Is there an alternative approach to fund SAAS startups?

May 9th 2018

Should all early-stage business aim to become Unicorns? (Unicorn is a term coined for a startup having a valuation of > $1 billion). A typical Silicon Valley VC assumes 9 out of the 10 businesses they fund would die thus they aim to hit a home run with each investment they make. Are there blind spots in this approach? We do feel so. This approach of hockey stick growth doesn’t work well with many business models which could be built in a more sustainable way with moderate growth. Pushing these businesses to grow explosively results in poorer outcomes. In fact, many such models if built the way they are meant to be can result in a much better outcome for their founders as well as the early backers. Many investors realizing this have started working on alternative models, they even have a name for this — a zebra movement.

SAAS business is more like a flywheel rather than rocket-ship. Flywheels are not as exciting as rocket-ships to watch but they don’t crash- they keep spinning. As we all know, building software from India has its added advantage, India has the right talent and has an affordable infrastructure to build SAAS compared to other geographies. Today, when infrastructure is available on cloud and distribution can be done digitally, a good sweet spot is available to build a SAAS company from India for the world. Not to undermine the burgeoning SME market in India, where software adoption is becoming more important and provides a good opportunity to sell in India.

There are different financial structures which could be used to fund sustainable SAAS businesses like convertible instruments where investors can make revenue linked payment structure capped at 3–4X of their investment with the upside of converting into equity if another funding round happens. This is a win-win structure where investors make decent IRR and founders may choose to not dilute themselves and thus keep their destiny remains in their own hands.

We feel the VC model looking for next billion-dollar startup is broken. A lot of such multi-million-dollar opportunities are missed if you are only focused on the next Unicorn. These businesses require patient capital and don’t want to be pushed towards unsustainable growth. A highly capitalized VC funded business may run the risk of running a negative contribution model for a really long time and this is nothing but a race to the bottom. To give you an example more than 350+ companies entered the grocery delivery business since 2011 in India only a few in single digits have survived ever after raising enormous capital.