SaaS Founders: Funding Challenges in a $232 B Market

Software-as-a-Service (SaaS) companies provide software to businesses and individual customers. The market is estimated to be worth approximately $197 billion and is set to reach $232 billion by 2024. This growing segment includes verticals such as fintech, security, marketing and human resources.

For most people hearing the term “SaaS” brings to mind tech giants such as Adobe, Salesforce and Microsoft. And yet, much of the industry is made up of small players including startups - by some estimates there are as many as 30,000 startups in the SaaS sector.

As the macroeconomic climate changes, these startups are experiencing increasing difficulty identifying sources of growth capital to survive. This article focuses on these funding challenges, and how founders can use Revenue-Based Financing as an alternative.

Three Key Obstacles

There are three key obstacles which are driving funding challenges for SaaS startups.

1. Changing Customer Behavior

The current macro climate is changing the preferences and expectations of SaaS company customers. The sales cycle for SaaS businesses has lengthened, with tech layoffs leading to many customers buying less “seat” licenses per software. The soaring SaaS growth seen in 2020 and 2021 has mellowed. 

Declining tech company budgets will force SaaS companies and founders to bring more agility, adaptability, and innovation. This is a good time for SaaS founders to invest in customer research and embrace user-centric strategies more pressing than ever, to meet the evolving needs of consumers and maintain a competitive edge in the market.

2. Decreased Access to Venture Dollars

In 2023, startup investments took a noticeable dip. According to Dealroom, in Q3 2023 early stage SaaS companies raised just $3B. This is compared to $9B in Q3 2022, a drop of 67%. Economic instability, disruptions in global trade, and a sluggish IPO market are largely to blame, causing V.C.s to shift their focus towards profitability over rapid growth.

Source: Dealroom.Com

3. Reduced Access to Credit

A series of US bank failures in 2023, have made startup loans more challenging to access too. Venture debt has become increasingly expensive and thereby less accessible for some startups.

The New York Fed signaled a 66% chance of a U.S. recession in the upcoming year. With the U.S. Fed raising interest rates again in July, the highest in 20 years, it has led to a projected GDP growth of just 1% for 2023, with inflation remaining above the 2% goal.

This, coupled with the banking crisis early in the year, has tightened credit conditions, affecting startups' access to loans and credit lines.

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Predictable Revenue - a Golden Ticket for SaaS Startups 

Compared to other startups, SaaS startups have a unique position in the current macroeconomic environment. Their business model gives them the flexibility to access different sources of capital than their peers. Their advantages are:

Recurring Revenue‍

SaaS companies often have a subscription model or other recurring revenue basis. Predictable revenue translates to financial stability. It facilitates better resource planning and allocation. A regular revenue inflow allows SaaS entities to fund growth initiatives, refine their offerings, and cater to client needs.

Asset-light‍

Typically, SaaS company assets are their software IP and technology. They minimize the costs of owning and maintaining physical operational assets. They can operate a financially “lean” business in downturns. Yet, asset-light businesses may be unable to access bank loans, due to not having collateral. 

Ability to access alternative lending‍

Due to their steady revenue model and cost efficiency, SaaS startups have additional financial avenues to secure funds. This can be of benefit when raising money from investors or other funders in a difficult macro climate, compared to startups in other industries.

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Funding Strategies for SaaS Founders in a Challenging Environment

Facing these challenges head-on, there has been a shift towards alternative funding methods, with Revenue-Based Finance (RBF) being a popular choice. 

Revenue-Based Finance is a type of funding where companies receive upfront cash on the basis of their recurring revenue streams. They pay back this amount over a period of time, which can be fixed or flexible. In exchange, companies pay either a fixed fee associated with the funding, or repay a percentage of their monthly revenue up until a “cap.”

SaaS founders are gravitating towards revenue-based funding to remain adaptable in this challenging financial landscape. Right now, they are focusing on three areas:

Extending Runway to Raise‍

Many startups are delaying their next venture capital raise by 3-12 months., This is to avoid a “down-round” where their valuation is lower than it was in a previous fundraising round, due to current macroeconomic conditions. These startups are using other sources of capital such as revenue-based finance, bootstrapping and even loans from other fintechs to extend their runway and cash on hand, until the next raise.

Cost Management

‍Keeping costs in check is crucial in the current economic scenario. Leveraging external support can help SaaS startups extend their financial runway and allocate resources optimally. By focusing on crucial expenses and fine-tuning operations, startups can maintain financial stability.

Market Entry

‍The U.S. remains a large market of customers for SaaS enterprises around the globe to tap. Startups are taking the opportunity to enter new markets in search of new customer bases, and potential niches for growth and development. In particular, Efficient Capital Labs has observed Indian startups focusing on US markets at this time.

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The Benefits of Revenue-Based Financing

Revenue-based financing (RBF) offers a unique funding model customized to a company's revenue stream. It provides several key benefits:

No Equity Dilution‍

Companies retain full ownership and don't have to give away a stake in their business. This allows founders to retain decision-making power and realize the full value of their enterprise upon exit.

Quick Access to Capital

‍The approval process for RBF is typically faster than traditional lending, enabling companies to get the funds they need quickly. While a bank loan can take 3-6 months to access, and the process of raising venture funds might take up to a year, some RBF providers will provide a decision within three days to two weeks.

Transparency

‍RBF tends to be priced at either a fixed fee, or a monthly percentage of revenue up to a cap. This pricing model is more simple and transparent than interest fees on bank loans.

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Partner With Efficient Capital Labs for Growth

The future of startup funding for SaaS companies is bright, with the emergence of alternative financing options. Efficient Capital Labs is at the forefront of this change. ECL is a provider of revenue-based financing for SaaS startups, lending out of its $100 M debt facility. Startups who are looking for a partner to navigate this challenging funding winter can reach out at contact@ecaplabs.com.

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Sources: Statista, TechCrunch, St. Louis Federal Reserve Bank

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