A ways back, I met with a sales leader I’ve known for years, and he told me The Most Curious Story. His SaaS CEO asked him to stop selling so much.
“Slow down. You are doing too good of a job,” the CEO said. “We can’t afford it.”
Now … how could this be? Well, it does make sense, when you understand the scenario, a combination of two things:
First, this SaaS company has a mix of freemium customers and sales-driven customers (with higher ACV, lower churn). The freemium ones really have no acquisition costs at this point (the main lead source is mini-brand). The sales-driven customers are very profitable on a CAC basis, since their lead cost is $0, and so the ‘Magic Number’ or CAC/CLTV ratio is very favorable. But … still … the sales team’s commissions consume cash in the very, very short term.
and
Second, this SaaS company had a very tight balance sheet. About $1m in cash for a $5m ARR business.
And here, they just couldn’t safely invest. Because every $10k, $20k, $50k customer they closed … Hooray!! … but … that sales commission, just put them into Danger mode on the balance sheet. Even though in 4 months, they’d be in the Black here … for years to come …
A crying shame, really.
We get that, but what’s the “right” answer? Many of us can’t raise a $50m Series Seed, and many others of us don’t want to get diluted to 0.0001% ownership.
I think in SaaS, and I learned this from an insight from Josh Stein at Threshold (first VC in Box and more) at a board we used to be on together (Talkdesk), what “The Balance Sheet Rule.”
Which is, once you are post-Initial Scale, past $3m-$4m in ARR or so, even if you have 80%+ gross margins and a very efficient sales and marketing engine … once your cash dips below 50% of your ARR … you’ll have stress, and importantly — underinvest.
And this is the worst time to underinvest. Because when you get here, every great hire starts to be accretive (more on that here) — as measured in 12 months or less. But you need enough capital to make these hires and let them pay for themselves in 12 months or less.
There's a moment in time in every SaaS company where money doesn't really matter anymore. You have enough to hit your goals.
And there's a much earlier moment in time where every single dollar matters.
Between the two is the art of investing your balance sheet as a SaaS CEO
— Jason ✨👾SaaStr 2025 is May 13-15✨ Lemkin (@jasonlk) July 24, 2021
I made this mistake myself, with hindsight. I was proud we got cash-flow positive at $4m ARR or so, and shortly thereafter, I figured out the “everyone great is accretive thing” and told all the managers to hire whomever they want. But … I should have gone further. At ~$7m in ARR I think we had about $1.5m in cash on the balance sheet, plus some venture debt. If I’d had $5m+ on the balance sheet, I would have made far, far more investments. At $7m in ARR and cash-flow positive, I didn’t have to worry about failing. But I still had to worry about the costs of making data-driven, well-thought-through, but unproven mistakes.
Now I’ve watched this in action again and again, and Josh Stein is 100% spot-on. Having 100% of your ARR on the balance sheet is a luxury. Do that if you can. But at least, once you’re at Initial Scale, make sure you maintain 50% of your ARR on the balance sheet. It will destress all your investments. Let you really go for it. And let you be OK if the amazing team you’ve hired makes a few more mistakes on the way to $100m in ARR.
As CEO/founder, once you’re at even just $3m or so in ARR, and have a few good VPs on the team … really your #1 job is to empower them. They need enough of a safety net, and enough runway, to do amazing things.
“Slow down, you’re selling too much.” It can happen, at least, as a construct, to anyone. Don’t let it be you.
It’s also a good rule for folks able to bootstrap to scale that are past the point they really need capital per se. If you’ve gotten to, say, $4m ARR, and are growing quickly … why raise any VC money at all? You don’t need to. Atlassian waited. Qualtrics waited. It’s just, you probably don’t have $2m of cash on the balance sheet at $4m in ARR if you’ve bootstrapped. So I’d raise at least enough to fund the growth and hires your team deserves. Or at least, give it a lot of serious thought.
A rough rule, but a good rule:
If you are in growth mode, to hire the team you need, and scale at the rate you want … you need at least half your ARR on your balance sheet
I.e., if you are $6M ARR, you need >=$3m in the bank to invest in hiring, etc.
If you have less, raise
— Jason ✨👾SaaStr 2025 is May 13-15✨ Lemkin (@jasonlk) January 24, 2021
Right now, we’re even flooded with unicorns that can’t meet this test. They raised $100m, but spend almost all of it. And now they don’t have the capital to grow.
Net net, when you raise Series A and later capital, it’s supposed to be for growth, yes. But maybe the ideal way to do it is by using the funds as a buffer. So that you can make those hires you need in advance, not arrears. But not with a goal of … spending it all.
(note: an updated SaaStr Classic post)
This even sort of happens at services businesses of the same scale (lower margins, easier to control). Selling more, and more suddenly is often the last thing we need. And yet, you can’t tell a VP/sales anything.
I bet. There the margins can be so tight, too many commission can probably kill you.
Jason – playing devil’s advocate here, but wouldn’t this be the perfect time to load up debt financing, it’s it’s purely a float / recoup issue?
It is. Debt financing has its limitations … it has to be repaid … but it’s a gift done right in SaaS. If you can get venture debt from SVB/Square 1 at 6% or less interest today, take it 🙂 These deals can be very helpful, but practically speaking are open to a subset of companies, often with material venture backing.
Other interesting alternatives include things like Lighter Capital which will give you say 33% of your ARR in a longish-term loan you repay from cashflow, without convenants, which is pretty cool. For many SaaS companies this is simply a no-brainer.
The key to debt is to take it, but to be able to survive without it. Then it’s low stress. Just use it to reach a little further, make that one or two extra accretive hires. Then debt is the best investment in the world.
If you use it like equity though, then it becomes super risky. Equity is there for the high risk stuff.
When I see these plans I can’t help but ask ‘why not tie commissions to cash flows’? Forget the ‘closed deal’ metric; just pay folks based on the cash they bring in the door, as it comes in. If the sales rep get a year-long contract up-front, great! They can then have their commission up-front, too. If the company has to wait over the course of the year to get paid then maybe the salesperson should too. No?
Yes you can, and in fact, a high % of start-ups that are at say sub-$10m ARR only pash commissions upon receipt of check or credit card — I did myself. This helps. Where it breaks down in the early-days is when you have monthly or quarterly payments. You can’t really make the rep wait, they don’t make enough money, and second, you turn them into your Accounts Receivable departments. You want your closers … closing.
Jake – if the numbers work, do it, but usually you’ll have to get sales guys to front-load annual contracts.. if you’re in enterprise and high dollar, no problem. The best financing of all is sales from the client when it works!
That said, most guys keep a short horizon and mostly seem to eat what they hunt – just my experience.
Jason and Roger – makes total sense. Thanks for your comment!