SaaS (Software-as-a-Service) is a rapidly expanding model for tech businesses; it is estimated that the market sector will reach nearly $172 billion dollars, globally, by the end of 2022. The SaaS industry has witnessed rapid growth over the past few years with the market’s projected annual growth rate at 18%. In the last year alone, the median value of the top 50 largest SaaS companies increased by 179%. Market leaders such as Salesforce saw an increase in their revenue from $161 billion in January 2020 to $251 billion in September 2021. Another example of recent success; Shopify in early 2020, was valued at $52.1 billion, but today it is valued at over $185 billion – Which equals a growth of 225% in just a 20 month period. Despite all this recent sector success, not all SaaS products are equally popular. For a typical SaaS business to pay back its CAC (customer acquisition costs) within 11 months, it must spend 92% of its first average contract value on sales, in this article we are going to take some time to understand the challenges facing most SaaS businesses and what makes the Software as a Service sector so different from ‘Normal B2B’ industries.
Why are SaaS companies different?
The life cycle of a successful SaaS company has all the hallmarks of a typical business trajectory. As with most startups, SaaS companies experience a very cash-intensive foundational stage, where the company does a lot of R&D and develops its product(s). In the preliminary stages of business, however, there is normally nothing to sell unlike most industries, most companies initially offer beta versions of their final product that are tested by early adopters and small internal groups to work out initial bugs, fixes and improve the product before going to market. As a next step, most SaaS products offer positive incentives for recruiting a wider range of users. This is most evident in marketing campaigns published to social networks such as Facebook & LinkedIn, similarly these social network platforms are only valuable there are a large network of users. This type of ‘positive incentive’ dynamic is now commonplace among all successful SaaS company’s – an example of this is DropBox’ referral rewards that grant more space (gigabytes) in the cloud for any friends that are referred to the service. Normally, as the userbase starts to grow, this is when revenue begins to trickle in, however, building this user base and keeping it is more expensive than generating revenue. This phase is typically the costliest in both B2C and B2B SaaS.
Why is it challenging to grow SaaS businesses?
Research suggests that the number of competitors for SaaS firms starting around 2012 was less than three on average. By the end of 2017, every SaaS startup faced competition from nine other firms competing in the same SaaS market segment. Consider the example of SaaS marketing solutions, the number of products increased from 500 to 8,500 between 2007 and 2017. Being in a highly competitive and saturated market comes with its own disadvantages, more so when you consider that as an SaaS business, your product is often competing with other state-of-the-art technology, so constant investment and advancements in your tech is always needed. To grow the revenue of SaaS businesses, SaaS businesses must hit customer acquisition targets, retain customers, and respond quickly to customer needs. Managing customer satisfaction requires investing significantly in sales teams, marketing managers, and special technical departments. To put it bluntly, scaling a SaaS business is costly and a great deal of funding is needed early in the company’s inception. Depending on how well the software is received by the market, SaaS companies may experience tremendous growth rapidly – This is called ‘Hypergrowth’. SaaS businesses need to expand their cloud storage, bandwidth, and other technical resources on a regular basis to accommodate newly acquired customers without throttling their product and receiving negative feedback. As SaaS have no ‘tangible’ product, constant concessions need to be made to keep the user happy and continue to use your product as their business solution. Such is the constant need to reinvent and advance their product to cater to the needs of the user, a great deal of investment is dedicated to R&D. Such is a SaaS company’s need for constant improvement, government grants are available to SaaS SMEs to advance their tech. If the SaaS company employs under 500 people and have an annual turnover of less than €100 million, the government R&D relief allows companies to claim the following renumeration:
- Deduct an extra 130% of their qualifying costs from their yearly profit, as well as the normal 100% deduction, making a total 230% deduction
- Claim a tax credit if the company is loss making, worth up to 14.5% of the surrender able loss
Which Financing Sources Are Available to SaaS Companies?
Working Capital Loans
A lender, such as ourselves, offer working capital loans to finance a company’s everyday operations. A working capital loan provides capital to businesses looking to make short-term capital expenditures such as payroll, rent, debt servicing, or to finance other activities, such as sales, marketing and R&D which are all key elements for the development of SaaS businesses. SaaS working capital loans are available from £5,000 to over £500,000. You can raise up to 75% of your average monthly turnover and pay it back through small regular repayments over 6 to 12 months. Unlike a traditional loan, Capify’s working capital loan is paid back in exceedingly insignificant amounts regularly; you can choose whether you want that to be every day, Monday – Friday, or every week. The repayments are completely automated, so you do not need to do anything other than spend your funding wisely, giving your SaaS company more budget to spend on growing the userbase and the needs of the business. Many SaaS owners love our regular payments, because they do not have to save a large amount by a fixed date each month and they are able to move funding between necessary elements of the business on an ad-hoc basis. To be Eligible for our Working Capital Loans, you must meet the following criteria:
- Be a Limited Company based in the UK
- Have a trading history over 12 months
- Have a minimum monthly turnover of £10,000
Pros: Flexibility/No spending restrictions
- Working Capital loans allow business owners the flexibility to invest in the areas that they deem necessary. There are no restrictions placed on the allocation of funds by the lender, as long as the funds are used to keep the business operational, and the business is able to pay back the loan – You’re free to grow the business how you please.
Getting funded is easy, allowing you more freedom to allocate capital to the business when necessary
- Fast and easy borrowing is typical of working capital loan providers. Getting a working capital loan can give your business an instant boost in case of any unforeseen circumstances. For example, if something happens that will affect revenue, such as delayed customer payments, you can get back to business as usual by obtaining a working capital loan, allowing you more flexibility to grow the business in lieu of deferred payments.
Retain Ownership & Control
- Business owners do not lose any equity. Working capital loan investors do not take board seats or place difficult financial promises and restrictions on a company. Ownership and control of the company are in the hands of the founders, allowing them to steer towards their business vision without outside interference.
Cons: Short Term
- Working capital loans are short-term financing options. Instead of serving as the primary method of business financing, they are positioned as a supplementary option when the need arises. Businesses need to be sure they will have enough cash to keep your business operating if their line of credit ends, otherwise they risk insolvency.
The loan needs to be repaid
- As with every loan, you are expected to repay on a regular basis – this means budgeting the funds available each month to keep up to date with your repayments.
Revenue-based financing is also known as a merchant cash advance, and involves investors, such as us, injecting growth capital in exchange for a percentage of monthly revenue. This is particularly useful for SaaS companies due to their sticky revenues and strong ability to scale. Pros: If revenue falls, so do the repayments
- As the RBF repayments are based on a percentage of your revenue, should your businesses revenue start to drop for any reason, your repayment obligations drop along with it – allowing your business more time to breathe.
Much cheaper than equity
- When comparing RBF to Venture capital and Angel funding, the latter are two of the most expensive sources of capital if your business is successful. They typically promise more than 20x returns on your initial investment. RBF is a much cheaper alternative to this as you are paying the debt off on a regular basis depending on the amount of revenue you generate regularly.
Access to capital almost immediately
- With Revenue-Based Finance you are not required to pitch your business and its products to venture capitalists for approval, which then might take months or years to secure the deal and release the funding required for your company’s growth. Companies can gain funding in less than four weeks (Typically less than a week with Capify) since RBF investors do not require hyper-growth or large equity exits to provide funding. All that is required for Revenue-Based Finance is evidence of your company’s revenue.
Cons: Need regular revenue to qualify
- Not widely available. For Businesses to qualify for this type of funding, they must have a steady revenue stream. In other words, revenue-based funding is typically restricted to SaaS businesses that already have an established, successful product and client base, which is uncommon for the SaaS industry early in their life cycle.
Revenue commitment/Variable lifespan
- The length of time you take to pay off the total amount will depend on the value of the card transactions which your customers complete. Whilst this is good news should your revenue intermittently decline; this would mean that you would have an outstanding balance for a lengthier period – Extending the commitment you have made to provide a percentage of your turnover.
The term angel investor refers to a person who invests their own money in a small business in exchange for a minority stake. Therefore, angel investors usually take a closer interest in the business, applying their knowledge and expertise to make the business more successful and their stake more valuable. Pros: No ‘Repayments’
- Small-business loans are expected to be repaid regardless of whether the venture succeeds. Angel investors on the other hand, buy a stake in your business. If your company succeeds, both parties’ profit financially. Whereas a failed business isn’t expected to pay back the angel investor.
- Most Angel investors willing to invest in a company are entrepreneurs, well-versed in the knowledge of what typically makes a business successful. As Angel investors would possess a stake in the business they have funded, they are likely to offer incredible insights into what the various areas of the company can be improved to further increase the value of their stake.
Cons: Should the business succeed, the value of their stake in the business will far exceed the initial investment
- As Angel investors buy equity in a company in return for a stake, they are relying on the company to be a success to recoup their initial investment. Five years on from releasing equity in exchange for a small amount of capital it may look like a poor investment when a company sees the amount of earnings that they can no longer claim.
Pitching for funds can be a lengthy process
- A lucrative investment opportunity is obvious to them because of their entrepreneurial background. Finding the right angel investor to offer the necessary experience for the business whilst being able to convince them of your business strategy isn’t a straightforward task. Turnover, projections, revenue and your business plan will all be carefully examined to ensure assure that their business interests and the company’s goals match before funding is released. Following that even more time will elapse whilst the paperwork is required to sign over a percentage of your business.
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Get in touch with one of our friendly team members to learn more about how Capify can assist your SaaS business today. We’re open Monday to Friday, 9.00-5.30pm. Or if you’d rather learn more about find out if you’re eligible, now, please click here.
If your SaaS business needs financing options to continue the growth of the business, or just to inject some prompt cash into areas of the business, then Capify may be able to help. Whether it is to improve cash flow, supply a cash injection to boost working capital or hire fresh staff that are pivotal to the successful operation of your business, it only takes 60 seconds to discover if you are eligible by applying here.