Fundraising discussions with potential investors can be some of the most difficult conversations that a tech startup founder can have. Often the most difficult aspect of that discussion is when it becomes time to calculate startup valuation. Unfortunately, there is no definitive template or well-defined methodology that works in “most” circumstances. Valuing a startup, and specifically formulating a SaaS valuation should become easier for the later funding rounds of your company’s growth journey. In this article we’ll discuss how to maximize your startup valuation at every round and most importantly, your FINAL SaaS company valuation at exit or IPO.
Focus relentlessly on your customer to increase your startup valuation
This may seem simplistic or not a good fit for this discussion. Or maybe it just sounds dumb! Focus on your customer, duh? Of course, focusing on your customer is important! But the fact of the matter is that this is truly what drives valuations, at the end of the day. If you’ve been maniacally focused on customer success from day one, the likelihood of finding product/market fit is greatly enhanced. If you have great product/market fit and a sticky SaaS product with low customer turnover, you are going to like your valuation. Investors won’t be able to resist.
But far too often I see early-stage SaaS and mobile software startups who would rather focus on their cool whiz-bang technology than reach out for feedback from potential prospects. Finding and getting feedback from prospects is HARD WORK, and often you might not like what you hear. That’s exactly why you need to hear it, and the earlier and louder the better. Make this customer mania as your over-arching company cultural driver. Assuming you haven’t badly missed on something important like market size or competitive evaluations – investors likely won’t be able to resist, even at high valuations.
Set reasonable benchmarks – and achieve them
This becomes especially important in the later rounds of funding. Software investors like nothing better than predictability in an investment, given how fraught with uncertainty the tech investment business is. But even early on, before receiving your first investment it can be very helpful to “Say what you’re going to do, and do what you say”. This will establish trust with potential investors that you engage with prior to even your first round of investment. It’s not unusual for prospective investors to “follow” your company for a couple of quarters to get to know the company before committing large sums of money. Get in the habit of meeting your milestones. Achieving these milestones on time and under budget will bring great comfort to prospective investors.
Worry a bit less about % of ownership and a bit more about total SaaS valuation
Many if not most SaaS founders are often focused on maintaining the maximum amount of ownership possible during each round of funding. This focus tends to be exaggerated early on in the life of a tech startup, due to concerns about corporate control. And of course, these things should always be a consideration. It’s important to have a growth and exit plan in mind before you start down the path of selling off part of your SaaS company. Now those plans usually need to be torn up shortly after formulating them, due to the uncertainty of early-stage businesses. This is especially true in the dynamic and competitive SaaS industry. But it’s important to have thought it through, nonetheless.
This planning will give you an idea of how much money you will need to raise or generate to meet each important milestone such as a working prototype, product/market fit, a customer reference list, significant traction, developing a SaaS MVP, achieving reasonable exit size, etc. With an idea of how much money you will need to raise, you can get an idea of how much total dilution to expect (figure 20-30% per round) prior to exit. Working through this exercise, forecast what you expect the revenue/profit metrics to be at your exit point. You can use this process to figure both your projected remaining % of ownership as well as projected valuation at exit (using mature SaaS company multiples as well as SaaS M&A data). If that doesn’t leave you with enough money from your exit to make it worth your while, you need to step back and reconsider the entire plan.
As a general rule of thumb, if you have a product in a large, fast-growing market your situation is likely to be highly competitive. In this case, moving as fast as possible is often very important to success. So it usually makes sense to raise as much money as you can and worry less about dilution. This is the profile of a company reaching a high valuation; here you won’t need to own all that much to become very wealthy. And you may need all that money to actually reach success. If you don’t reach success, it won’t matter how much ownership % you’ve retained.
The other end of the spectrum is a niche SaaS product in a modest-sized vertical market. Here you may not need to move nearly as fast. The ultimate potential value of the company is also usually constrained by the size of the addressable market. In this situation, it may make sense to minimize the amount of outside capital that you raise (or raise none at all in many cases) and retain as much ownership as possible. This enables you to generate an acceptable return on the great investment in time, effort, and money by the company founders.
So there is no one perfect answer for every case here. But as a practical matter, in most cases, if you are successful and create a high SaaS valuation the founders will do plenty well financially.
Get to know your potential investors
Get to know your potential investors personally. Personal familiarity and comfort on both sides build trust. Trust increases valuation. But also before an angel or VC invests, research them heavily by talking to people in their network, understanding how much is left in their fund as well as typical round sizes, and how familiar and well connected they are in your vertical. All of these things can not only increase valuation if you find the right fit but will also increase the level of assistance that they will be able to provide you, past the value of the money itself.
Consider tranches instead of “whole round up front”
Getting the whole round up front ALWAYS sounds like the preferred approach, right? And it may be in many circumstances. But it’s not always the best way to maximize your SaaS company valuation. If you’re confident in meeting your projected milestones, think about agreeing to “earn” your round in tranches which are released to you by meeting milestones. This may be a great way to break an impasse on a startup valuation disagreement with a potential investor. Investors may be more comfortable with the risk associated with a higher valuation by using this logistical approach to funding.
Protect your intellectual property
There is great disagreement about the importance of intellectual property (IP) in the software world in general, as well as when it comes to SaaS company valuation. Even if code isn’t stolen or copied, as a practical matter most software patents can be “coded around”. So what’s the value in that? This is a longer discussion as a topic unto itself. But when considering taking on outside investors or selling a company, this topic takes on outsize importance.
Investors are naturally concerned that the product of the company they are thinking about dropping substantial sums of money into will be “knocked off” or otherwise passed by a competitor. And this CAN and does happen in the software business. From an investor’s perspective, having some reasonable IP protection in the form of software patents provides at least a modicum of comfort with a higher startup valuation. If your SaaS company has created something unique and that you’ve taken steps to protect your advantage, this may at least give a potential competitor pause. So don’t break the bank with your patent attorney But if possible, having some patent protection will at a minimum “check the box” on one potential investor concern.
Drive up your startup valuation by creating an auction for your deal
Every startup striving for a high SaaS valuation should endeavor to get multiple investors interested in their deal. The more, the merrier! Because competition is what really drives up the valuation of a business. To do this, of course, you need to be successful in many of the points discussed above. If you are able to get multiple investors interested, you can essentially run an “auction” for the round (politely, of course!). If you are lucky enough to do this, it’s important to keep in mind that not all investors are created equal. This isn’t a used car transaction. You will need to “live” with your investor as a partner. So it’s not simply a matter of accepting the highest valuation offer; you need to consider both the investor and what they offer holistically. But competition WILL drive up the size of your offer sheets, make no mistake about it. That’s a good thing for you. Potential investors may not like it and will often complain about it, loudly (again, it’s important to be polite). But if your deal is so desirable that you have competition from multiple potential investors, most will live with it and won’t walk away. As long as you don’t get too obnoxious about your position of strength. As Teddy Roosevelt used to say “speak softly and carry a big stick”.
Fundraising is a pretty universal topic in the SaaS and mobile software industry. What’s your take on working the startup valuation question optimally? We’d love to hear your experiences, so post a comment below.
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