If your company has a Software as a Service (SaaS) product or idea, you’re part of an industry that is growing at break-neck speeds. The global SaaS market is valued at approximately $3 trillion dollars, with some business pundits projecting it could reach $10 trillion dollars by 2030. Even with this tremendous industry growth and a bright future, it can be difficult for businesses and individual entrepreneurs to get the financing they need to grow their B2B SaaS companies.
Ensuring you have the cash and financing needed to grow and scale your SaaS startup or existing venture is always top of mind. It’s common for entrepreneurs to initially fund their SaaS product from idea to their minimum viable product (MVP) using their savings, credit cards, lines of credit, mortgages, investments from friends and family, and the list goes on. As your SaaS product gains traction and you need to make further required investments, you will need access to external funds through either equity or debt financing. If your company is pre-revenue or isn’t earning a material level of revenue, it is difficult to get debt financing, and equity financing is the most viable and practical option.
This article will detail what equity financing is, and why your SaaS company will eventually need equity financing to grow. We will also review the different sources and stages of equity financing and common terminology.
Equity Financing 101
Equity financing is when a company sells shares in their company to investors to generate capital to meet its short-term and long-term cash needs. With the sale of equity, the company gets an influx of capital to meet its cash requirements for a defined period.
In exchange for shares in the company, the investor may get seats on the company’s board, a degree of decision-making control, a portion of future profits, or a capital gain when they sell their shares. The shares the company sells will either be common or preferred shares, with equity investors favoring preferred shares in the early stage of a B2B SaaS start-up.
Why Selling Equity to Raise Capital Makes Sense
The thought of selling a portion of their company to help generate cash can be a difficult consideration for a B2B SaaS founder. The founder of B2B SaaS company spent countless hours developing their idea into a SaaS product, slowly earning sweat equity. The initial thought of selling even a small portion of their equity can be unthinkable, however; it’s a sound business decision the vast majority of B2B SaaS companies will make as they grow. “55% of something is better than 100% of nothing” is a popular saying that adequately explains why selling equity in your B2B SaaS company to raise capital makes sense.
As a B2B SaaS company grows and gains traction, it will have burned through a lot of its available capital. The initial capital used is generally personal funds or credit products, as well as investments from friends and family members. Every B2B SaaS company will have a different point in time when it needs to pursue equity financing. However, it’s generally at the point the business can’t move forward in a meaningful way unless it generates more capital. With debt financing from traditional sources like banks difficult to get if the B2B SaaS generates negligible revenue or is pre-revenue, equity financing can be the only option.
In addition to giving capital to the B2B SaaS company in exchange for shares, equity investors can also bring experience and expertise to the leadership of the company. While they give up some company ownership, equity investors and their investments can increase the probability of the B2B SaaS company’s success, and it doesn’t need to repay the funds provided.
Below we highlight the different equity funding stages in order of when they generally occur as a business B2B SaaS grows.
Equity Financing Types and Stages
In this section, we will describe the different equity financing sources and at what stage B2B SaaS companies traditionally seek them out. The equity sources described below are organized under the business stage they are most commonly found. However, it’s important to note that each source of equity financing isn’t strictly available during one stage or the next, and can be used at any stage.
Equity Financing – Seed Stage
The Seed stage is typically when B2B SaaS companies are getting off the ground and aim to raise enough capital to build, test and validate their B2B SaaS product. While investing in seed capital can be risky for investors, they get to purchase equity in the company when it is at its lowest valuation. Below we review the common sources of seed stage equity financing.
Friends and Family
Having friends and family purchase equity in your company is a common way B2B SaaS start-ups raise enough capital to build their MVP and test if there is an adequate market for the product. The advantage of raising capital by selling equity to friends and family is that they are primarily investing in you and not your company. This is to say that it’s less difficult to convince friends and family of the viability of your B2B SaaS product.
Accessing capital from friends and family isn’t limited to selling equity; companies can also borrow funds from these groups. However, the main advantage of equity financing from friends and family compared to receiving loans is that the equity does not need to be repaid.
Angel investors are generally wealthy individuals who invest their capital and time advising seed and early-stage businesses in exchange for equity in the business. Ideally, angel investors have experience and knowledge in the industry and market the B2B SaaS product is targeting. Angel investors are often friends, family, or acquaintances in an entrepreneur’s professional network.
Having an angel investor purchase equity in your B2B SaaS company at this stage provides validation and a vote of confidence that can help the company raise equity financing from more sophisticated investors, such as Venture Capital firms.
Crowdfunding has become a popular method for businesses to generate capital and help generate interest in their company and connect angel investors with companies looking for investments. Equity crowdfunding is when businesses offer to sell small amounts of equity in their company to a large group of investors using an online platform such as Fundable or Fundr. Raising capital through equity crowdfunding is regulated by the Securities and Exchange Commission (SEC), and there are many rules a company must follow to ensure its business is onside with the regulator.
In addition to equity crowdfunding, a business can use two other types of crowdfunding.
Reward, Gift, or Discounted Products Crowdfunding
This is the most common crowdfunding type, and it has become popular over the past 15 years with platforms such as Kickstarter and WeFunder. Investors don’t get shares in the company or a return on their investment; however, they get compensated through rewards, gifts, and discounted products. While the average cash pledge is relatively small, this is offset by the volume of pledges from the “crowd.”
Debt Financing Crowdfunding
Debt crowdfunding is when the “crowd” lends capital to a business with the expectation the loan is repaid with interest. There are different types of debt crowdfunding: peer-to-peer lending, micro-lending for businesses in underserved communities, mini-bonds with short terms between three to five years, and invoice financing based on outstanding accounts receivables.
Equity Financing – Early Stage
As companies progress their B2B SaaS product and business model, and have a clearer path to revenue or grow revenue, it’s time to consider the next stages of equity financing.
At this point, the company needs to have a concrete plan for how it will develop and grow the company. The plan needs to be backed up by information, such as current financials and projections, key performance indicators (KPIs), current and planned reporting, and any external research that further validates the potential for the B2B SaaS product and its market.
Series A Funding Stage
The Series A round is the first round of equity financing after the seed stage. The B2B SaaS company will typically seek out investments interest from multiple Venture Capital (VC) firms, and it’s not uncommon for companies to have investments from multiple VC firms. In exchange for capital, VCs will get shares in the company and seats on the company’s Board, where they can influence and direct the company’s actions.
It can be difficult for early-phase B2B SaaS companies to attract interest and investments from VC funds. Companies will commonly use start-up accelerators or firms like FinStrat Management to connect them with VC firms.
The 2022 median and average Series A funding rounds in the U.S. raised $15 million, and $17 million respectively.
Series B Funding Stage
The Series B round is for B2B SaaS companies that have gained considerable traction, have a material user base, and have a proven business model. The Series B funding will allow the company to scale, expand its market reach, and hire top talent to execute its growth strategy.
In addition to the VC firms involved in the Series A round, the Series B round will typically have new VC firms who often specialize in later-stage equity investments.
The 2022 median and average Series B funding rounds in the U.S. raised $35 million, and $51 million, respectively.
Series C Funding Stage
The Series C round is for companies that are already reasonably successful, and want investments in strategic areas that will help them grow quickly. This funding is commonly used to acquire other companies that allow the B2B SaaS company to grow much faster than if they only grew organically.
Series C round typically involves investments from entities such as private equity funds, hedge funds, and investment banks. While there can be further equity funding rounds, most companies will use Series C as the last round of funding intended to give them the highest valuation prior to an Initial Public Offering (IPO).
The 2022 median and average Series C funding rounds in the U.S. raised $55 million, and $76 million, respectively.
When you’re developing your B2B SaaS product and company, managing the day-to-day finances is a challenge and can become a distraction. Financial solutions and tools can help you get through the business phase you are in. However, chances are you’ll need to revisit these financial solutions and tools when your business enters the next business phase.
At FinStrat Management, we offer a suite of financial solutions customized to the changing needs of your B2B SaaS company as it continues to grow. We provide services to an extensive list of VC-backed companies services, and we can connect you with potential VC investors from our growing list.
Book an introduction call today!