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SaaS Financial Projections: A Breakdown of Investors Expectation

SaaS startups encounter a plethora of challenges in their early stages. Among them is putting together financial projections for potential investors. Although 82 per cent of all startups’ early funding comes from the founders themselves or their friends and families, the remaining 18 per cent have to raise initial funds from angel investors. Often, when startups meet with investors, they’re still in the pre-revenue phase, which makes it difficult to build a well-crafted forecast. That goes for both companies led by experienced founders, and companies led by first-time founders. Fortunately, there are a few metrics which angel investors are usually looking for. As a startup looking for funding, part of the objective is to build a model including those metrics. In this article, we not only identify the metrics; we also specify all the key business elements a SaaS startup needs to focus on to raise funds successfully.

Here Are The Main Things Investors Want To See:

Is there a large-enough opportunity for this product in this market, i.e., $100M+? This is a ‘gating factor’ for many investors or VCs. Your financial projections need to show there is a clear path to building out a $100 million revenue business. Due to the economics of VCs, they need home-run businesses. For that reason, the first thing an investor is going to ask herself is, ‘Do I see a path for this business growing to be $100 million of revenue?’ There are two elements to that opportunity:

1. ‘Is the market large enough?’
2. ‘What portion of the addressable market do I think this particular company I’m evaluating can capture?’

In order to support a $100 million revenue business, you’ll want to (a) have an overall market worth billions of dollars each year, and (b) show why your business can capture a share of that market. In other words, you (the founder) want to see a large, healthy, billion dollar market, and they (the investor) want to see a path for your business capturing $100 million in revenue from this market.

Some Markets Present Bigger Opportunities Than Others

Markets that currently have a high demand for startup businesses include the following:

• Disaster relief: revenue is expected to increase to $11.2 billion in 2022 from $10.1 billion in 2017.
• Alternative-protein foods: revenue is expected to increase 6.8 percent by 2022 from $4.2 billion in 2016.
• eSports: revenue is expected to increase to $1.7 billion in 2020, up from $1.1 billion in 2018.
• Influencer agents: revenue is expected to increase to $10.8 billion by 2022, up 2.2 percent from 2017.
• Beauty tech: revenue is expected to increase to $27.8 billion in 2022, up from $22.1 billion in 2017.
• Women’s reproductive healthcare: in 2015, the U.S. fertility market was valued between $3 billion and $4 billion.
• Canned wine: U.S. sales increased to $32.3 million in 2017, up from $29 million in 2014.
• Elderly care: revenue was $50.7 billion in 2017, and its expected to increase 42 percent by 2022.

These are just a few examples of markets heating up right now, but it highlights how important it is your overall market is not only large, but is also growing. The more prevalent the market, the higher your odds of success are. 

Your Projections Should be Ambitious, But Accurate

In the early stages we’re primarily talking about pre-revenue companies. Therefore, investors are going to take the whole set of financial projections with a grain of salt. Nonetheless, they want to make sure you are aggressive in capturing this opportunity. Make sure you are not showing (in the projections) a fast and seemingly simple way of reaching $100 million in revenue. For example, if you show growth to $100 million of revenue in three years, investors aren’t going to believe it; it’s just not realistic, and – in a way – it shows a lack of understanding what it takes to scale a business. Even though most successful SaaS businesses and startup businesses do not grow to $100 million of revenue in three years, conversely, you don’t want to show a path of growing to $100 million in 15 years either. There’s sort of a sweet spot where investors want to see you achieve this $100 million number. Battery Ventures, a Boston-based private equity and VC firm, has come up with this acronym, T2D3, which means ‘triple twice, double three times.’ It really sums up what most venture investors are looking for. Generally speaking, investors want you to show the business can grow:

• From $1 million to $3 million, or triple the first year;
• Then, triple again, from $3 million to $9 million;
• And then double 3 times, from $9 million to $18 million, $18 million to $36 million, and $36 million to $72 million of revenue.

This represents growing from $1 million to $100 million of revenue in a six-year period, which is how the overall curb appears in the mind of the investor. That said, in terms of what to put in your financial projections, you’ll probably want to put a three-year financial forecast into your model as well as a five-year forecast.

Components To Include in Your Financial Model

In terms of the specific components of your financial model, make sure to include an income statement, balance sheet and cash flow report. On the income statement, which is where most of the attention will be focused, include no more than three lines of revenue. I’ve seen a lot of financial projections with five to seven lines of revenue, but that shows a lack of focus – and perhaps a lack of belief in your core revenue model. You also want to include cost of goods sold (COGS) line items, and achieve 80-90% gross margins. In terms of operating expenses, you don’t want to get too detailed; include somewhere between five and ten lines under operating expenses. This is where you will have items like salary, bonuses and commissions. About 70-80% of your expenses are going to be in headcount. Then, you will want to have line items for sales, marketing, software, traveling and entertainment, some general and administrative (G&A) expenses, and then rent. With roughly a three-year model, you want to show the right growth rate. At this early stage, investors are mostly focused on top-line revenue growth when evaluating the business, and not as much on expenses. Investors are not going to drill too deep into the expenses.

Specific Numbers and Benchmarks to Show Investors

In addition to top-line revenue growth, there’s another important piece of information investors want to see: the efficiency of your revenue acquisition. When you’re thinking about the expense portion and – more specifically – the sales and marketing piece of your operating expenses, it’s important to think about a ratio called ‘the magic number.’ The magic number is the relationship, or ratio, between the sales and marketing expenses or the investment in a particular period relative to the amount of booking in the subsequent period. Generally, investors want to see a magic number of at least 0.75 to 1. For example, let’s say in Q1 of a certain year, you have $100,000 of sales and marketing expenses. In the next quarter, investors would like to see at least $100,000 of bookings. If you have $100,000 of investment in Q1, and then $200,000 of bookings in the next quarter, this would be a magic number of 2. What this all means is bookings are your annual contract value you’ve captured in a particular period. So, a magic number of 1 means your investment in a period will be recouped within a one-year period. A magic number of 2 means a six-month payback period, so it’s the inverse.

Make Sure What You Ask For Matches What You Actually Need

Another important factor to think about is the amount of cash your financial model shows you require aligns with the overall total of what you’re looking to raise from investors. Remember, this is likely a pre-revenue company; what I mean is this: Let’s say you are looking to raise a $1-$3 million initial round of investment, which would be a “pre-seed round” on the West Coast, but it might be a “seed round” on the East Coast. The general expectation is that it will last for ~18 months. In this case, you want to make sure when you look at the cumulative losses for the first 18 months of the business, those do not equate to more than the amount raised because it would indicate you should be raising more (or spending less). And if – conversely – the losses in the first 18 months are only half of the amount raised, the natural question to investors is, “Why are you asking for that amount?” Ultimately, you want to relate whatever amount you’re asking for to the cumulative loss for that first 18-month period. If you do happen to be profitable – some SaaS companies turn a profit in their first year of operating – there’s a handy growth calculator tool online that will at least provide you with a baseline projection for how much funding you may need.

Investors Are More Focused On The Big Picture Than Numbers

Although it’s important you include elements in your financial model indicating your company is capable of generating $100 million of revenue, also keep in mind that investors are looking at your business from a 10,000-foot view, meaning:

1. They are not going to drill into the granular details at this stage
2. They know it’s a very high-level set of projections based off of no operating history, so there’s a huge degree of unknown in this model
3. And, generally, they have a high level approach of evaluating the model

Investors mainly want to make sure you are on the same page and are aggressive about going after the opportunity. They also want to make sure you’re gearing the funds you’re asking from them in a manner appropriate to get you to that $100 million growth trajectory over a reasonable amount of time.

The Importance of Startup Exit Strategy Planning

For angel investors, an exit strategy is a part of their investment process and return. This means that investors will expect to be presented with various risk strategies for their investment. The chronological payout of the investment is something to be planned in detail by SaaS startup. Exit strategies most commonly include:

• Acquisition
• Initial Public Offering (IPO)
• Buyout (Management or Familly)

The exit strategies will depend on the level of control and involvement chosen for every possible scenario of your SaaS startup. 

The 4 Main Takeaways for Presenting Your SaaS Financial Projections

The financial projections you present to angel investors can be boiled down to a few key points:

1. Prove your business is poised for $100 milion of revenue within six years with your income statement, balance sheet and cash flow report
2. Show that you can at least match in revenue what you spend on sales and marketing
3. Ask only for what you need – your number should not be greater than your expected cumulative losses
4. Demonstrate your eagerness to capitalize on the opportunity

By putting together a proposal that aligns with these points, you’ll maximize the odds of receiving the funding you’re requesting. And your business might be on its way to $100 milion of revenue.