You’re a SaaS startup looking to raise seed equity from VCs or angels? Read this before you make that call.
I get it, we all like the admiration from other founders at the SaaStr after party. Whisper. “John just raised a $1M seed round from Hunter and Jeff”. Or Mark and Jason, or Leo and Marc — insert any likely or unlikely VC-Seed combo here. “Wow, cool. Awesome.” But the conversation probably dies down when you ask the following questions: Was it a priced round or a convertible? What’s the cap on the convertible? Or what was the valuation? What’s the liqu pref? What’s your current revenue? How much was invested into the company before that?
The details usually remain opaque. But one thing for sure is that SaaS founders have wised up to VCs in their fundraising knowledge. Now, many founders prefer to bootstrap their startup as long as they can and not raise money too early. Or never raise money. It keeps you focused on the product, there is no board hassle, no legal overhead, no pressure to grow faster than you like. Maybe you even realize that your idea is good but not growing fast enough and with $20K MRR and 5% net growth per month you decide to give it a shot and put your project up for sale with a website broker like FE International. Depending on many things, but most importantly their magic, they can probably sell it for anywhere from $500K to $1.2M. That’s a pretty decent cash-out for 1–2 years of work for 2 founders and … no investors. And this is where things turn out very differently for those entrepreneurs that raised equity vs. those that didn’t. The bootstrapped entrepreneurs go home with $250K-$600K each whereas that cool entrepreneur that single-handedly raised the $1M seed round 2 years ago from Hunter and Jeff goes home with …nothing. Because, in the end, that liquidation preference somehow did make sense for the investors. They got their money back. Sure, the entrepreneurs had a good time and spent it all but they couldn’t raise any follow on funding because $20K MRR just wasn’t enough to raise a Series A (I know I’m simplifying a bit here). In addition, they learned what “signaling risk” meant when Jeff said he wouldn’t follow up and every single Series A VC they talked to said “Uh. That’s bad. But, hey I gotta go. I’ll call you next week”.
Point of the story is, if you decide to try your hands on that next idea, maybe take it a bit slower and make sure you reached product market fit not just with your 5 friends who tried the MVP. Bootstrap. Be scrappy. Don’t (over-) hire. And most importantly: Raise non-dilutive financing. Giving equity away is the most expensive financing there is. Because it dilutes your equity. At that stage, each one of the two co-founders go from 50% to 30% in their own company. And your investor gets her money back first when you have to sell for “just” one or two million dollars to that death star in San Jose. Or you get acqui-hired by those other entrepreneurs who had the same idea but had the network to raise a gazillion dollars and you hated/admired [pick preference] them for that.
After a couple years in venture capital I’ve learned a few things but one stands out:
Bootstrapped entrepreneurs rarely go bankrupt from one day to another. But insanely funded companies do.
Remember Zirtual? Burned $5M in no time. In SaaS, you can easily bootstrap a company to $5–20K MRR in revenue and then devote 1 day per week maintaining the service. Highly profitable. Some people call those entrepreneurs Micropreneurs. Build a portfolio of bootstrapped projects. Maybe raise non-dilutive financing for each. A revenue based loan by Lighter Capital is such a non-dilutive option. They’ll give you up to 1/3 of your annualized revenue as a loan and you pay it back as a percentage of your revenue. So if you have a slower month, no problem. Your instalment goes down too. Think about it. Before you sign that term sheet. Worst case, you postpone the equity fundraising for a year and grow from 5 MVP customers to $20K MRR and then raise equity for the first time. You’re in a stronger position. I know the M&A stats. High chance you’ll thank me for that advice in a year from now.
PS: Ever thought about “The Exclusivity Asymmetry”?* VC equity financing by design requires outsized returns. Which means you must devote your time exclusively to the project and therefore to the VC. You don’t get to build a portfolio. But the VC gets to build a portfolio. You’re exclusive with her, but she is not exclusive with you.
* Not the title of a Big Bang Theory episode. But could be.