Characteristics of the Ideal SaaS Startup

Earlier this week I was talking with an entrepreneur about the ideal characteristics for a SaaS startup. Some characteristics can be identified at ideation and many of the characteristics emerge once the product is in market with customers. As more of the characteristics emerge, they drive how fast the startup grows and ability to raise capital (if desired).

Here are characteristics of the ideal SaaS startup:

  • Product Value – It can’t be repeated enough: every successful SaaS startup either helps the customer make more money in a quantifiable way or runs a function of the business that’s mission critical. Most startups fail and most startups have nice-to-have products.
  • Product Distribution – Getting the product into the hands of customers in a financially justifiable manner is one of the biggest challenges post product/market fit. Ideal go to market is either viral (like Calendly), high volume inside sales (like Terminus), or a combination of inside and enterprise sales (like SalesLoft). The more complicated the sales model, the higher the average order needs to be otherwise the business won’t scale efficiently.
  • Total Addressable Market (TAM) – Ideal startups serve small, fast growing markets that are going to be large (billions) in a few years but are too small currently for big incumbents to care. Tomorrow’s TAM should be dramatically larger than today’s.
  • Gross Margins – As the startup scales, margins should be in the 70% range at a minimum with 80%+ as the long term target. If the margins can’t be in the 70% range long term, the business likely isn’t SaaS.
  • Renewal Rates – Two of the most important metrics for SaaS startups are gross renewal rates (how many customers or dollars renewed in a time period divided by how many were up for renewal) and net renewal rates (how many dollars renewed and expanded in a time period divided by how many were up for renewal). Gross renewal rates should be in the 80% range, at a minimum, and net renewal rate should be above 100%.

The ideal SaaS startup has both great market fundamentals and excellent metrics across key categories. Most startups won’t achieve all the desired characteristics, but the ones that do have the opportunity to create large, enduring companies.

Top 10 Atlanta SaaS Startups on the 2018 Inc. 5000

Every year I enjoy jumping in and reading the Inc. 5000. The 2018 awards just came out and there are a number of excellent Atlanta SaaS startups on the list.

When reading the list, always remember that growing fast becomes much harder with scale (doubling revenue every year is hard!).

Here are the top 10 Atlanta SaaS startups based on growth rate:

Congrats to all the winners! Onward and upward.

3 Initial Studio Concept Ideas

One of the more popular questions about The SaaS Startup Studio is regarding what ideas we’re evaluating for our first studio companies. Great question! Before sharing the ideas, it’s important to note that most people would say wait(!), don’t share the ideas because someone could steal them. Ideas are common, execution is uncommon.

Here are three initial studio concept ideas:

  1. Tax Credit Management Platform
    States issue billions of dollars of tax credits per year that are turned around and sold through brokers at a discount to their value so that a portion can be realized immediately. Take the film tax credit it Georgia. Most companies that get the tax credit don’t pay enough taxes to use it all, so they sell it to other tax payers for 90 cents on the dollar (e.g. you get a $500,000 income tax credit based on expenses but only have $50,000 of state income tax bills, so there’s $450,000 left over to sell to someone else). Imagine a SaaS platform similar to Carta/eShares that keeps track of who has what and also doubles as a marketplace to bypass the middleman so that the seller gets more money and the buyer pays a lower price.
  2. Restaurant Ordering and Delivery Routing Platform
    With the rise of UberEats, Postmates, GrubHub, Caviar, DoorDash, and others, there’s tremendous competition to deliver food. Only, the delivery company owns the relationship leaving the restaurant without knowing their customer. Finally, combine that with delivery marketplaces having unique incentives (e.g. sign up a new customer and get $10), driver availability, and quality control creating an opportunity to route orders to the best delivery platform based on different attributes. Imagine a SaaS platform for online restaurant ordering where the restaurant owns the relationship with the customer (build loyalty!) and then routes the delivery of the order to the best service based on business rules (e.g. if UberEats has the shortest delivery time right now, give them the order).
  3. Human Presence System
    Open workspaces have put increased pressure on conference rooms, meeting rooms, and phone rooms. Combine the increased demand with the age old problems of people scheduling rooms too long, scheduling rooms and then not using them, and not being able to find a room ad hoc. Imagine a SaaS platform that connects to off-the-shelf cameras (e.g. Nest Cam) and uses machine learning to figure out if someone is in the room. Then, it displays a visual layout of the floorplan with open and occupied rooms highlighted and it interfaces with resource management systems like Google Calendar (e.g. if room scheduled for 90+ minutes and no person present after 15 minutes, release the room for someone else to book it and record that person as a no show).

These are three ideas we’re currently considering as well as several more (we have a large Google Sheet of ideas). Remember, ideas are easy — the hard part is executing well, finding product/market fit with a must-have product, and timing the market just right.

If you know a potential Studio Entrepreneur, please let us know as we’d enjoy talking.

The SaaS Startup Studio

One area I’ve been fascinated with is how to systematically start successful startups. I’ve talked to hundreds of successful entrepreneurs and thousands of unsuccessful entrepreneurs in search of patterns, best practices, and any insights into what does and doesn’t work. Even after talking to thousands of people, writing thousands of blogs posts, and reading hundreds of books, I can’t tell what will and won’t work.

What I have seen is characteristics that increase the chance of entrepreneurial success.

Founders full of grit, resourcefulness, and a past full-time entrepreneurial failure are more likely to succeed. The team matters.

Markets that are undergoing change and transformation are more likely to have great opportunities. The disruptive stream matters.

Must-have products that are clearly differentiated and not a nice-to-have are more likely to win. A not-a-meme product matters.

Over the last several years I’ve worked with a number of excellent entrepreneurs to start companies such as PardotRigor, SalesLoft, and Terminus. Some thrive, most fail. Personally, I’ve started many more that have failed than succeeded. Thankfully, the power of SaaS plus bigger markets makes winners cover many losses.

Now, our amazing team is working on a startup studio to systematically start and grow successful startups. We’ll combine past learning with new learnings to start several companies per year and help accelerate the next wave of startups.

Know anyone looking to become a SaaS entrepreneur? We’re hiring entrepreneurs-in-residence (EIRs) to evaluate and build new startups. Please let me know here or on LinkedIn.

When SaaS Valuations Weren’t So Rosy

With Thomasz Tunguz’s recent post The 5 Forces Driving Startup Valuations Today it reminded me that SaaS valuations weren’t always so rosy. Today, the median forward multiple for public SaaS companies is 8.5x (meaning, these companies are valued at 8.5x expected revenues).

10 years ago we were out actively raising money for Pardot after hitting $1M in annual recurring revenue. We met with 29 different venture firms in Atlanta, D.C., Boston, and Silicon Valley. After being turned down several times with the message that the total addressable market for marketing automation was too small (hah!), we had three interested parties that floated valuations and wanted to talk potential term sheets.

By the time of these advanced conversations, we had $1M in trailing twelve months recognized revenue, $1.3M annual run rate, and 300% growth rate. Here were the verbal offers:

  • $500,000 investment at a $2M pre-money valuation
  • $1M investment at a $2.5M pre-money valuation
  • $5M investment at a $7M pre-money valuation

After doing some spreadsheet math it became clear that we were better off not raising money and continuing to go it alone. We decided not to raise money and kindly discontinued conversations with the VCs. If the valuations back then were what they are today, the spreadsheet math would have likely turned out differently.

Know that SaaS valuations have never been better but that we’re in unusually good times — it wasn’t that long ago when they were substantially lower. Still, do what’s best for the business and don’t raise money just because valuations are high.

What else? What are some more thoughts on SaaS valuations?

3 Alternative SaaS Funding Strategies

One of the things I love about startups is that every week I’m learning something new. Naturally, there’s no one way to do things and so entrepreneurs are always trying out different ideas and occasionally sharing them with the world. Earlier this week three different blog posts came out detailing alternative SaaS funding strategies a) Raise one time from angels ($1.3M) and might do more, b) Raise from multiple rounds but smaller amounts ($2.5M) each time depending on the progress of the business, and c) Raise a tremendous amount of money ($700M+) as quickly as possible over multiple rounds. Let’s dive into some of the highlights.

SparkToro Raised a Very Unusual Round of Funding & We’re Open-Sourcing Our Docs

  • “We believe that there’s room for a company that can be successful for its customers, employees, founders, and investors (generally in that order) without demanding a multi-hundred-million or billion-dollar outcome. We spent a lot of time discussing the frustrating binary (succeed on a massive scale or die trying) of the classic tech startup model, and how we might craft a creative structure that would allow for the potential of a huge outcome without forcing an unhealthy growth rate or a destructively impatient approach.”
  • Only raise from non institutional investors so that there’s no timeline
  • Investors initially expected to get their money back via dividends (1x non pref)
  • Keep optionality open to go the venture route but don’t drive towards that

Anatomy of our $5 million seed round

  • “SaaS companies do not require large amounts of capital all at once in order to fund expensive R&D, brand marketing, or giant sales teams. Instead, we require small amounts of capital over an extended period of time, in order to experiment and continuously push harder on the things that work. This is why most SaaS companies today should raise several smaller rounds of funding during their “seed phase” before raising a series A. The ideal funding for a SaaS company looks closer to an IV drip than a shot of adrenaline to the heart. We need more funding sources that understand this.”
  • Most SaaS startups don’t warrant the traditional VC model of go big or go home
  • Raise enough money each round to get to breakeven at another milestone
  • SaaS supports dripping in more modest amounts of capital and still producing great outcomes

Domo IPO | S-1 Breakdown

  • “Domo recently drew down $100M from their credit facility and currently only has ~6 months of cash left with their current burn rate. Given they raised $730M in equity capital from investors and another $100M through their credit facility, it implies they have spent roughly $750M over the past 8 years to reach a little over $100M in ARR, an extraordinary and unprecedented amount of cash burn for a SaaS company.”
  • Last quarter burned $40M to add $8M of new ARR
  • CAC of $430k with avg ACV of $67k
  • Median payback of 98 months

It’s great to see people detailing different funding strategies as there’s room for innovation and new ideas. Figure out what’s best for the business and execute accordingly.

SaaS Winners and Daily Newspapers in the 1980s

After reading Buffett: the making of an American capitalist by Roger Lowenstein I couldn’t help but equate Warren Buffett’s views on daily newspapers in the 1980s with the SaaS winners of today.

After Buffett bought The Buffalo News he was sued by the other daily paper for launching a Sunday edition and initially lost on the grounds that it was anti-competitive (which was patently false). In the trial, a number of statements came out including the idea that owning a daily newspaper with no competitors was like having an exclusive toll bridge that crossed the main river in town. Buffett was focused on businesses that had pricing power such that they could raise prices and continue to thrive even in an inflation-heavy environment (a.k.a. a strong moat!). Eventually, the other daily newspaper in Buffalo went out of business and The Buffalo News generated a tremendous amount of cash for many years until the Internet disrupted it.

SaaS winners demonstrate many of the same characteristics as monopoly daily newspapers in the 1980s. Only, instead of being specific to a geography, they are specific to a market and a segment. People love to comment how marketing automation had many success stories, but it really was a winner per segment at time of market consolidation:

  • Eloqua – enterprise
  • Marketo – mid-market
  • Pardot – low mid-market
  • HubSpot – small business

Just like New York is a market and Buffalo is a segment for daily newspapers, there are hundreds of SaaS markets and thousands of segments that will produce winners. Let’s look at some more comparisons between daily newspapers pre-Internet and SaaS winners:

One question I’ve been asked many times over the years is, “Why can’t Google take 10 software engineers and just copy XYZ product?” The answer, it seems, is the similar to trying to be the number two or three daily newspaper in the 1980s: the scale, expertise, product/market fit, and accumulated brand value was too much for an upstart. Put more simply, the market and segment coalesced around one winner and that momentum steamrolled everyone else. Google took 1,000 software engineers and tried to compete with Facebook as a new social network, only to lose miserably.

Now, in this comparison, one type is a monopoly media provider to consumers and the other type is a business software provider to businesses, but many of the same desirable characteristics that Buffett looks for applies to both. Winning a SaaS market and segment is incredibly valuable, just like monopoly newspapers in the 1980s.