As SaaS founders ourselves, we know how tricky raising capital for your online business can be. Between deciding which funding route to take to develop your MVP and finding investors—there’s a lot to consider.
In this in-depth SaaS funding guide, we break down when the time is right to seek investment, your main sources of funding, the five most common stages of SaaS funding, and how to increase your chances of getting funded the first time round.
So let’s jump right in!
What is SaaS Funding?
SaaS funding is a financing option specifically designed to help companies offering Software as a Service (SaaS). So if your software is bringing in recurring revenue, you'll have access to a range of finance options that are tailored to how you're running your business.
Why is SaaS funding different?
The main difference between SaaS funding and regular business financing options comes down to the nature of SaaS companies. A successful SaaS company generally has a fairly typical trajectory:
1. The initial stage is very cash-intensive, where the company does a lot of R&D and develops the product.
2. The second stage usually consists of attracting and retaining paying users with features and an experience they love.
3. The third stage focuses on maximising revenue by becoming more efficient. A typical SaaS company will generally start to make a profit here.
4. The final stage sees continued growth by entering new markets or making acquisitions, or even by being acquired.
SaaS funding: The right time to apply/raise funds
Most businesses are ready to apply for SaaS funding when they’ve got a clear strategy, evidence that they can bring on repeated revenue at a near-sustainable customer acquisition cost, or have proven product-market fit.
You need resources like staff, legal advice, and marketing to scale—and these resources usually cost more than you think they do. So, getting funding sooner in your company’s journey can help you plan for growth.
SaaS funding: Your Options
Here are the four main types of SaaS funding:
Venture capitalists generally offer access to large sums of money (and growing - according to recent research), but they want understandably want something big in return. That ‘something’ is an equity stake in your business.
Pros of Venture Capital
- Large capital opportunities
- No repayment or interest is required
- Networking and mentorship opportunities
Cons of Venture Capital
- More expectations and pressure from investors
- Your investors own a stake in your company
- Less room for failure and experimentation
Who Venture Capital is best for
Venture capital is typically for start ups that have huge growth potential or for those with a strong track record of recent growth. Basically, Venture Capitalists want to be sure that they can expect much larger pay-outs later on. They will manage a portfolio full of 'bets', and they want as many of those as possible to pay off.
Angel investors are individual investors rather than firms or a fund, and their investment will often come in the form of convertible debt or ownership equity. These are often friends, or networks of high-net worth individuals, who group together to make a seed investment.
Pros of Angel Investments
- No repayment or interest is required
- Networking and mentorship opportunities
Cons of Angel Investments
- High expectations
- You will lose some control over your business (but less than with venture capital, who offers more funding)
- It can take a long time to find a suitable angel investor
Who Angel Investments are for?
Angel investors are ideal for SaaS startups looking for their first investments. They’re most effective when the company’s mission and the angel’s priorities and experience align well. The angel usually has to feel strongly enough about the problem the start up is trying to solve to invest in the
Revenue-based financing asks SaaS companies to share a percentage of their future revenue each month in exchange for investment. You’ll keep paying these monthly payments until the full loan amount has been paid.
Pros of Revenue-based Financing
- No interest
- Payments are tied to how your business is doing
- Retain ownership and control
- Shared alignment towards growth
Cons of Revenue-based Financing
- Proof of predictable future revenue required
- Investment amounts generally aren't more than $5m
- Required monthly fee
Who is Revenue-based Financing for?
Revenue-based financing is perfect for SaaS and companies that have recurring revenue models. Businesses with consistent high monthly recurring revenue and high gross margins are most likely to qualify.
Incubators and Accelerators
Incubators are designed to support the growth of very seed stage start ups. It’s a founder-focused investment type that’s incredibly flexible. Accelerators, meanwhile, are aimed at providing slightly later-stage startups with a platform to scale up. They’re a lot more team-focused and provide fixed-term opportunities.
Pros of Incubators and Accelerators
- Mentorship and training opportunities
- Access to investment (either through the program or via a network of potential investors)
- High credibility
Cons of Incubators and Accelerators
- Hard to get into accelerator or incubator programs
- Mixed quality of programs as more pop up
Who are Incubators and Accelerators best for?
Incubators and accelerators are great funding choices for founders that are just starting up, or more mature start ups that are looking to reach their next stage of growth.
Alternative funding options
Apart from the main four types of funding, there are also a few alternative funding options available to you:
- Crowdfunding: This involves getting others to finance the development of your SaaS product. Popular SaaS crowdfunding platforms include Kickstarter, Indiegogo, and Seedrs.
- Bootstrapping: Here you'll use your own money to get your business going. Going this route usually means that you have another stream of revenue to support your cost of living, you’re using your savings, or you take out a personal loan. The main benefit is that you maintain full ownership of your company and your ideas.
- Contests: While the prize money may not be massive, winning a contest could be the financial injection your SaaS startup needs.
- Government grants: Obtaining a government grant can be an uphill task, but you’re under no obligation to pay it back. Horizon2020 is an example of a grant that SaaS startups could apply for in the EU.
The 5 rounds of SaaS funding
Each step of the SaaS growth journey is different, requiring different types of funding at each stage. Here are the five main SaaS funding stages, including why and when you’ll need investment at each one.
Pre-seed funding helps startups get off the ground. It can help you develop a proof of concept or an MVP version of your software. Many start up founders dip into savings, remortgage homes, or take on second jobs to get this funding. If this isn’t an option for you, then you’ll need to look into pre-seed funding.
Since businesses are in their infancy at this funding stage, venture capitalists or other equity finance sources aren’t usually an option. Founders, therefore, usually turn to friends, family members, or confident, independent investors (angel investors).
Seed funding is what really gets a start up going. Receiving financing at this stage helps turn the ideas behind a SaaS start up into reality. This investment can be used to fund a product launch, research the market, or finance staff hiring to move a firm forward.
Your company will have approximately doubled in valuation from the pre-seed round to be eligible for seed investment. It means you’re already pretty close to having a viable product either launched or ready to launch, but you need an extra cash injection to meet your final goals.
A Series A investment is when your company has already started to generate a profit and is looking to expand. The main goal here is to optimize existing processes further and prepare your company to scale.
By tracking key performance indicators (KPIs), customer numbers, or turnover, you can spot when you may be ready for Series A funding.
Since getting investment at this stage is more competitive, you’re going to need to put in a considerable amount of work in developing your business model to be eligible for this funding. It requires you to show evidence of a business model that can sustain cashflows in the future.
A great idea and a few early adopters won’t cut it, unfortunately.
Series B investments are for businesses that have captured a significant user base and bring in high monthly revenues. Investments of $20 million+ are there to help you grow to meet levels of demand in current and new market segments.
Most founders consider Series B funding when your fundamental KPIs are promising and your monetization strategy has proven to be strong. These investors are very similar to the previous round, and most successful Series B funding rounds see original backers add more cash, along with new joiners.
Series C start-ups have already achieved significant scale and are on a journey to higher growth. The size of investments grows significantly in this round—hovering around $50 million on average.
By this point, your company will likely be worth around $100 million, which means you’re no longer a risky proposition. As such, private equity firms, hedge funds, and investment banks often get involved in Series C rounds.
Increase your chances of SaaS funding success
Getting funding for your SaaS business is never a sure thing, but it helps to be prepared.
Choose the right funding option
Choosing the right option depends on where you are in your business growth, what you need funding for, how much finance you need, your current assets, and the level of risk you’re willing to take on.
Going with the wrong funding option can result in getting too little money and needing further investment rounds, which can damage your credibility and - even worse - waste your time. Or it can mean getting too much funding and then out-pricing future funders.
What VCs look for
While it’s important to know what to look for in investors, you also need to understand what investors look for in your company. In most cases, it comes down to attractive metrics.
Here are a few critical factors that VCs look for:
- MRR growth: the net increase or decrease in monthly recurring revenue from one month to the next. You want a positive growth rate.
- Churn rate: the number of customers who leave your service over a given time frame. The lower, the better—ideally 1% or lower.
- Average revenue per user (ARPU): indicates how much the whole of your customer base is bringing in to you on average.
- Customer acquisition cost (CAC): the cost related to acquiring a new customer. Having a solid grasp of your CAC costs is vital for later funding rounds.
The more prepared you are, the better
SaaS funding is there to get your business through each stage of the growth journey—from getting it off the ground through product launch and mass-market expansion. Each funding option can make sense for you at different times, so prepare to call on a range of funding types as your business grows!
Lastly, remember that no matter which route you go, do not underestimate the amount of work you will need to put in when you are trying to raise funds. Getting funding can be a lengthy and time-consuming process—so be prepared to take some time out of growing your business to make it happen!