Last year Clement Vouillon of Point Nine Capital wrote an article entitled The Rise of the Non “VC compatible” SaaS Companies. It made the rounds in tech circles online. And it expressed a growing sentiment in the world of SaaS start-ups; for the majority of SaaS founders the traditional VC model is a clusterfuck that makes very little sense.
Fast forward 18 months, and the article looks downright prophetic.
In recent months some of the most well known names in tech have announced that they’ve decided to buy out their investors. First it was Wistia, followed shortly thereafter by Buffer; both buyouts a sort of declaration of independence that gave both companies back the ability to build their businesses on their own terms.
Rand Fishkin of Moz poured his heart and frustrations into his book Lost and Founder, then began building SparkToro taking a drastically different approach than he did in building Moz. Investment funds like Indie.VC have turned from a little known “isn’t it cute what they’re doing” blip on your Twitter feed to a highly regarded fund with an extremely passionate following.
If you’re reading this post, this probably isn’t news to you.
I’ll be the first to admit that all of the above resonates with me - I think more companies looking to stay independent and operate on their own terms is, generally, a good thing. But that said, the dialogue around the “VC compatibility” issue has quickly become very much divisive and polarizing.
Venture capital is not inherently bad or the manifestation of greed and commitments to impossible-to-deliver growth. And the companies choosing the independent path are not all hipster led lifestyle businesses choosing nobility over bankroll and operating with a chip on their shoulders.
The fact of the matter is there are countless ways that you can choose to build your business, and even amongst this new flock of independent SaaS companies there are significant, deliberate differences in the approaches these companies have taken.
This post will look at two more established companies - Wistia and Buffer - and two newer start-ups - Outseta (my start-up) and SparkToro - taking a closer look at the pros and cons of the unique decisions each company has made on their road to independent growth.
TWO ESTABLISHED COMPANIES CHANGE COURSE
Don't fret, we just bought out our investors and took on some debt
$650,000 from angel investors in 2008
$775,000 from angel investors in 2010
$17.3M in debt from Accel-KKR in November 2017
Wistia, a Cambridge, MA based video hosting company, made waves throughout the SaaS world this July when they formally announced that they had taken on $17.3M in debt to buy out their investors.
The company had for a few years prior followed a growth-first path, hiring aggressively and prioritizing projects designed to make an immediate impact on their growth rate. This newfound focus created cultural issues within the company, saw the company’s monthly burn rate dramatically increase, and did little to accelerate growth. At the end of the day, “We broke pretty much everything,” says CEO Chris Savage. Perhaps worse yet, long tenured employees of the company began leaving, saying the new focus on growth “didn’t feel Wistia.”
Wistia is certainly not the first tech company to suffer from over-scaling, but their story is both unique and illuminating for a number of reasons.
First, Wistia had for years taken a long-term approach to growth. They had built a highly profitable business that was generally adored by its customers. They had been very deliberate about not raising too much money, and to date the company has only raised a total of $1.4M. Their first round of Angel investment in 2008 had not been a round for the sake of raising a round, or funds really even earmarked to invest heavily in growth. Founders Chris Savage and Brendan Schwartz only raised money when after two years, “we admitted to ourselves we needed some help from folks with more experience than us.”
Despite taking this carefully considered, only-what-we-need approach to growth they began hearing advice and a narrative that you’d be hard-pressed to find anywhere outside of the traditional Silicon Valley tech bubble.
“As we grew the company and began sharing our story, we kept hearing the same counterintuitive advice from other entrepreneurs — Wistia was too profitable. We weren’t spending enough on growth, thereby limiting our opportunity.”
While I’m all for reinvesting in growth, it’s hard not to chuckle when you hear that a business is too profitable. In a for-profit business, isn’t making profit the objective? The idea of temporarily jacking up your annual growth rates so you can sell your business at a high valuation multiple is really a much more sideways approach to growth if you take off your tech blinders for a minute and use your head.
But after a few years of more aggressively chasing growth and realizing that they were no longer having much fun, Wistia’s Founders decided something had to change. If they were to get back to growing Wistia on their own terms, some serious challenges lay ahead.
They needed to provide a return to their angel investors
They needed to provide return to their employees
With no intention of selling their business, they needed to replace their stock option plan
They didn’t have enough cash on hand to buy back stock, so they had to raise money
They had to raise debt which increased their ownership in Wistia, but also their risk
The solution to the problem that gave Wistia back the right to grow on their own terms came in the form of taking on $17.3M in debt from Accel-KKR in November 2017, an enormously difficult decision that has since been generally and rightly lauded in tech circles.
“We felt confident that the profitability constraints the debt imposed would be healthy for the business. Spending or hiring ahead of budget to try to juice growth weren’t options in this model and we’d be forced to grow the way we wanted to: sustainably, with a focus on creative, long-term solutions for our customers and team,” said Savage.
As one of Wistia’s very early customers, I watched the company grow up from afar and had heard bits and pieces of this story from those both inside and outside of the company. But as I reflect on this story, there’s three things that stick out in my mind that I admire.
Wistia’s Founders made the decision to take on debt after they received an offer to sell their company outright. It was a large enough sum of money to change their lives, and their family’s lives, forever. Not many people choose to walk away from a pot of gold. Especially when you’re taking on $17.3M of debt in a business with an annual run rate of $32M.
In raising debt, the company chose to provide a return to both their investors and their employees. It was the right thing to do, but this is exceedingly rare.
Ultimately one of the major reasons Wistia chose to raise debt was so that they could get back to taking long-term, creative risks that had been hadn’t been prioritized when they were pursuing growth more aggressively. While taking creative risks may not be what’s most important to your tech company, it’s one of Wistia’s four core values and is deeply important to them. I applaud them for “knowing thyself” and serving their values above all else.
Curious how he felt reflecting on the decision to raise angel money - a decision that ultimately resulted in Wistia needing to take on $17M in debt - I asked Wistia Co-founder and CTO Brendan Schwartz if he’d do anything differently.
“That money brought us two phenomenal teammates, a really helpful mentor who's still on our board, and lots of connections and help from investors. I'm quite confident we would not be as successful without raising that money initially,” said Schwartz. “The only thing I think we would have done differently in retrospect would be to structure the deal with some kind of payback terms similar to what Bryce has been doing with Indie.vc. I think that's a great way to preserve optionality - you can pursue the venture track or you can aim for profitability, pay back your investors, and maintain full control over your business.”
$120,000 through AngelPad start-up accelerator in August 2011
$330,000 seed round in December 2011
$3.5M series A round in December 2014 (60% was from Collaborative Fund)
Bought out main series A investors (representing $2.3M of $3.5M raised) in July 2018
Just a few short months after Wistia’s announcement another household name in tech circles, Buffer, announced that they were also buying out their investors. While they didn’t need to take on any debt to buy out their investors - let alone $17.3M worth - their story is uniquely turbulent in a number of ways.
Buffer began as very much a darling child of the tech world - they had everything going for them. After raising a total of $450,000 in 2011, Buffer would raise a Series A round of $3.5M in 2014 - 60% of which came from Collaborative Fund.
Buffer was so hot at the time - revenues were growing 150% per year - that the terms they got for their Series A were insanely good. They were doing $4.6M of revenue at the time and the business was valued at $60M - a valuation multiple of 13x revenues. The $3.5M they raised only required them giving up a 6.2% equity stake in the company… and no board seat. The company even took $2.5M of the $3.5M and paid it out to the Founders and early team members.
Without question, Buffer was flying high.
After the Series A, Buffer fell into a similar trap to Wistia - they hired too quickly, specifically to accelerate product development. Shortly thereafter Co-founder and CEO Joel Gascoigne and team had to make the tough decision to layoff a number of Buffer employees to regain financial control of the business. Morale took one on the chin.
Shaken by this experience and unwilling to compromise on many aspects of his company’s unique culture (open salaries, fully-remote team) that he viewed as Buffer’s secret sauce, Joel began articulating a vision for the company that accepted a slower, more deliberate growth rate. This vision was not aligned with his investors, or his Co-founder and CTO, both of whom would leave the company.
As tensions with his Series A investors increased, the fine print on the Series A term sheet surfaced some additional challenges if Buffer sought to control its own growth trajectory.
They needed to provide a return to their investors
They had to layoff employees after hiring too aggressively
They could not provide liquidity to employees or seed investors without majority support from Series A investors. They had to buy them out first.
Their Series A term sheet provided downside protection for Series A investors, who had the right to claim a guaranteed 9% annual interest on their investment at any point 5 years after the initial investment.
Communication soon broke down with Collaborative Fund and Joel found himself in a meeting where he was being asked if he would step down as CEO of Buffer if he could not afford the 9% annual interest his investors were entitled to after 5 years. If Joel was not willing to pursue growth that was in alignment with his investor’s expectations, he could be squeezed out of his company altogether.
Luckily for Buffer, the layoffs and slowed emphasis on growth had helped Joel regain control of the company and start operating profitably again; so much so that he was putting $400,000-$500,000 of profit away in the bank each month. Buffer spent $3.3M - about half of the cash they had in the bank - to buy out their main VC investors (who had kicked in $2.3M of the $3.5M Series A investment). Those that chose not to accept the buyout proved to be comfortable with Joel’s decision to grow the company at a slower, more organic rate moving forward.
While Buffer’s path to independence did not require walking away from a pot of gold and taking on a large amount of debt, the company’s path was both turbulent and admirable in its own right. Laying off employees, watching your relationship with investors who believed in you sour, losing a Co-founder and a CTO, and having it suggested that you might be squeezed out of the company you’ve spent the last 7-8 years of your life building is all agonizing stuff that will keep you up at night.
To make matters worse, when you “had it all” previously these things are even harder for your team and employees to understand. Said Gascoigne, “Whereas in the past we’d had it all and achieved growth alongside creating a unique culture with a fully remote team and high levels of transparency, it now started to feel like we had to choose between those things. It was suggested that some of the fundamentals that I had come to value could be removed to create a productivity environment that would increase the growth rate.”
Another takeaway for me from Buffer’s story is how easy it is for Founders and investors to become misaligned, even when both sides have good intentions. When Buffer set out to raise their Series A, they knew they were raising an “atypical round” in terms of the round’s size, not turning over a board seat, and only giving up a small stake in their company.
Collaborative Fund, who looks to make investments that are “better for the world” and “pushing the world forward,” was open to this structure granted some downside protection. Said Gascoigne, “We shared openly that we may not want to raise further funding, sell the company, or IPO. We were transparent that we wanted to be able to keep questioning the way things are done. Specifically, we communicated that we wanted the option to be able to give a return via distributions, not an exit.”
The point is these conversations were on the table from the get-go and from afar this looks like a situation where neither the Founder nor the investor meant any ill-will or malice. But while stashing away $400,000-$500,000 of profit per month and accepting a slower growth rate made a lot of sense to Joel, it certainly didn’t jive with the expectations of his lead investor; previous conversations had or not.
Ultimately what I appreciate most about Buffer’s story is similar to what I appreciate about Wistia’s.
Buffer chose to pay out $2.5M of the $3.5M they raised in their Series A to their Founders and early team. I applaud the decision to pay out those who were responsible for the company’s early successes and the company’s ability to raise that round in the first place.
While Wistia wasn’t going to sacrifice their ability to take creative risks, Joel wasn’t going to compromise the remote workforce and highly transparent culture that he’d built at Buffer. In fact, he saw these aspects of the company as largely responsible for their successes. I admire his recognition of this part of their culture as a strategic advantage and something that he would absolutely not compromise on.
TWO NEW COMPANIES PLOT THEIR COURSE
Our start-up structures are new and daring, we distribute wealth through profit sharing
Sparktoro, a Seattle based company that’s building a “search engine for audience intelligence,” is a product of Rand Fishkin (formerly Co-founder of Moz) and his Co-founder Casey Henry.
$1.3mm from 35 angel investors in June 2018
When Rand Fishkin made the decision to start building his next company after Moz, he came out of the gates swinging with his book Lost and Founder followed shortly thereafter by a very atypical funding round.
The traditional VC model was not a fit for his new business, and he wasn’t afraid to say it. He’s hell-bent on showing that there are alternative paths for Founders who want to retain the right to grow their company on their terms.
Rand and Casey chose a corporate structure and investment terms that are a departure from the norm - the company is a LLC and can pay dividends to employees and investors when the company does well. The company has the option to pay profits out to investors or choose to invest profits back into the company’s growth. On the surface, this structure looks similar to the deal Basecamp made when they took investment from Amazon.com CEO Jeff Bezos - a no control stake in a LLC that has now returned (via profit sharing) more than 5 times the amount Bezos initially invested.
The structure is also specifically designed to hold the Founders accountable; neither Casey nor Rad can take any profit or raise their salaries above the market average for Seattle until they have returned all invested capital to their investors.
Changes to this structure require that 80%+ of outstanding units (think of these as stock options) vote for the suggested change. If the company is sold, investors get to greater amount between the amount they invested or the worth of their outstanding units.
They wanted the ability to stay independent and profitable vs. seeking an exit or IPO
They wanted the ability pay out invested capital as dividends when the company did well
The Founders had different financial situations and didn’t want to wait to start working on SparkToro full-time
SparkToro’s path is most interesting to me because the decisions they made were very much intentional and deliberate. While Wistia and Buffer had existing investors and lots of success before they were faced with the financial restructuring of their businesses, if they wanted to plot their own independent course their hands were somewhat tied and they had to figure out how to best make that happen. Casey and Rand were starting with a perfectly blank slate.
The first thing that I like about what they did is they made a deliberate effort to highlight their new course in the hopes that others can follow or at least derive some inspiration from the decisions they made. This is evident in their one page term sheet, their investor prospectus, and even their mention of using tools like Carta to distribute units. All of this is helpful fodder and they took the time to make these documents clean, understandable, and generally as useful to others as possible.
But what’s really most interesting to me about SparkToro’s path was that behind the term sheets, financial figures, and equity structures they took the time to share the human element behind some of their decisions.
They could have bootstrapped the business, but they decided not to because that wasn’t an option for Casey’s family or financial situation. Rand had previously funded Moz in the early days via consulting revenue, and was well aware of the hidden costs and tradeoffs that come with bootstrapping.
And let’s face it - between Moz’s success and Rand’s standing in the worlds of marketing and VC-backed technology companies, money wasn’t only available but it was available on their terms. They got a decent valuation with very little traction and were able to add a number of key investors with a vested interest in their business without giving them voting rights.
While this scenario is exceedingly rare, it definitely removes the majority of the drawbacks often associated with raising money. While SparkToro did give up a good amount of equity, the only other real downside in this scenario is adding some complexity around reporting and legal costs earlier on than they might otherwise have. And while their investors don’t have voting rights, they still represent stakeholders that need to be considered in future decision making.
With these realities on the table, I appreciate the deliberately frugal approach and agreements Rand and Casey made regarding how their funding would be spent. By agreeing to take market level salaries and not allowing themselves to raise their salaries or dip into any profits themselves until all capital is returned to their investors, they’re demonstrating self-imposed financial constraints that show investors they’re being responsible and judicious with their investment dollars.
It was also cool to see the one area where they admittedly splurged - high quality health insurance through WTIA. They weren’t afraid to call out their needs in this area or compromise and put their families at risk by skimping on their healthcare until a later stage. Personally, I was not aware of programs like these and while WTIA’s program only serves the state of Washington, this set me on a course to exploring options like this for California residents (where I live).
All of which brings us to my start-up, Outseta, a fully remote team that’s building a suite of software tools specifically for early stage SaaS start-ups. We’ve been in business since late 2016, and since the get-go have been building our own intentionally independent path. Like SparkToro, we also open sourced our operating agreement in the hope that it would be helpful to others considering a similar path.
My Co-founder, Dimitris, also Co-founded Buildium, where we met. Buildium (founded in 2004) was set up as a LLC with a membership units plan to help drive employee retention and deliver financial rewards to employees in the case of a liquidity event. It was certainly one of the few SaaS start-ups I was aware of with this structure at the time. Buildium bootstrapped for its first 8 years, well past $5mm in revenue, before eventually raising money to keep accelerating growth. The path we’ve chosen at Outseta certainly reflects this past experience, but with some notable changes.
We wanted the ability to stay independent permanently and have all employees reap financial benefits when the company does well via profit sharing rather than pursuing an exit that makes a small number of shareholders wealthy
We wanted to to embrace self-management, a structure that rewards autonomy and focuses on rewarding employees for their contributions to the company rather than their positional authority or job title
We knew we’d be bootstrapping against heavily venture-backed competitors in a particularly competitive market
Our founders have very different financial situations, which we knew would predicate us taking a long term approach to building the company
The first thing that I’ll note is that by deliberately choosing to bootstrap in such a competitive market, we knew that we had to take a very long term approach to building Outseta. We have and are continuing to ramp up the amount of time we spend on the company - Dimitris is still involved with Buildium as a board member, and my Co-founder Dave and I both continue to take on some consulting work.
There’s obviously a trade-off here, one that was questioned recently when I was interviewed by Nathan Latka on his podcast. “If you’re so confident in what you’re building, why don’t you go all-in?” he asked. In short, our answer is…
We’re building a product with key functionalities - CRM, subscription billing, and customer communication tools (email, live chat, help desk) - that don’t need to be “validated.” These are established categories and known needs of the companies we serve - there’s no “first mover” advantage in this market and there are already players of all shapes and sizes.
Like Wistia, we think that needing to operate within the constraints of our own profitability is actually a good thing and will keep us financially disciplined.
I would argue that the path we’ve chosen is much more “all-in” than building the company using someone else’s money. We’re putting ourselves, our own time, and our own money on the line.
Perhaps most importantly, I’d say our ability to take this long term approach is only possible because of the relationships our founding team has with one another. I worked with Dimitris for 5 years previously at Buildium, Dave and Dimitris worked together previously at Sapient. In addition to the prior working relationships, there are friendships. While that creates challenges of its own, what it’s meant for us is a high degree of confidence and philosophical alignment in how we want to build Outseta.
Secondarily, it’s really important for us to share Outseta’s financial successes with our team without requiring an exit event. As such, all employees at Outseta are eligible to participate in profit sharing once they’ve been with the company for one year. We also issue membership units (like stock options) to employees and offer a buyback program so that if an employee gets a great opportunity elsewhere they can take it and still cash in on the value of their units. This program pays back employees based on the number of membership units they hold and the valuation of the company, which we calculate as 2X the past year’s revenues.
Finally, as Rand and Casey did it’s worth acknowledging that our founding team has different family and financial situations. This is certainly a potential source of misalignment, but at the same time it’s a reality that’s forced us to consider how we wish to structure and operate Outseta that much more.
Since day one, every hour spent working on Outseta has been tracked and everybody is earning sweat equity in the business commensurate with their time invested in the company. The plan, absolutely, is for us all to go full-time when we have the revenues to support our own salaries.
In the meantime, I have all the “normal” financial challenges that you might expect; I have a mortgage payment each month, school loans to pay off, and a fiance who wants to remodel our bathroom. On top of that, I simply need to “keep the lights on” as well as pay for my own health insurance. All of the above is without question stressful, especially when you look at friends with big-salaried corporate jobs and growing 401ks.
My advice for anyone considering bootstrapping that doesn’t have financial freedom is this; don’t fall into the trap of viewing bootstrapping as this noble endeavor that’s going to impose some short term limitations. Manage your burn rate obsessively, and create a plan to keep yourself financially afloat for 3 or 4 years.
I’m coming up on two years now making about a 50% salary without any benefits. I’m 32 years old and generally healthy, so I opted for a “good enough” health insurance policy that really just provides coverage were anything bad to happen to me health-wise - it costs about $280 month through Covered California.
Bootstrapping for 3 months is very different than bootstrapping for 3 years, so do some soul searching ahead of time to figure out if this is feasible for you.
Wistia and Buffer are two very admirable companies that have done well for themselves already. Outseta and SparkToro are really just getting started. But while all of these companies have made very different decisions to get to where they are today, they all share a common belief - that the right to grow your business at a more organic, deliberate pace can actually be one of the biggest advantages to long term revenue growth that’s out there.
If you’re considering a similar path I hope this provided some inspiration, and I’d love to hear about your company’s path via a comment below.
By Geoff Roberts 9 min read
BJ Lackland is the CEO of Lighter Capital, a Seattle based company that provides revenue based financing to tech start-ups. Lighter Capital typically invests $50,000 to $2mm of growth capital into businesses without taking an equity stake in the company or a board seat.
Geoff Roberts (GR): Thanks for taking the time to chat with us BJ. The funding model that Lighter Capital uses is really interesting and might be a great alternative for our audience of early stage SaaS companies. Why don’t you start by walking us through how revenue based financing works?
BJ Lackland (BJ): Revenue based funding is an alternative to the typical model of angel or venture capital funding that’s so common in tech. This funding model allows companies to raise growth capital without giving up equity or a board seat, so entrepreneurs maintain control of their businesses. Companies agree to pay a percentage of their revenue on a monthly basis until they repay their loan, and the amount that they repay is capped. What this means in practice is if your company has a good month, you repay a little bit more. If your company has a bad month, the payment is less. Typically monthly payments are 2%-8% of monthly recurring revenue, and repayments are capped at 1.35x-2x of the amount invested in the business. Repayment typically occurs over a 3-5 year period.
GR: When I first heard of revenue based financing, an analogy was made to how funding is raised in Hollywood when it comes to making movies. How did the idea come about to leverage this model in the tech sector?
BJ: There a huge need in the tech sector for alternative funding sources. Traditionally, the only growth capital available is equity investments from angels and VCs. But raising VC money is incredibly time-consuming and it’s like strapping a rocket to your back - you’ll either shoot to the moon trying to make investors a 10x return or you’ll blow up halfway.
The vast majority blow up.
That just doesn’t fit a lot of companies and entrepreneurs. Lots are great business people who want to build companies to last. Or they want to put off an equity round until later. Or they don’t have 6 months to spend raising VC money. Either way, there’s a huge opportunity to provide capital that is non-dilutive and yet still aligned with the entrepreneur toward growth.
GR: What problems does this model solve when you consider the typical model of VC/Angel investment that’s been so prevalent in the tech sector?
BJ: This model solves several important problems. To start, the non-dilutive nature of the model means entrepreneurs don’t need to give up an equity stake in their business, or a board seat. The second is we allow companies to spend substantially less time on the fundraising process - this can become a huge distraction to early stage start-ups whose time is better spent building their business. I heard a statistic that it typically take a start-up something like 60 meetings and 40 pitches to raise $500,000 from angels or VC firms. We offer companies seeking funding an easy online application, and the funding process typically takes 3-4 weeks. Last but not least, with this model entrepreneurs don’t need to hit a “home run” or have some sort of liquidity event in order for the investment to be seen as a success. This model works much better for entrepreneurs who are looking to build a sustainable business.
GR: What do you look for in potential investments? What’s the profile of your typical investment?
BJ: There’s really three criteria that we look for in potential investments. The first is a monthly recurring revenue stream of at least $15,000 per month. We’re typically investing in businesses that have anywhere from $200,000 to $10mm in annual revenue. The second is high gross margins - at least above 50%, but more often than not above 80% which is fairly normal in SaaS businesses. Last but not least, we’re looking for an indication of stickiness - products that are providing sustainable value which is evident through low customer churn rates.
GR: My understanding is your decision to invest in any particular company is based more on an algorithm and the financial performance/unit economics of the business than qualitative factors like strength of team, market opportunity, etc. Can you speak to the process you use in deciding whether or not to fund a business?
BJ: You’re completely correct. We’re really looking more at the financial performance of the company, the unit economics, and you know - is the company offering a basic, durable offering for the market? And certainly the management team is a piece - we want to be working with good people and good people are what drive good returns no matter what business you’re in. It’s not nearly as important to have an MBA from Stanford or Harvard; you don’t have to be fraternity brothers with a VC to get funding at all. We do background checks, we want to make sure the entrepreneurs understand their business well, that they can speak articulately about their business, that they have a good financial understanding of what’s going on when operating their business. What’s least important is are they going to go on to be the next Uber? I mean, we just don’t really care. We’re really focused on funding businesses that are solid, that are durable and are going to be around. And they’re able to scale up - one of the reasons we want to see high gross margins is we want to see that if they land a bunch of new customers they can scale this thing up from $2mm to $10mm in the next 4-5 years. If they do, this model makes a lot of sense for the entrepreneur.
GR: What have been some of Lighter’s most successful investments?
BJ: It’s interesting because when you think of successful investments for a VC fund it’s all about what was the multiple and what was the exit and was it a brand name? And we have a couple of those but by our very nature our upside is capped. For us as investors, sometimes the companies that do best with us aren’t exactly household names. The biggest brand name company that we’ve funded is probably Steelbrick. We funded them when it was 5 people, a virtual organization, and they were totally bootstrapped. The original entrepreneur brought in a new and highly experienced CEO, they raised a ton of money, and they ended up selling to Salesforce for $360mm. An incredibly great outcome for them. That’s probably the biggest name we’ve funded because of the big exit. MapAnything is another - they do geolocation on Salesforce and ServiceNow’s platforms and are growing like a weed. They also went on and raised a lot of VC money. But most of the companies we fund are small businesses that are well known in their niche industries.
GR: What involvement does Lighter Capital have with their portfolio companies post investment?
BJ: It really depends on the entrepreneur and what they want. The only thing they need to do is provide us with financial data and handle the payment. We try to make that light as possible, so we have software that attaches to their accounting software package so they can login to our portal and hit a button and do all the reporting. A lot of the businesses have a bookkeeper or a controller do that work. Aside from the reporting, where we are most helpful is planning out their financing, frankly. As opposed to a VC we don’t necessarily need to know the best VP of Sales candidate in healthcare tech in South Carolina. What we know is if you’re doing X million in revenue and have this kind of burn rate and this kind of growth rate, what kind of capital is available to you from which different sources? Whether it’s angels, VCs, banks, and probably how to introduce you to any of those sources. So we can help with strategy, mostly on the capital side. We’re also coming out with some BI tools for entrepreneurs - we’re learning more and more and more about what drives growth. For example, we can say what an acceptable churn rate is for a company with an ASP of $1,000 per year and we can share that information back with the companies so they can benchmark themselves and learn how to grow their businesses.
GR: This all sounds great, and I love the non-dilutive aspect of this model. But what are the disadvantages or downsides of this funding model? What happens with your investments that don’t do well? Who does this model not work well for?
BJ: We’re a creditor, we’re not equity so we get paid first. We’ll take a second position behind a bank, but we’re not equity so we get paid first if the business goes down and is not successful. That’s the legal side but we try to work with the entrepreneurs. The businesses we’re funding don’t have any hard assets so it never makes sense for us to go and try to force a liquidity event - there’s nothing to liquidate. Their real core assets are the fact that they have sticky, high margin revenue streams. And if things don’t go well hopefully they can cut their expenses and survive with a sticky high margin revenue stream and have enough money to keep the business alive and pay us back our principal. If we don’t get the full amount that we’re owed, we have to work with the companies to figure that out and we’re not always going to win. That’s the reason we have a large and diversified portfolio. We fund something like 10-12 business per month and funded 101 businesses last year. Our goal is instead of having what a VC might have - 10-20 highly concentrated positions - we’ve funded 160 businesses and accept the fact that with some portion of those we’re not going to get repaid.
GR: You spend much of your time with founders of early stage SaaS businesses… what technology related challenges do you see most frequently within these organizations?
BJ: I think the number one thing is finding good developers. That’s a key, and it’s hard in this market and you need to have the capital to do that. One thing that’s cool that you’re doing at Outseta is you’re simplifying a lot of the software offerings that SaaS start-ups need, and that’s going to save them a lot of money. Another thing is getting their product offering good enough to sustain customers. I’m sure you’re familiar with the lean start-up and the notion of minimum viable products, but the majority of our customers are B2B and they just need to get their products to a good enough place where they can not only attract but sustain customers without under serving their needs and having them go elsewhere.
BJ Lackland can be found on Linkedin, or on Twitter @bjlackland.
By Geoff Roberts 8 min read
One of the single best pieces of start-up or SaaS related content that I stumbled across in 2016 was David Cancel and Dave Gerhardt’s Seeking Wisdom podcast when they welcomed Hubspot CRO Mark Roberge to the show. Prior to Outseta I was lucky enough to work at a company where Mark was a board member, so I decided on a whim to tune in. The entire 52 minutes was insightful - I suggest you check it out for yourself - but it was one of the first things out of Mark’s mouth that gave me pause for thought.
Mark described his framework for advising SaaS start-ups as…
Then unit economics
The basic concept he introduces is thinking of each of these as distinct stages in a start-up’s life cycle. Before you do anything else, you need to figure out how to make customers successful with your product. Only then should you turn your attention to the viability of the business model. And only when the business model is healthy should you be concerned with your start-up’s growth rate. You get the idea.
To be honest, this didn’t strike me as a surprising concept or even really a new idea - but it stuck with me because of how simply and concisely it conveyed a framework that made so much sense. There's a heck of a lot of logical thinking and important start-up concepts inherently baked into a framework that's articulated in just seven words. This post serves to unpack and explore the simple beauty of this framework.
It makes good, logical sense that before your start-up is ready to grow you need to figure out how to make customers successful with your product. I think that few people would argue that, but surprisingly few companies actually practice it. Customers are like crack - you get a little taste, and you immediately want more. Lots more. And with most start-ups having limited runway, it makes sense that many founders decide to forge ahead with the intention of figuring out how to make customers successful on the fly as they bring them on. The problem is that rarely happens, especially if customer acquisition begins to take off.
Sam Altman, President of start-up accelerator Y-combinator, shares a similar sentiment in his Start-up Playbook, “Your goal as a startup is to make something users love. If you do that, then you have to figure out how to get a lot more users. But this first part is critical—think about the really successful companies of today. They all started with a product that their early users loved so much they told other people about it. If you fail to do this, you will fail. If you deceive yourself and think your users love your product when they don’t, you will still fail. The startup graveyard is littered with people who thought they could skip this step.”
The value of looking at “customer success” as a stage of growth is really two-fold for me. First, there’s a lot written in marketing circles about “vanity metrics.” I would argue that most companies that are focused on growth before they’ve figured out their recipe for customer success are only achieving “vanity growth.” Inevitably customer churn will become a show stopper.
Additionally, the emphasis on customer success inherently implies “do things that don’t scale” to me. This is a tried and true start-up mantra. Do whatever you need to do to figure out how to make your early customers successful, even if it’s not scalable or profitable. This is perhaps the single biggest competitive advantage that start-ups have over established competitors, and I love that this framework emphasizes it.
As Mark mentions, it’s important that you find some sort of leading indicator of customer success that you truly believe in before you’re ready to leave this stage and focus on unit economics. I think one useful and easy measure of customer success can be simply asking your customers the question, “how disruptive would it be to your business if I took our product away?” No doubt about it, finding the recipe for customer success is the most challenging of the three stages. The best founders are the ones who take a deliberate approach to finding customer success and fight the urge to chase growth prematurely.
Now that you’ve figured out how to make your customers successful with your product, you must turn your attention to the fact that you’re running a business. If it’s costing you $1,000 to acquire a customer with a lifetime value of $1,000, it’s going to be tough to make a living. If you’ve gotten to this stage at all, kudos to you - you’ve found a recipe for making your customers successful; now you just have to figure out how to do it cost effectively.
Challenges at this stage can look very different. Maybe you’ve handheld each and every one of your early customers, with your team spending hours upon hours onboarding each new account. Employee time costs money, and it’s entirely possible that you’ve spent so much time with each early customer that your relationship with them isn’t even close to being a profitable one. Or maybe it’s the efficiency of your lead generation programs that’s to blame - you’re generating some leads that are turning into paying customers, but your average cost per lead is prohibitively high to support any sort of true growth potential.
In an industry obsessed with automation, this is likely the time for automation. This is the time to bring people onto the team with a “growth hacking” mindset. This is the time to be endlessly analytical and obsessed with all of the metrics related to your customer acquisition programs.
Whatever you decide is the indicator that you’ve gotten your unit economics in order; from a particular payback period to a target LTV:CAC ratio, once it’s achieved (and there’s reason to believe it can be sustained)... now you’re really on to something. Now you’re dangerous.
David Skok’s SaaS Metrics 2.0 - A Guide To Measuring And Improving What Matters is a great resource at this stage, including insights from the metrics that fueled the growth of companies like Netsuite, Hubspot, and Constant Contact.
At this point, you’ve found a recipe for making customers successful and your churn rate is healthy. On top of that, your unit economics prove that you’ve found a viable business model - one where you invest money into one end of your customer acquisition machine and a healthy return is spit out at the other end. You have made a real, viable, compelling case for investing in growth.
By the time you reach this stage you should have plenty of options, and doors opening for you left and right. With healthy unit economics, you may choose to reinvest some of your business’ profits back into the company to grow as fast as you can organically. Or maybe this is the point where you want to stake your claim as the leader in your market, and you want to raise that big series A to support that goal. Either way, by following Mark’s framework you’ve put yourself in a position to chase down growth via whichever path suites you best.
The question you now must answer logically becomes “how fast should we try to grow? What growth rate should we be shooting for?” Much has been written on this topic - I had always been told that as a SaaS business starts to scale, showing an annual growth rate of 50%+ for 2-3 years was the path towards an exit with a company valuation of 5x-6x your company’s annual revenue. Brad Feld, Managing Director at Foundry Group, introduced The Rule of 40% for a Healthy SaaS Company. This rule is more for SaaS companies at scale (greater than $50mm in revenue) but it states that a company’s growth rate + profit should add up to 40%. Tom Tunguz of Redpoint Ventures explored the rule of 40% further, finding that for early stage SaaS businesses this metric if often well over 100%. “But for early stage companies, whose metric may exceed 100% or more, founders should focus more on the unit economics (average revenue per customer, cost of customer acquisition, churn rates, contribution margin), which drive the business’s top line and bottom line. Everything else will take care of itself.”
In an early stage SaaS business, if your unit economics are healthy you have an opportunity to step on the gas - but more important than any specific target growth rate is that you choose to grow at a rate that is responsible and that won’t derail your business. David Heinemeier Hansson, CTO and Founder of Basecamp, writes of the many ways that chasing exponential growth can devour and corrupt your company. If you’re lucky enough to work at a business that’s found a recipe for customer success and has healthy unit economics, then of course you should be investing in growth. We all want to grow - but how fast and aggressively you pursue growth is at the end of the day a personal decision that needs to fit you and your business rather than Silicon Valley’s expectations.
More than anything, I think this framework surprised me so much because of how infrequently it’s truly followed. But stop for a moment and think about the alternative. In my head I envision a ship heading slowly towards a whirlpool in the ocean, much like Titanic heading towards an iceberg. Someone is yelling, “turn on the second engine, let’s speed up to 20 knots!” while the whirlpool (churn) looms ahead. If you’re steering the ship, do you really want to accelerate and hope that you make it through the swirling pool of water ahead? Or would you do everything in your power to keep a steady speed, or even slow down if you need to, until the seas ahead are calm?
By Geoff Roberts 10 min read
A couple of weeks ago, we publicly announced a new software start-up that we’re building, Outseta. Our introductory blog post outlined what we’re building, why we’re building it, and how we plan to build our new company. It was the first of hopefully many milestones to come for us.
So naturally I figured I’d use our next blog post to tell you why Outseta is a bad idea... you know, to keep the momentum going and what not.
All joking aside, we’re serious about building an audience of early stage SaaS businesses and founders. My hope is that being abnormally transparent with how we build our own business helps us win some of that audience - so we’re not just going to tell you why Outseta is a great idea, we’re going to highlight the mistakes and miscalculations we make along the way.
Transparency aside, this topic consumed my thinking for the past few months. Even as we uncovered significant pain points for early stage SaaS businesses during idea validation interviews, I had serious reservations about our idea. I asked myself over and over - is this idea “good enough” to commit the next 10 years of my life to? This post will explore each of my reservations, and how I ultimately came to terms with each of my concerns.
First, a bit of the backstory...
In late 2016, Dimitris Georgakopoulos approached me and asked me to work on a new start-up project with him. I had worked with Dimitris previously for 5 years at Buildium, a company he Co-founded. I had a front row seat as Dimitris not only engineered an awesome product, but built a remarkable company. He won my respect on both a professional and personal level in the process. So when Dimitris approached me to work with him again, even before the words came out of his mouth describing what he wanted to build I found the word “Yes” was coming out of mine.
Luckily, I had just enough self awareness to recognize my overzealousness. While Dimitris built a very successful business once before, there’s no guarantee that we’ll be able to do it again. And as we explored the idea for Outseta further, it became very apparent that there would be significant challenges (particularly on the go-to-market side of the business) in building Outseta that we simply didn’t have to face at Buildium.
Given that I’d be responsible for bringing the product to market successfully, I had to consider these challenges carefully. And the more that I considered these reservations in my own head, the more I realized that the last thing Dimitris is going to need around him is a “Yes man,” blindly following his lead as a result of his previous entrepreneurial success. So as we wrapped up our idea validation interviews and circled up as a team to discuss what we’d learned and whether the idea for Outseta was worth tackling, I made it a point to play devil’s advocate. Here are the reservations I shared, and how I ultimately overcame each concern.
Our target market is small
We are very specifically building Outseta for early stage, SaaS businesses. While there’s long term potential to move up market or explore secondary markets, any way you cut it our target market is going to be pretty small. Angellist currently lists around 11,000 SaaS businesses, and most other estimates I’ve found estimate there to be around that number of SaaS businesses globally. To win even 500 or 1000 customers in a market of that size is a challenge for anybody.
Ultimately I overcame this concern by looking at the number of other companies out there that sell explicitly to SaaS businesses, or even early stage SaaS businesses. There are plenty of them that have built significant businesses for themselves, particularly in the subscription billing category. Outseta will contain a subscription billing component, which helped me feel better about the potential to build a business that’s “big enough” to be worthwhile. It’s also helpful that the number of SaaS businesses globally is growing; a trend I think will only continue over the next decade.
On top of that, we’re not out to build a billion dollar company. I don’t want to be a unicorn. (I want to be Tom Brady) Dimitris shared a great article with me that the Founder and CTO of Basecamp, David Heinemeier Hansson, wrote on this topic. Basecamp today is something of a household name in tech and creative circles, yet they remain a company of about 50 employees. They’re not out to build an empire, they’re out to build a killer product that their customers are rabid about. Looking at what other companies selling to the same market had achieved revealed that the market was plenty large enough to support our own interests and desires in building Outseta.
Our customer churn rate will be high
This was by far my biggest concern. Churn kills SaaS businesses.
Knowing that we’d be targeting early stage SaaS start-ups, there was a tough reality to swallow - 90%+ of start-ups fail and go out of business. There’s no way around it, that’s going to be true of our customers. As I thought about this, I had visions of any potential investor interest slinking away and the number of visits to our Angellist profile all but drying up.
I overcame this concern by looking more broadly at the market, as well as how we might eventually go about acquiring customers. No doubt about it, we’ll be going up against an extremely crowded ecosystem of point solutions - an ecosystem that consists of better funded competitors, many of whom also have meaningful brand equity (think Mailchimp, Recurly, etc). There’s just no way we’ll be able to compete effectively with these businesses if we get into an arms war using “traditional” paid customer acquisition strategies. And knowing that 90% of the businesses we do sign-up will eventually fail, we’ll need to find extremely cost effective means of acquiring customers. I’ll outline how we plan to do that in the next section, but I think we can effectively let customers come and go using a very low cost and low touch acquisition process with the successful companies going on to be our power users. There’s no way around it - if you’re selling to start-ups, a huge percentage of them will fail. But even with the failed companies we have an opportunity create a loyal tribe that loves our product and will use us again at their next start-up. And for the companies that do succeed, Outseta will be a particularly “sticky” product as the operational backbone for so many aspects of the company.
Better funded competitors
Competing with better funded competitors is the norm for a start-up, but with a product that will touch categories including subscription billing, CRM, email marketing, support, and reporting we’ll be up against multiple competitors in each of those categories with the financial muscle to effectively squeeze us out (if they were even interested in doing so) of many channels.
I overcame this objection because I think there are a number of ways that we can successfully compete.
I believe we can compete on content quality.
We are singularly focused on SaaS, whereas the majority of the point solutions that represent our competition are not.
Most of our better funded competitors selling point solutions are chasing growth at all costs, and will naturally move up market to sustain growth rates. It will be very difficult for them to sustainably compete on price because of the cannibalization effect on their revenue, especially when we can deliver our product covering the basics across the board for a fraction of the price.
I believe that a single fully integrated product that covers the basic operational needs of an early stage SaaS business is a better solution than a handful of point solutions duct taped together. When there’s a better product/experience/way of doing things, I believe it will eventually win out.
The notion of “Product Qualified Leads” (PQLs) is rather en vogue, but I think it makes good sense for us as an acquisition strategy. There are plenty of low cost ways that we can drive qualified traffic to our website, and with no barrier to entry potential customers can get started using our product without needing to talk to anyone in sales. Plenty of these free users will churn before they ever pay us a penny, but that churn will be tolerable because of low marketing spending and no sales costs associated with signing up these businesses. The most successful users will eventually self select themselves and upgrade to paid plan with minimal (if any) interference from sales.
Start-ups solve for their immediate need
My final reservation was not one that I initially had, but rather one that came out of our idea validation interviews. During these sessions, we asked SaaS founders how they planned to solve a series of problems, including capturing leads online, communicating with prospects and customers, and billing for their services. We also asked about the order in which they would solve those problems. One thing we heard consistently was “we didn’t think about what all of our needs would be early on, we just solved the immediate problem at hand.”
And that made a lot of sense. Most start-ups have limited runway, and don’t have the luxury of planning for the long term. If they need to send an email communication, they sign up for Mailchimp. Need to charge a customer? Maybe they sign up for Recurly or Stripe. Need a CRM? Hubspot CRM is free. Next thing you know, for better or worse, you’ve got a handful of point solutions that you’re trying to integrate.
Also in line with this concern was a ton of feedback, and our own experience, that the integration work and subsequent maintenance associated with so many point solutions only grows over time. This pain tends to be felt more acutely at later stages than it is at day one. The running joke between Dimitris, Dave, and myself became that we’d limited our target market to “early stage Saas businesses, with second-time SaaS founders” - founders who had lived through the integration and maintenance woes that come at later stages and understand the value of solving these problems with a fully integrated solution from day one.
I overcame this objection simply because I don’t expect start-ups to change their behavior - I think they will continue to look to solve their immediate need. But if our product is free to start, is custom built for an early stage SaaS business, and also solves two, three, or four other problems you know you will soon face, it’s definitely a better experience to work with a single vendor than to evaluate and purchase a slew of point solutions. Solve the problem at hand just as you set out to, and you’ll have solutions to your future problems waiting behind the same login credentials whenever you’re ready.
My reservations aside, I have significant reasons to believe
Despite the fact that I had to grapple with several of my initial reservations about Outseta it’s worth noting that I have a lot of reasons to believe that Outseta is a great idea. Chief among them are:
I know Dimitris and Dave will build a world class product. As someone on the go-to-market side of the house, this is the most important box to check off for me when thinking about joining any potential start-up.
I’m sold on one fully integrated solution offering the basic operational functionality SaaS businesses need being a better solution than integrating a handful of point solutions that aren’t custom built for SaaS.
I’m confident we can make low-touch or no-touch customer acquisition work. We signed up 10,000+ new customers while I was at Buildium with an overwhelming majority of them subscribing without ever talking to a salesperson.
I believe Dimitris, Dave, and myself have the trust, long term view, and philosophical alignment we need to work together successfully.
These strengths, coupled with getting a better grasp on my initial reservations, are why I decided to jump into the deep end with Outseta. I’ll explore my reasons to believe and their relative importance further in a subsequent post.
I have always been interested in giving my own start-up a whirl, and one of the reasons I haven’t to date is I’ve shot down many of my own ideas for one reason or another. I am a skeptic, often to a fault. As I initially considered the idea for Outseta, I found myself wearing the skeptic’s hat - small market, intense competition, high churn - woof! But as we dug deeper, I found reasons to overcome these objections. Sometimes ideas that don’t appear to be good ones on the surface end up being the best ones. Sometimes the best ideas haven’t been tackled simply because they’re hard. I suspect that might be true in this case, and a little conviction and stubbornness might just be our recipe for success.