Funding options for your SaaS startup: The pros and cons of the most popular funding methods

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Funding your SaaS startup is something all of us are thinking about and it feels particularly difficult when you’re starting out with your first business. Once you’ve validated your idea you’ll need to have a funding path because without one you can’t realistically plan for the future and support the growth of your business.

Here’s a rundown of the most frequently used funding methods from my own experience. I’d like to thank the lovely James Gupta from Synap for his contribution to the section on crowdfunding. He’s recently run a very successful campaign on the popular crowdfunding platform, Crowdcube.

Self-funding

Most SaaS companies will have some element of self-funding whether that’s been validating your idea while you hold down another job or taking the leap and living off your hard earned savings while eating nothing but baked beans for a few months.

There are some folk who have enough cash to get their business a long way while retaining full ownership. That’s great, but there usually comes a point where external cash is required to fuel growth.

The good stuff

  • It gives you motivation, focus and a timescale to work within – nothing like the prospect of more baked beans to give you a push along.
  • You spend 100% of your time getting your business going – no need to be worrying about pitch decks for investors, setting up a crowdfunding campaign or taking bad deals just to get some cash in the bag.

The not-so-good

  • For most people, it simply isn’t sustainable – the initial motivation can turn into negative pressure if you’re not careful and this can cloud your judgement. The last thing you need to be doing in the early days is making poor decisions due to financial pressure.
  • It’s near impossible to hold down other jobs to fund your startup – I’m sure there are people who manage to sustain a full-time job on the side (super heroes?) but a mistake I’ve made before is not giving a business my full attention. Once you’re past validating your business idea and you’re ready to go, make that commitment and focus completely.
  • You’re going to need solid financial and moral support from your partner if you have one. Make sure they know why you are doing this. If they stop supporting you, that’s a whole new way for your startup to fail.

Self-funding is great while you validate your idea and get going, but I wouldn’t recommend it for the long term unless you have a ton of your own cash that you’re prepared to spend (and maybe never see again…)

Crowdfunding

Coin

Crowdfunding can be a great financing option for many companies. There are two main types: reward-based crowdfunding, where people pledge money to receive rewards such as special edition or pre-orders of your product, and equity-based crowdfunding where people invest and receive shares in your company. For a SaaS company, equity-based crowdfunding is usually the way so you should check out Crowdcube, Seedrs and Syndicate Room.

The good stuff

  • Exposing your idea to ‘the crowd’ can be a great way to validate further, start gaining traction and making new contacts who can help you in the future.
  • As the equity you give away will be shared by a number of different investors, you avoid the potential pitfalls of giving a large amount of equity away to one party, who will then have a significant controlling stake in your business.

The not-so-good

  • Contrary to popular belief, crowdfunding is not an easy way to get funding. Whilst the campaign itself will last around 1 month, plan for a 6 month process overall involving preparing your pitch deck, business plan and financials, generating pre-launch traction and campaign marketing.
  • Around 50% of all pitches fail to meet their target which, at least on equity crowdfunding sites, means they do not receive any funding at all!

Whilst all the major crowdfunding platforms have a stream of ‘regular’ investors who come to look through pitches frequently and do sometimes make sizeable investments, it is the quality of your own network and outreach efforts that will determine whether you meet your target or not. Make sure you prepare at least 30% of your investment target before you launch, and once you’ve launched don’t expect people to just come to your pitch and invest; you’ll need to drive them in through social media, emails and face-to-face networking.

From revenue

Image Credit: Franco Folini

There are some businesses that simply work. I know a few people who have been in the position where they start making cash almost immediately giving them funds to fuel early growth and keep the founders’ pockets lined.

The good stuff

  • You’ve got revenue early – after validation, people actually paying hard cash for your SaaS product is pretty awesome.
  • Your focus is on the business – as with self-funding, cash in the bank allows you to dedicate the precious early days to growing the company, rather than worrying about raising funds.

The not-so-good

  • You might not be fuelling your growth properly – don’t fall into the trap of getting by with what you’ve got. When you have early revenue and the beginnings of a sales process that works, you’ll want to boost and strengthen that, not hold it back because you don’t have the funds to accelerate the business.
  • It’s unpredictable – I’m sure a lot of you have read Predictable Revenue (if not, please do) and that gives you something to aspire to. We’d all love predictable revenue, and in SaaS you can get pretty damn close, but not when you’re starting out. Yes, you might have closed a few of those precious annual contracts, but while you’re getting going, nothing is certain.

As with self-funding, when you have cash to keep you going it’s a great position to be in, but it’s not always the best long-term plan. Additional funds from smart investors or VCs can open a lot of doors and add a ton of value as you’ll suddenly gain access to experience, support and new connections.

Convertible loans

Many VC funds will offer early stage businesses a convertible loan note which is very different to a straight equity deal where investors simply buy a share in your company. Loan notes are different because they are like any commercial loan agreement but also include terms in which that loan can be converted to equity. Notion Capital have an excellent write up on the pros and cons parts of which are included below:

The good stuff

  • They are very flexible –  “Investors usually have the freedom to choose between repayment or conversion and, if they choose conversion, they get the benefit of a healthy discount to the share price on the next equity round.”
  • A good option before a company’s first equity raise – “negotiations around the valuation of the business can be postponed until the full equity funding round or until an important commercial milestone has been achieved. This means a company can avoid unnecessary dilution by giving away too much of its equity too early.”

The not-so-good

  • UK tax relief schemes don’t apply – “This is a complicated area, but investors can only get UK-based EIS / SEIS when they invest their money for equity.  Loans do not qualify, even if / when they convert into equity.  This point is often missed by individual investors looking for EIS or SEIS relief.”
  • They can put other investors off at later funding stages – “…the new investor might not like the discount existing investors are due to receive on conversion.”

Another thing to consider here is what happens if you only raise that single round of finance from the debt financing and go on to build a viable business. The “investors” (think “creditors”) may be able to call that loan in on strict, non-negotiable terms, shutting down the “lifestyle” business you’ve sweated blood to build. Having that risk hanging over the business can demoralise founders and scare off future investors.

Equity deals

An equity investment is one in which someone buys shares in your business – an exchange of cash for an agreed number of shares based on the valuation of your business.

The good stuff

  • It’s an opportunity to bring on smart investors – get people on board that you can work with in the long term. You’ll be amazed at the amount of experience, expertise and connections the right investors can bring with them.
  • Great tax relief schemes – for early stage businesses, there are some fantastic tax relief schemes available which will help you attract top-quality investors.

The not-so-good

  • It’s a very time-consuming process – if you decide an investment is right for your company, make sure you have the time and resources to invest into the process. A “quick” investment can be many months long and I’ve seen seed rounds go on for at least 18 months.
  • You are giving away part of your business – I’ve listed this as many people see this as the biggest downside. Yes, you are giving up shares in your company but as long as the valuation is good and you’re giving a sensible amount away at each fundraise, investment gives you so much back in return.

The best thing about investment (other than a cash injection) is the opportunity it presents to strengthen your team. You have to go about it the right way though. Always seek to maximise the value you are getting from your investors. Choose investors who genuinely care. People with experience in your industry. Bring in folk that can truly add something. Afterall, investors are simply an extension of your core team and you wouldn’t choose to employ someone who does nothing for you.

Final thoughts

While I’ve focussed on your first round of funding, thinking about your cashflow never goes away. Beyond an initial cash injection (regardless of the form it takes), it’s your job as a Founder to always be thinking about the funding you need to support your company…what’s next, what’s best for your business and what options are available? Everyone’s situation is different so all you can do is be aware of the options and choose what works best for you.

Would love to hear other people’s funding stories. What’s worked for you? What hasn’t? Anything you would have done differently if you could start again?

Further reading

 

By Hannah Chaplin, co-founder of Receptive. (contribution on crowdfunding by James Gupta)

James Gupta contributed the section on crowdfunding. He is Founder of Synap, an online learning platform that uses neuroscience to enhance learning. He recently closed a seed round on the popular funding platform Crowdcube.

James Gupta

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