Equity Financing for SaaS firms

Yash Shah (00:01)

set and I think we are live. Let us hope that we are. This time let us assume that we are live and let us just directly get started and see what happens. Yeah, so perfect, perfect. So let us assume that we are live and fingers crossed.

technology has never let us down and so hopefully it will not let us down today as well. You got a notification, perfect. So, great yeah, perfect. Then we should get started. hello and welcome to Momentum Office Hours. My name is Yash and I joined by my co -founders Harsh, Jay and Aashish. We will discuss topic of the week.

equity financing for SaaS products. Our goal is to provide you with actionable insights and practical strategies that you can apply to your own SaaS products. Throughout the session, we encourage you to engage with us by asking questions and sharing your thoughts. This is a fantastic opportunity to learn from each other and gain new insights that can help drive your SaaS initiatives forward. So let's get started. Jai, Harsh, Kaushik, how are we doing today? Good.

Perfect. It seems like every life that we are doing, the energy goes down a little. It feels a little like that. But also, have a good time to join and talk about equity financing for SaaS companies. So what are your early thoughts? I am sure we are going to have more views today somewhere in field. So yeah, would like to just get started with a very basic question on

When and why would someone just, when a sales founder should think about equity finance?

So the first, like I'd go to one level before that and I would say that the first thing that a SaaS founder should try and do is figure out whatever product that they are building, is it venture fundable or not? So, and there's nothing wrong with businesses that are not venture fundable. They are more often than not very, very successful as well. However, the first thing that you want to try and figure out is,

a venture investor or a VC fund is only interested in funding a SaaS company, if the market is big enough and if the product can reach to a point where it becomes a 50 million, 100 million sort of a run rate company. So VC funds and private equity typically end up seeing returns only if the company goes really, really big and for that to happen the market

has to be that big, the problem has to be that important and urgent and frequent for that it is solving. And so, as a SaaS founder, the first thing that you want to decide is whether this product is venture fundable or not. If it is not, then you want to figure out a way to bootstrap it. So then you want to figure out where you can raise some small amount of capital from friends and family or some angel investors and stuff like that. And you have the ability to build a really, really profitable

SaaS company, but then over there, the returns come in the form of the dividend that are being paid out from the profits rather than the value of the equity growing. Having said that, if you now know that, okay, this my company is venture fundable, arguably, I would say that you should start thinking about fundraising right away. You may not be ready, but you should start thinking about it right away. You should start building the relationships.

with prospects and with prospective investors start going to events, you should start asking for advice, should that start doing all of those exercises, I would say right away and then figure out when is the right time to raise from what type of investors. So, how much capital do you need to raise? How much, till what stage can you yourself support the SaaS company and the growth of the SaaS company and then sort of ask for money.

So, asking for money and thinking about equity financing, I would say that if your venture fundable should start thinking about equity financing right away, start networking with investors, meeting with them and then having this as a conversation as well. So, let us suggest, let us think any SaaS company looking for the equity financing, right. So, what are the, we can say there are some keywords such as valuation, dilution, right.

So, there are what are some we can say the keywords that have to understand before we have to start on the equity side. So, couple of things. So, one I wouldn't say that those are keywords. Yeah, not keywords. That's a very SEO sort of way of thinking about it. But these are key terminologies, right? Terminologies, yeah. That you want to understand. So, the first thing that you want to understand is dilution.

So which basically refers to what percentage of the company is going to be diluted and owned by the investor who's coming in. Valuation is sort of a calculated function of dilution. So if I'm the investor who's putting in, let's say, $1 million for 10%, then the company gets diluted by 10%. And by the function of me investing $1 million for 10%, the company is now valued at $10 million.

So whole company is 10 million dollars. So valuation is something that you want to know and understand. The other thing that you want to understand is your vesting schedule. So one of the things that typically ends up happening as soon as an investor steps in is that the founders start getting paid in cash as well as equity, which means that at the time of founding, let's say there are two founders and we started at 50 -50.

I have 50 % of my equity with me and then I get paid in some salary, whatever it is that the company is paying me. However, as soon as the investment happens, the percentage equity that I own, so let say it is 45, 45, 10, 10 is for the investor, 45, 45 for the two founders, my 45 % will be vested to me over a period of next two years or three years or four years, right? Depending on how long do I stay with the company, so that way if one of the founders leaves the

The company is not sort of left without a large chunk of equity going away with that particular problem. So, I want to understand what is cliff and what is wasting. The other thing that I want to understand is what are certain affirmative rights. So, affirmative rights are rights that an investor or a person who is putting in the money, they will have in the company decision making process. So, there are certain decisions.

that will need to have an affirmation from the investor. And so, more often than not, at seed stage, these are not big questions or concerns, but at later stages, affirmative rights as an example could be, you know, for going public, getting listed on any public market, you need to have an affirmative vote of yes from the investors. Another example is for opening up an office or operations in a new geography, not sales, but operations in a new geography where you are recruiting people.

like that, you may need to have an affirmative right from the investor. So it depends on the negotiation that you've done with the investor. The other thing that as a founder you should understand is what are the exit clauses. you know, because we don't have a lot of time, so I just mentioned those things and then you can search yourself. But you want to look at drag along clauses, tag along clauses, you want to look at what are the liquidation preferences.

and what are the modes of exit that an investor is expecting from the organization and what is the time frame. So these three four other things that you should also want to look at. But these are very, primarily very early stage sort of a look at key terminologies that a founder should know when they raising capital. So Yash, so let's say I am, when I have a product, when I have a SaaS product and when I am looking for equity financing.

So what key metrics do investors look out for that's to SaaS products? And also, how do they come to a conclusion based on these key metrics? think that's something someone who is looking forward would probably want to know. Sure. So the seven, eight SaaS metrics that you should also measure

to figure out health of your SaaS business are also the metrics that an investor looks at. And then there are a couple others that I talk about in a little bit. So the key metrics that they look at is your customer acquisition cost, your lifetime value, your MRR, your ARR, your growth rate, your churn rate, your net revenue retention, your net promoter support, which are the general metrics that you should measure yourself as well that an investor also looks at. A couple of other metrics that you might not be measuring, but an investor wants to

measure and will also look at is they'll want to look at what is the ability of your SaaS company to land and then expand. So as an example, a lot of SaaS companies will have the ability to be adopted by a very small part of the organization by the customer, a very small part of the customer, and then they will expand within that organization.

So basically you've spent as an example, a thousand dollars to acquire a customer who's paying you $300 a month. However, over the next one year, that $300 a month eventually ends up turning into like $2 ,000 a month because your product went in, was loved by a small group of people and then it expanded. So that's one thing that an investor likes to see. What's the ability for your product to land and expand? The other thing that they would also want to see is what are your turnaround times of

So, from the first contact made to closure, how long are your deal cycles and how involved do people have to be from your organization, how complicated is the decision making process on their side and does the value of the deal make economic sense for the deal cycle or for the turnaround time of a particular closure, does the value of the deal make sense, are you spending three months to close a $10 ,000 a year contract.

or are you spending like one month to close $100 ,000 a year contract? And so that's another metric an investor would like to see. The third thing that they would like to also see is how scalable are your customer acquisition costs? sorry, customer acquisition challenges. So as an example, one of the mistakes that we make assuming that Google Ads is infinitely scalable, but that's not true.

If I'm building a category creator, so if I'm building a SaaS that is a new category, there is no search volume for that category, which means that even if I want to invest a million dollars into Google Ads over the next two quarters, I will not be able to because people are just not searching for it. So whatever acquisition channels that I have, how scalable are they? Am I acquiring customers through doing webinars much like this? Then they are not scalable.

but or am I acquiring my customers through SEO because in those cases they are skilled. So these two three things as a typical SaaS business we may not measure, however an investor will look at these things as well.

Right. So there was a question little beyond in the journey. before starting the journey of equity financing at times, happens is founders are little concerned about losing their control over their company in exchange for equity. So is there any particular advice that you would like to give them? So again, very arguable. say that founders will eventually lose control of company, whether they raise capital or

So as and when an organization grows, you would see that founders are left with less and less things to do and it is very difficult for them to make changes in the organization because an organization or a group of people have a mind of their own. So founders should not go in, whether they raising capital or building a company, they should not go in thinking that I want to maintain...

of this organization, if all goes well and the organization starts growing, there is a very good chance that you will not be able to maintain control. So what you typically want to do, however, if you still want to maintain control of the organization, I would recommend in those cases, you want to raise capital from investors who you know really, really well, who have invested in your industry.

you know, five or six times before, who have seen a couple of exits, who have seen a couple of companies shutting down as well. So you want to raise capital from investors who are experienced in investing in the space that you are operating in. In those cases, you will realize that investors more often than not are significantly more supportive and they want to help take the founder and the company forward. But I would again say that this

this would be an incorrect goal of trying to maintain control of the company because as it is that's not going to happen. That's really good insight I mean. again, one more question to this. Is there any way where platforms can structure equities just to maintain long term strategic control? So in India, as soon as you give away 26 % or more,

to an individual or a group of individual or entities, you lose control. So as soon as a group of people have 26 % in an organization, all of those can get together and then exercise their right of first refusal. So exercise their right of not going ahead or not allowing you as an organization to go ahead. If you end up raising two or three rounds of financing, doesn't matter how you structure

your equity or board or whatever 26 % will be outside with other stakeholders I mean a good way to think about it is even if I have two founders, right? If there is 50 -50 split neither one of those has control in the company So that's already like none invested, right? But there's no way to make sure So here's another way to look at it

If control is extremely important to you, like for whoever on behalf of whom you are asking this question, like if control is really important to you, here's a great way to look at it. While you may not maintain control, you will not be, you can make sure that other people also don't have control. Right? So you can take the company into a limbo. There is nothing that can happen, right? And then so ultimately, but investors don't want to.

So they want to make sure, I mean they only make money in one scenario. So there are 999 other scenarios where they lose money. They only make money when it hits the bullseye and they want to enable the company to get there. Yeah. yes, this foundation journey, we have different ages. Like first they are looking for the seed funding, right? Then after that sometime they are...

looking for the series, series pay funding. So can you just give some brief on which stage we have to look for which type of funding. So these are not technical terms. These are terms that are given by market. So it's like someone is old or someone is young and like I could be young at 40 and I could be old at 35.

So these are relative terms, right? So like age is a technical term. But old or young is not a technical term. That's how I would equate series A, seed and so on and so forth. So as an example, in our previous organization, we raised our seed round and our seed round was 100 ,000. You will see in Silicon Valley, there are people who are raising seed rounds of 5 billion. So again, so typically,

what you see is you have FNF, is your friends and family and then that's followed by SEED, that's followed by ANGELS, that's followed by Series A, B, C and then up to F and then the company goes public. That's the idea journey. However, you might be able to see a company that's like raising somewhere in the middle and so you'll say that they raise the pre -Series A.

Yeah, right. Or there is the bridge round and stuff like that. So more often than not, every funding round has a goal that's attached to it, ideally. Again, you can feel free to do your own thing, but more often than not, these are the goals that are attached to it. So friends and family is to build out an MVP and put out there in the world. Your seed round is to get to your first 10 or 15 customers depending on your ticket size.

your angel round is to get to a PMF, right? So is a product market fit sort of a stage. You raise your series A, once you hit PMF and then now you know that at product market fit, you know that these are the acquisition channel, these are the conversion rates, this is how much I have to invest in the product. So you know all of the ratios within the company and the economics sort of make sense. And then B, C, D, E can happen for whatever reason. So in certain cases, they happen for expanding into new geographies.

In certain cases they happen because they want to have inorganic ways of growth which could be acquisitions. In certain cases they happen because they want to explore a new line of business and stuff like that. So B, C and D there is no rule as such. your friends and family, seed, angel, series A is primarily for your first few years of your journey for you to achieve your product.

Okay, great. Yeah, so it can be possible that I have raised fund for series and then after I want to raise fund for series C, I can skip series B, can it be possible or not? You just call, so like the funding round that happens after series A is called series B. So whatever it is that you do will be called series B. Series B automatically, okay.

we call it series B or you could skip it. mean it's like please B, C is like 50 million, 100 million like that's the range that we are talking about. So at that scale I think you have the money so you can if you have 50 million dollars you can say that I am raising my series Y. it's up to you.

I like how at a point you just mentioned it very philosophically that the more you... if everything goes well, the lesser you will have control over the company. Yeah, yeah, for sure. So that brings me to a question in respect to this. When does one think about raising funds? When do I decide that, when should I raise funds for my company? So if you have a very specific purpose for the funds,

you should start thinking about raising funds right. So, there is, so think of it this way, if there is an experiment that you want to perform or you want to design, but you are not able to do that because you do not have capital, then and it is extremely important for you to do, then you should think about raising capital. So, as an example, you may be in a position where you want to see if you know,

Google Ads and SEO and inbound and doing Pro Max campaigns, all of these can be very viable customer acquisition channels. Then what you want to do is you want to figure out a way to invest like $50 ,000 into those channels, have some very early numbers and then use those numbers to raise like a million dollars so that you can then invest those million into those experiments and see what happens. So as long as you have a very specific

use all those for that capital, you should look at raising capital. So, like the very simplest way of looking at capital is basically it helps you unlock value with as little labor as possible. If you do not have capital, you have to put in the labor. So, but if you have capital, you can employ labor from other people. So, capital is just

acceleration of unlocking value and so in companies, your whole central advantage of running the company or growing the company is that once I acquire a customer, they will not go away. So capturing the market is one of the key ways of making sure that there is an entry barrier for another competitor of yours. Then you should raise capital. If you're working on a technology

which requires like, you know, a team of 10 data scientists or something like that. And without that, it's just not going to go from zero to one. Then you should look at raising capital. So yeah. Right. So for us as company, let's say it is in a seed stage and now they are planning to raise. In these cases, are there any practical ways for them to deploy the equity capital so as to make sure that there is a sustainable

if there are any tips that you could share? So I'd say that you want to deploy the capital in a way that you are able to cover parts of your costs. So the first thing that you want to do is you want to deploy the capital in a way such that the revenue that you generate is able to take care of your customer acquisition cost, which includes all of your ads, marketing campaigns and the sales and marketing. And then whatever little capital that you have left,

you want to deploy it in a way that it starts to take care of your fulfillment costs, which is your engineering, your servers and stuff like that. And then whatever capital that you have, you want to deploy it in a way that it starts taking care of your leadership costs. And then it allows you and then it generates such revenue that you are able to run smaller experiments, like after taking care of your customer acquisition, after taking care of your fulfillment, after taking care of your leadership, it gives you some budget to run some experiments also.

At that point of time, you essentially become cash flow positive. So if you stop investing capital, you have become a sustainable SaaS company. You have infinite runway. You can stay alive as long as you want. And then look at profitability over a period of time. So that's how you want to think about it. You to first take care of

customer acquisition and then your fulfillment and then your leadership and then experiments and then profit. Right. in this case, just because there could be some confusion. So I mean, I have some confusion. So in this case, most of the time for appraisers, sounders are keen to build new features to attract more set of users. So building that particular feature would also be considered, should be considered under customer regulation cost itself, right? Because in one way it is going to acquire more customers or

I would vehemently disagree. Sorry for vehemently, but I sort of disagree. So a couple of things to think about. Basically, if you are losing deals, so first is that most SaaS founders at early stages are not losing deals. They are not even getting enough deals to lose them.

So that's one. Second is that if you're losing deals because you don't have a very specific feature, then it's a different thing. But more often than not, if you actually look at all the sales calls that are happening and all the deals that they are losing, the first reason that you will see is that it's also a problem that they don't want it to be fixed. It's not even a big problem. Or they're losing deals because the purchase process is cumbersome.

there are lot of people involved and they are not able to see enough ROI or they will lose deals because the pricing is not clear or the pricing is too high or they lose deals because the prospect doesn't trust the company enough. And then the fifth reason if there is, is because there is a lack of features. You will see in the world out there that there are a lot more inferior products doing significantly better than

other products which are feature rich but don't have any customers. And so the thought process of thinking, the thought process of assuming that more features equals to more value is incorrect. And so I'd say that every ounce of capital or every cent of capital that you have, you want to invest in making sure that you have customer acquisition sort of

set up correctly and that's the distribution is the only differentiating factor. Right? Technology is commodity, we at Momentum can build whatever it is that you want. Whatever it is that you want to build. So yeah, it's a commodity. Great, great. Yeah. So, so just once, once any software have decided, now they are looking for the fundraising, right?

And so first step they need to is to create the pitch depth, right? So that they can go to the investor and they will try for fundraising. So there are any good tips, such like that we have the list of metrics, right? That we have mentioned. So we can add these metrics in the pitch, Is there any additional things that it is a good or it is a better way to add in pitch depth in the deck? So this is one of the major

misconception I would say that so pitch deck is an executive summary of the business. You cannot write an executive summary of a report if you not written the report. pitch deck is like a 10 minute or a 15 minute short summary of what the whole business is. So what you want to do is the first thing that you want to do is you want to have some amount of

quantitative understanding of the market. So you want to look at the market, the size of the market from whatever research reports that you are able to find. Then you want to have qualitative understanding of the market. So by speaking to prospective buyers who if you build the product are going to buy, but asking them questions, understanding what their requirements are, and then sort of document that. So that's the first thing that you want to do. Second thing that you want to do is you want to have deep understanding of your competitors.

and not just like their website and their positioning and the pricing and stuff like that. We also want to look at how are they running their ads, what are their acquisition channels, going and getting demoed by them and looking at what their sales processes like and undergoing all of those things. The third thing that you want to like very genuinely answer is why are you the right people to build this product? Why not someone else?

And so, you need to figure out what are your past experiences that enable you to build this company or to build this product in a more efficient way or a better way. The fourth thing that you want to do is you want to write your financial projections. So, you want to assume certain things, make assumptions and then create a three -year projection. So, if you had a reasonable amount of capital, if you had a reasonable style of

team, then where do you think the company can reach in the next few years? And then you want to take all of that work and then present it as a pitch deck. So pitch deck, we'll typically talk about your problem. How is that problem being solved today? What is your solution? Who are the competitors who are offering similar solutions? You want to talk about the team that is working on this. You want to talk about the size of the market.

about your customer acquisition channels, you want to talk about what, how much revenue will you be able to make over the next few quarters or next few years. So all of that is an executive summary, but you need to have all of these supporting documents because the pitch deck is great and you can send it out and people can read it. But then the outcome of the pitch deck is like, you cannot use the deck to close a deal.

The pitch deck basically leads to another meeting. And that meeting is like a one hour coffee meeting or a two hour discussion at the office in a conference room or something like that. And at that point of time, you cannot just show your 10 minute pitch deck for two hours. They'll want to inquire more and they'll be curious. They'll want to understand more. So you want to have all of those things done as well. I think that's pretty much it.

for today unless we have some, do we have any final thoughts? If not, then that's sort of pretty much it for today. I hope this was helpful. Thank you everyone for joining in on LinkedIn and on YouTube. I hope this was valuable. If you have any questions around equity financing, I've raised a couple of rounds of equity financing for the company. You can write those in comments. Happy to answer those as well.

Thank you. Thank you, everyone, for joining in. Until next time. Yes.

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