I originally wrote this post way, way back in the first year of SaaStr and have updated it every 2 years or so, because it’s an important thing to think about as a founder. Especially now in 2023, when venture capital again is scarcer, and more expensive, and far harder to close than it was during the go-go times for SaaS of 2021 and late 2020.
Let’s take a look at 3 B2B acquisitions from a few years back as an example.
Let’s first start with the $35m acquisition of TokBox after 11 years and the $220m acquisition of SpringCM after 13 years. I know a little about both companies — and both are good products from good companies that well deserved their acquisition prices or even more:
But the outcomes for the founders after 11 and 13 years are probably tough. Both were sold for about 1.5x the amount raised. 1.5x means everyone makes a little bit of money, but no one really makes enough.
Does this make venture evil or something because these deals probably didn’t make all the founders multi-millionaires? Of course not. Venture capital is risk capital, and the VCs here for the most part also didn’t make much money either. But it’s important to understand how the math works here — and how it figures into how much to raise.
My simple advice when you raise capital: assume you have to return a liquidity event (sale or IPO) of at least 10x the amount you raise for raising venture capital to be worth it.
Valuations change from round to round. Later stage investors will expect lower ROI, seed investors will be looking for a lot more. How do you make sense of it all?
Just Multiply Amount of Venture Capital Raised Times 10. That is What You Must Sell or IPO For — For it All to Really Work Out.
Now take Cisco buying Duo Security for $2.35b? That was about 20x that $120m they’d raised. An incredible outcome:
So my advice: worry less about valuations and venture mechanics, and just stick with this simple math when you decide to raise $X of capital:
- Raise a $1m seed? You’ll need to sell for $10m to make everyone OK. More is better, but less is going to create issues. A $2m seed, you need a $20m+ exit for everyone to be OK. Probably $50m+ for everyone to be happy.
- Raise a $10m Series A? It’s going to have to be at least a $100m sale to get everyone around the table to say good job (or at least just to say yes). Ideally, $200m+.
- Raise $100m? That’s a billion+ IPO you’ve just committed to, sir. As it should be. Don’t raise this much if you aren’t convinced it will take you to $100m+ ARR.
We can stop there, but it gets more helpful to think about the types of potential exits, especially in SaaS.
First, you’ll notice a lot of BigCos. talking about “tuck-in” acquisitions that can attach to existing revenue streams. It makes sense — if you can add something to Office rather than building something in a new segment, it should be pretty high ROI. These “tuck-in” acquisitions though tend to top out at around $100m or so. That’s about all the Big Guys are willing to invest in their old products via M&A. So bear in mind, if you raise more than $10m, you’re probably giving up a good economic outcome in tuck-in opportunity. See, e.g, the TokBox example above. Giving this option up may well be fine, just be aware of it.
What’s between $100m and $1b in acquisition prices? New growth areas. E.g. Salesforce bought Datorama ($800m), Krux ($700m – the SaaStr story here and below), BuddyMedia and Radian6 all for healthy nine-figure sums to build out AI, Analytics and Marketing Cloud respectively in a hurry. These are the same spaces VCs want to invest tons of capital, too, so it’s all synergistic. But where I think you have to be careful is you can raise a lot of capital, but you aren’t really in a new growth area for the BigGuys, even if your ARR is solid. This can happen a lot in SaaS. PE may still buy you, but the M&A offers here are fewer. So be thoughtful about overfunding yourself here.
Which can leave you with nothing but an IPO or bust. Great work if you can get it. But it can be good to have options along the way.
T-Shirt Image from Zazzle here.
If most founders knew that eventually, they’d have to get to $1B in ARR for the math to pencil out
Would they ever raise more than a few million in venture capital at all?
— Jason ✨Be Kind✨ Lemkin (@jasonlk) July 27, 2022