Our approach to understanding the capital requirement for a seed-stage B2B SaaS company.
We see pitches all of the time with a variety of funding needs ranging from $500k to $5M. Startups are doing new and exciting things, but often the founder and the team do not have a clear idea of exactly how much they need and why they need it. The ask comes from a mix of heuristic, benchmarking seed or series A rounds on the coast, or a model based upon faulty assumptions.
A Closer Look at How B2B SaaS Firm Founders Think
Seed stage initial budgets are varied and no two businesses are exactly alike. They do, however, share one common thread: they will be proven wrong. It’s likely the wise founder already knows this is the case, which is why he or she builds a model based upon assumptions that are backed by fact and logic. Then, after establishing a solid case for the actual cash need, the wise founder asks for slightly more than the model suggests and plans on spending less.
By following this approach, the wise B2B SaaS founder builds optionality into the plan. He or she is no longer locked in by faulty assumptions. And best yet, the B2B SaaS founder does not depend upon customers to onboard at a top-quartile rate and for a bottom-quartile acquisition cost.
The Root Cause of Faulty Numbers for B2B SaaS Founders
Raising capital and budgeting for a startup business isn’t something that many people have a lot of experience with. But the problem is, it is an infrequent activity with significant consequences. Mix this task dynamic with the optimistic characteristic of most B2B SaaS founders and you have the root cause for faulty numbers.
Most of the time the founders are convinced of the conservative nature of their assumptions. In fact, I’ve never heard a business pitch that didn’t highlight the founder’s belief that the numbers are conservative. However, this typically falls on deaf ears for investors. Startup business investors know all too well that all initial models and capital needs analysis are over-optimistic on revenue and far too light on factoring in costs.
A Proven 5-Step Process to a Better Capital Budget
As a B2B SaaS founder, your goal is to create sustainability. All the pillars of your startup business (investors, employees, vendors, and customers) must have a long-term sustainable exchange with you for the organization to be truly sustainable. Likewise, all of the valuations come down to sustainability.
The fact is the more sustainable the organization, the better the valuation. Use these five steps to create a better capital budget for your startup business.
1. Start with Benchmark Metrics
How can a founder design sustainability into the capital request? A wise founder knows that initially, he or she doesn’t know the following:
- What the employees will need in compensation and culture
- What customers will need in value and services
- What the vendors need in terms and in margin
However, a wise investor does know, that the B2B SaaS journey is a well-trodden path and he or she can get averages from tools, like the Keybank SaaS Survey.
The key to picking the right set of benchmarks is to look for a set of comparable companies and then compare those results to the average of all SaaS businesses after filtering for a few key features: contract size, contract term, customer size, company size, and delivery model.
The reason to find some comparable firms is that there are unique dynamics in certain areas of the B2B SaaS space. For instance, a marketplace will have a different concept of customer lifetime value and acquisition cost due to the two-sided nature of the exchange, which is compared to a workflow application.
Similarly, however, the comparison set you will find will likely be larger companies that have ‘succeeded’ in a few key ways. This means they have figured stuff out that the wise founder knows he or she doesn’t know yet. Hence the need to compare those results to the benchmark of average results.
2. Use a Model that is Driven By and Produces KPIs for Comparison
Once the wise founder knows what benchmarks will drive the B2B SaaS startup business, he or she can then set about building a model to see what people and capital capacity are needed to execute on the opportunity.
There are a lot of great options for models. Wise founders will build their own if they have prior experience with such things. If not, they will rely on an expert and save themselves valuable time for more strategic things than fiddling with spreadsheets.
Most likely, either of these approaches will require significant work to get the model in a logical format. This means countless hours of manipulation, array functions, lookups, etc. Another great option is to outsource this task to a team member with that background, hire the team at Foresight, or finds a contract CFO to add input.
In all cases, the model should be flexible, accurate, contain actuals and proforma, monthly, and have annual and quarterly views.
3. Iterate the Assumptions and Benchmarks
Most of the benchmarks for a B2B SaaS startup business have intersecting formulas. This means that if you aren’t constantly checking the benchmarks, you will find that your model has flaws.
For instance, if you might use a decent assumption that your acquisition cost will be 13 months of your gross margin and that your account churn will be 15% while your revenue churn will be -1% due to expansion. These could be very consistent with norms. However, you might not have missed that the expansion revenue (representing approximately 16% of the annual new revenue growth) also carries an acquisition cost (accounts do not expand on their own). This would put you out of conformance with the global metric of sales efficiency (the number of sales and marketing spend to achieve $1 of new annual recurring revenue).
The interrelation of these key startup business metrics requires iteration. And it doesn’t stop once you start fundraising. The iteration cycle is a monthly process!
4. Keep Tight Version Control
The iterative process of building a model produces a ton of versions. You need a mechanism to track version control and ensure that you know what has changed. Have one page on your deck with the financial backup to your figures and make sure the version of the model that produced that output is included as a footnote to the numbers. Separately, you should also keep the model secure and protected for every presented version.
This level of care will pay huge dividends down the line. It also has the side benefit of helping founders meet with the management team and discuss the ways in which employees are or are not hitting the original metrics.
Finally, tracking the versions allows founders to see what the organization has learned as the team executes tasks during identified periods of time.
5. Get Feedback from Experienced Business Owners
Everyone needs a mentor. To find the right mentor, look for a different startup business mentor who is not involved in your business, who has no equity in what you’re doing, who isn’t selling you anything, and who has raised a similar round from a similar source (i.e. angel, friends & family, venture, etc).
Entrepreneurs love mentoring! It is a defining characteristic. Don’t be afraid to reach out, but be careful to make it worth the mentor’s time to advise you. This means being teachable, empathetic, and grateful.
(Acton’s Naïve Networking and Stars and Stepping Stones have some of the best advice I have read for finding and securing a mentor!)
6. Gain A Better Understanding of How to Fund Your Startup Business
As a wise founder yourself, you need to follow this process before asking investors for their hard-earned money. In doing so, you show your knowledge of the market and your resolve to protect the investor’s money.
You don’t need to point out the ways in which your model is “conservative.” Rather, your presentation speaks for itself. You can rely on statistics and on your assumption that your team doesn’t need to operate in the top quartile to succeed, but could be in the bottom quartile and still achieve success!
So, take a closer look. How much cash do you really need?