The Software as a service model (SaaS) has seen explosive growth over the past fifteen years. In 2023 an estimated 30,000 SaaS companies are operating worldwide, and end-user spending on public cloud services is expected to reach nearly $600B this year. I expect these numbers to steadily increase in the coming years.
It’s easy to understand the appeal of the model. SaaS products tend to be simple and affordable for end-users, and SaaS businesses can provide predictable and scalable revenue with the possibility of hypergrowth for entrepreneurs and investors.
The growth of the SaaS model has created a “SaaS gold rush”, with new SaaS startups launching every day.
Many of these startups are understandably eager to raise their first round of equity funds. Raising a good equity round puts a big injection of growth capital into the company all at once and provides an exciting third-party validation of your model. Who doesn’t love cash and bragging rights?
As a consulting CFO to numerous high-growth SaaS startups, I’ve witnessed firsthand the powerful benefits of a well-timed equity round. However, I’ve also observed enough potential pitfalls that I advise new SaaS founders to be cautious about how early they raise equity funding and explore all options for funding the business through its first milestones.
I advise new SaaS founders to be cautious about how early they raise equity funding and explore all options for funding the business through its first milestones.
Consider Professional Services
One effective but often overlooked funding source for early-stage SaaS startups is professional services.
I realize at first this might sound antithetical to scaling a software company, but it isn’t. Many successful SaaS startups began as services companies and only pivoted to a product-based model later. For example:
- Salesforce: Salesforce started as a professional services company in 1999, providing customer relationship management (CRM) consulting services. However, they soon realized the need for a scalable software solution and launched their flagship SaaS product, Salesforce CRM, in 2000.
- Zendesk: Zendesk began as a consulting firm called Trio in 2007, offering professional services related to customer support. They later shifted their focus to developing a SaaS product to address the gaps they observed in existing customer support solutions.
- HubSpot: HubSpot initially started in 2006 as a digital marketing agency called “HubSpot Inbound Marketing.” As they developed expertise in inbound marketing, they recognized the need for an integrated software platform to support their strategies.
Consider the following benefits of deferring your initial equity investment and using services revenue to scale your business:
1. Maximize Your Valuation
You can generally expect a higher valuation on your startup if you wait until you have a developed product, proven product-market fit, and solid customer list before approaching investors. When the time does come for an equity round, you can raise more funds in exchange for a smaller stake than you’d be able to if you had raised funds earlier.
2. Maintain Control
With outside funding comes expectations, like 1) getting the product out the door, 2) recouping ROI, and 3) scaling fast. These are perfectly reasonable expectations for any investor and, ultimately, the goal for many startups. However, taking them on too soon can limit your startup before you’ve had a chance to explore all of your best options for business strategy and product-market fit.
3. Gain Insight
A third significant benefit of starting with a services model is that you can receive valuable feedback on things like features, pricing, and messaging from your market at each step of the way. The key is actively listening to your early customers as you build the product.
I don’t suggest that scaling via the professional services route doesn’t come without its own challenges. The biggest tradeoff is typically speed. Startups that fund development with professional services must manage a careful balance between serving current customers’ needs and long-term product development. This generally means slower progress and a longer time to market.
For most SaaS startups, there will come a time when an equity round makes sense, and delaying it will cost valuable opportunities. It just might not be as early as you think. Watch your data, listen to your customers, and work with your CFO and FP&A expert to know if the time is right.