place to start is SaaStr Annual, a yearly industry event hosted by SaaStr, the world’s largest community of SaaS executives, founders, and entrepreneurs. The Bay Area conference attracts over 12,000 visionaries and technologists; the European version has over 2,500 attendees. The conference is enormously popular and SaaStr founder Jason Lemkin is a highly ranked source on Quora.

About the Authors

Mitch Zuklie serves as Chairman and Chief Executive Officer of Orrick, Herrington & Sutcliffe, an international law firm. Under Mitch’s leadership, the firm has pursued a strategy to be a leading advisor to the global Technology & Innovation, Energy & Infrastructure, and Finance sectors. Mitch is an experienced business and legal advisor who has completed hundreds of venture capital financings and numerous public offerings, mergers, acquisitions, and licensing transactions. He counsels technology companies at all stages of their life cycles, as well as their founders, advisors, and investors.

He serves on the Board of the Berkeley Center for Law and Business and the Advisory Boards of the Stanford Law School Center on the Legal Profession and the Harvard Law School Center on the Legal Profession. He is also a member of the Board of the Wild Salmon Center.

Mitch posts regularly on social media about Orrick, venture capital, innovation and other interests. Follow him on Twitter and Instagram.

Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a large venture capital fund in the San Francisco area. His focus is on Internet, digital media, and software companies, and he was the founder of several Internet companies. His articles have appeared online in Forbes, Fortune, MSN, Yahoo, FoxBusiness, and AllBusiness.com. Richard is the author of several books on startups and entrepreneurship as well as the co-author of Poker for Dummies and a Wall Street Journal-bestselling book on small business. He is the co-author of the recently published 1,500-page book by Bloomberg, Mergers and Acquisitions of Privately Held Companies: Analysis, Forms and Agreements. He was also a corporate and M&A partner at the law firm of Orrick, Herrington & Sutcliffe, with experience in startups, mergers and acquisitions, and venture capital. He has been involved in over 200 M&A transactions and 250 startup financings. He can be reached through LinkedIn.

The post 12 Key Issues for SaaS Startups Seeking Financing appeared first on AllBusiness.com

The post 12 Key Issues for SaaS Startups Seeking Financing appeared first on AllBusiness.com. Click for more information about Richard Harroch.

To discover more visit: allbusiness.com