2023 is a doozy of a year for SaaS founders looking to capitalize their business.
Venture Capitalist’s (VC’s) are still sitting on a war chest of capital raised in 2021, but it isn’t being deployed as freely as it once was. To complicate matters, VCs are now more often saying they want to invest in capital efficient companies, with a path to profitability! What happened to investing in growth to gain critical market share and build unicorns, is that strategy now dead?
As a founder, it can be tricky to decide on the best path forward – do you pull back on growth and focus on getting unit profitability and churn looking better, or is growth still the north star to follow?
If chasing VC capital, the answer is both – the reality of VC’s saying they want strong unit economics and strong growth is also their way of saying they are limiting investments to only the very best SaaS companies with incredible product market fit. Otherwise they will hold onto their money and wait to see how this all shakes out.
When we talk about VC style growth, we are really talking about something north of a 10% compound monthly growth rate or 3x year-on-year growth. Being in the range of 2x-3x year-on-year growth would put you in the ballpark of what a VC is looking for, and at the lower end of that range, they would typically be looking to see strong unit economics. But you don’t need to grow at 200% per year to be a great business, and in some ways, slower growth can lead to better companies (we’ll look at that more in a second).
Once you take VC capital, in most cases you have implicitly agreed to an “all or nothing” approach – get a 10-100x outcome or blow up the company trying. Your financial model will have presented a plan for this, and now your role is to deliver to that plan.
So, if the 100x outcome isn’t what you want, or you want optionality, then bootstrapping and finding a way to profitability might be a better path. And, if you choose to bootstrap, the sacrifice is likely growth.
But there is more that goes into this decision as a founder than just growth rates and valuations.
Should You Bootstrap and Seek Profitability or Seek Growth with External Funding?
Start by asking yourself what kind of business you want to build? The economics of SaaS, where customer acquisition is paid back over time through recurring revenues, means that the more customers you acquire, the faster you burn cash – and to grow fast, you need capital.
Let’s say you take $8 million in venture capital on a $40 million post money valuation and give preferred shares with a 1.5x liquidity preference. You use this capital to grow your team, but things don’t go as well as planned. Now you are looking for an exit and are potentially laying off team members. Let’s say you end up selling your company for $12 million, which on the surface, is not a bad exit in the grand scheme of things. But with those liquidation preferences, as founder and owner of 80% of the share capital of the company, you will walk away with nothing, as it all goes towards paying out the preferred shares.
If you had bootstrapped, didn’t overgrow your team, didn’t give up liquidity preferences, and diligently grew your business, taking say an extra 2 years to reach profitability and an exit half the size – so a $6 million exit – would leave you with six million dollars in your pocket as the founder.
Bootstrapping With a Path to Profitability:
Reasons why slower growth and bootstrapping seeking profitability make sense:
· Primarily, you retain control over your startup. You get to decide what to do, how to do it, and when to do it.
· The other benefit of bootstrapping, at least up to say $5m ARR, is that you get to fix product market fit issues while small, rather than throwing money at a problem when all it does is mask the real issue. A classic example is when hiring more salespeople to sell a product that doesn’t have great product market fit – that is a sure way to burn through a lot of money fast!
· Scarcity can often lead to better products than abundant capital, and running lean with a profit focus can drive efficient resource allocation, fostering careful decision making based on small experiments.
· You minimize dilution when the company is not worth as much.
· Once profitable, the SaaS business can reinvest funds into research and development, enhancing product innovation and maintaining a competitive edge.
Drawbacks of choosing slower growth and bootstrapping:
· Without external funding, for most B2B SaaS companies the growth would be significantly slower compared to venture-backed companies.
· Having to do a lot more with very little capital might lead founders to adopt a cost-cutting mindset, which focuses more on cost reduction that can include not investing in first class talent, less research and development and product innovation, or too few dollars earmarked for scaling the sales and marketing teams.
· If profitability becomes the primary goal, competitors who prioritize significant R&D investments will outpace the business and ultimately offer more compelling products or services, faster.
· Without a cushion of external funding, bootstrapped companies have less room for error and companies may not even find product market fit. It can also lead to a short-term focus, rather than making better long-term decisions.
· Founders will have to wear many different hats without having the expertise needed, which can be very costly in the end.
Growth With External Funding:
Benefits of growth from external funding:
· One of the main benefits for founders is that with more significant resources, founders can surround themselves with the expertise needed. Companies can attract great talent.
· External funding injects necessary capital to fund marketing or create a sales-led growth engine allowing startups to expand rapidly, seize market opportunities and gain a competitive edge.
· Strategic investors often bring valuable industry experience, networks, and resources to the table, guiding start-ups into growth mode acceleration.
· At the same time companies can focus on continuous product enhancements and innovation.
· By prioritizing aggressive expansion and scaling operations, businesses can quickly gain market share and increase brand recognition. A larger customer base often translates to more revenue in the long run. Additionally, high growth positions the company for potential acquisition opportunities, partnerships, and substantial valuations.
Common pitfalls of growth from external funding:
· Raising external capital means giving up a good portion of ownership which can lead to loss of control to investors. A typical VC round will look to own 15-20% of the company.
· Raising funds through multiple rounds of financing dilutes the founder’s equity stake, potentially reducing their ultimate financial rewards upon exit.
· You can enter a never-ending fundraising cycle, forever asking “when should I raise my next round, and how much?” This takes the focus away from running the business and creating real value.
When Should a Founder Choose One Path Over the Other?
There is no one-size-fits-all answer to this question. The key thing to consider is the type of business you want to build, the speed with which you want to build it, and what you are prepared to give up get there.